This is a working document on inflation, as I find more evidence I will likely change my mind on some of these positions.


My approach to understanding inflation is firstly empirical. Models — abstractions that simplify reality in order to explain some feature of it — can be made to say anything, and very frequently abstract away key relationships that actually exist. A good working knowledge of history shows immediately most models are wrong.

Inflation doesn’t effect social wellbeing

Inflation is held by most economists to be socially disruptive and highly undesirable or, stated differently, inflation leads to poor social outcomes.

As I said in the approach I will only give this argument credence if it can be demonstrated empirically that inflation correlates with negative social outcomes. Social outcomes are seldom measured directly (“Society, tell me, how are you?”) but are inferred from indicators. I state this because when I get into arguments about inflation with economists they immediately give me non-empirical, deductive arguments, arguments like ‘people like price stability’, ‘planning is difficult when there is high inflation’ and ‘allocative efficiency is reduced by high levels of inflation’. Now these all may be true, but in order to persuasive they need to be empirically shown.

The big empirically observable indicators of social outcomes from an economic perspective are:

  1. GDP growth,
  2. unemployment and
  3. wage growth.

If those are all good I assume that good social outcomes are being achieved. (I am looking at these indicators rather than more proximate indicators of social wellbeing — life expectancy, educational attainment etc. — because the rise of these indicators is so obviously unrelated to inflation that to consider them would immediately decide the argument in my favour.)

Who measures these indicators? Luckily, the RBA is awesome at research and they measure them. RBA charts are always a pleasure to read, they feel solid and classy, like old oak furniture.

Here is what they show.

There is no pattern there. (Source: The Australian Economy in the 2000s RBA conference, 2011)

This chart shows pretty unequivocally that GDP growth per capita and unemployment levels have nothing to do with inflation. There are doubtlessly many models each demonstrating that there is indeed a connection, but what you believe some model thrown together with from a 2nd year maths course or your lying eyes.

It is very clear inflation has little negative impact on society economically speaking, and indeed it is enormously helpful if you are a battler with a mortgage.

Wage growth is shown in the following chart and again, has no relation to inflation rates.

If you are a battler, inflation is good

Below I have done two cashflows, one under a high inflation environment, and another under a low inflation environment. What it shows is that under a high inflation (and therefore high interest rate) environment you can initially borrow far less on a given income and repayment schedule, but once you borrow it your debt is quickly reduced by the inflation. Obviously everyone else is as limited in how much they can borrow as you are. This means the price of assets that are determined by debt availability like houses actually remain low.

Under low inflation, you have far more borrowing power — debt driven asset prices rise rapidly as you know — and worse you sit under the debt a lot longer since inflation doesn’t help you out.

Cashflow under high inflation:

This is your parents.

Cash flow under low inflation:

This is you.

Stable prices are not real

The main argument given for keeping inflation low is that price stability is a good thing for all. But inflation is a composite measure: it is made up of multiples prices and each one of them moves even if CPI does not. There has been no price stability in your lived experience even though inflation has been low and stable. This lack of price stability has had no impact on your ability to plan and enjoy your life. This chart demonstrates very clearly that massive inflation and deflation over the 10 years to 2014, note this chart is net of CPI.


Given inflation is demonstrably ok, what inevitably happens in these arguments is that the spectre of hyperinflation is raised. The argument is as follows: inflation may be ok, but inflation may lead to hyperinflation and hyperinflation is bad.

Most of the argument is true. Inflation is ok below a certain level (looks like about 10–20%) and no one would argue that hyperinflation is good. But inflation does not lead to hyperinflation naturally. Hyperinflation is always a deliberate policy choice. At some level this is obvious: you cannot have a trillion dollar note without deliberately setting the machine to print one.

The major story about this is Weimar Germany. To understand this hyperinflation you need to understand that the Germans were waging economic and diplomatic war to force the Allies to remove the reparations they had imposed. The French even invaded Germany in 1923 as part of this economic war.

To see that this was a series of deliberate policy choices you can simply browse the wiki.

“From August 1921, Germany began to buy foreign currency with marks at any price.” This was a decision by the German government in response to their political reality. They did not have to buy foreign currency with marks at any price. There were other policy options available to them. They preferred hyperinflation.

“Inflation was exacerbated when workers in the Ruhr went on a general strike and the German government printed more money to continue paying for their passive resistance.” Yes, the German government printed money — not by accident, but by deliberate operation of government and machinery — to achieve a political outcome.

When the German government felt that hyperinflation was not achieving the desired political outcome, they simply stopped it in one day: “On November 16, 1923, the new Rentenmark was introduced to replace the worthless paper marks issued by the Reichsbank. Twelve zeros were cut from prices, and the prices quoted in the new currency remained stable.”

Prices were not sticky upward, or downward, or in any direction. Inflation expectations did not affect anything, and cryptic forward guidance was not required.

More evidence that the hyperinflation was engineered is the complete lack of impact that it had on the economy. The below table is from here. Notice that even in 1922, with major inflation, the economy grew 8%. Of course the economy shrunk in 1923: the French invaded the Ruhr and everyone stopped working. This is the single best way to reduce GDP. In 1924 the Weimar continued its run of highly deliberate, complex, economic policy successes by growing the economy 17% in real terms. Notice also that it was only when the enemies of inflation got into power in 1929 that the economy went down the toilet, and Hitler ascended to power.

In conclusion inflation is good for young people and not so bad for everyone else.

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