What Inflation Is and Isn't

I see too many people get this wrong.

I’m not an economist.

I don’t have any authority to speak of when it comes to financial matters or the state of the economy.

That being said, I know enough economics - really, just econ 101 - to know what inflation is, and perhaps more importantly, what it isn’t.

I’ve seen a lot of people get this wrong, so I want to lay this out as clearly and concisely as I can.

I also want to clarify why ‘greedflation’ is a nonsense word made up by people who don’t understand how markets work.

What Is Inflation?

The classic definition of inflation is:

Inflation is an increase in the general level of prices.

This is true, but not useful. Prices go up and down for a lot of different reasons. Sometimes they all go up, sometimes they all go down. Calling the times when they all go up ‘inflation’ doesn’t tell us much.

A better definition of inflation is:

Inflation is a decrease in the value of money.

The core of the concept is as follows.

Money is fictitious. It’s made up. It’s a magical construct that civilization invented so that we don’t have to figure out how many chickens a cow is worth.

Now, money doesn’t often feel fictitious or made-up, especially when you don’t have enough of it. But that doesn’t change the fact that a dollar is essentially a piece of cotton with some ink on it, and a coin is a bit of metal. Neither is particularly useful to a human being; you can’t eat them, they don’t shelter you from the weather, they’re not good tools for farming or harvesting.

That being said, money is extremely useful in the context of a society where we all want to trade with each other. Barter is fine in limited circumstances, but you can’t build cell phones by bartering for things. A universal store of value allows universal trade.

So on the one hand, we’ve got a bunch of fictitious money. On the other hand, we’ve got everything of actual value in the economy - food, blankets, houses, cell phones, computers, cars, etc.

If there’s X money in the economy, and Y value in the economy, then the prices of everything in the Y will be some fraction of X.

That being said, what’s important to understand is that X and Y are not directly tied together. As in, one of them can get bigger or smaller without the other. The treasury can print more money, without any new value being added to the economy. The economy can create a new product, adding new value, without the treasury minting a dime.

An Example

Talking about X money and Y value is abstract. Let’s operationalize this.

Imagine a society with only 100 dollars in it. Maybe you and a few friends are marooned on a desert island, and there’s only 100 one-dollar bills between all of your wallets.

Now there’s a certain amount of value on this island - maybe there are some coconuts, maybe you were marooned with some supplies.

Either way, we now have a small model economy with $100 of dollars and Y amount of value.

A Brief Digression on Price

As you and your friends trade and figure out how to get by, certain things (e.g. coconuts) become worth a certain amount of money. Maybe one coconut becomes worth one dollar.

This is a price:

A price is a monetary amount assigned to a unit of value.

A price can be set by negotiation (bargaining, haggling) or by “the market” (a company calculating the amount of revenue it needs to generate per item sold, given the costs involved in producing the item).

In every case, there are two forces that balance out to set the price:

• if the price is too high (too much money for a consumer to spend for that amount of value) then no one will buy it

• if the price is too low (too little money to justify the costs of production for that amount of value) then the value won’t be produced

and the actual market price becomes the point where those two forces meet.

Value::Money

So in our model economy on this desert island, let’s say there are coconuts, a bunch of scavenged driftwood, and one book someone brought that wasn’t ruined in the water (Robinson Crusoe, for the irony).

There are four of you in total, and everyone starts off with $25 in one-dollar bills.

Let’s also say that you’re the one who brought the book.

What happens?

Well, you offer to pay someone $1 for climbing a tree to get five coconuts, and they refuse. You haggle, and eventually they agree to get you five coconuts for $5, so each coconut is worth $1.

Someone else puts together some driftwood to form a basic shelter, and offers to sell it for $25, but is haggled down to $20.

You keep the book, because it’s boring on the island and reading is something to do.

Disinflation

Now, as time goes on, more coconuts are picked, more shelters are built, and so on. Value is added to the economy. But the number of dollars stays fixed at 100. This is disinflationary - the ration of value/dollar goes up, because the value in the economy went up but the amount of dollars stayed the same.

One dollar, when you first landed on the island, bought one coconut. After a month, it might buy two coconuts, because dollars have become more valuable relative to coconuts. A fixed amount of dollars can now be used to buy shelter, crude wooden tools, someone else digging the latrine, and so on. With the same amount of dollars chasing ever more stuff, you can get more stuff per dollar.

Inflation

Now suppose that one day, a bundle of 100 one dollar bills washes up on shore. In the interests of fairness, everyone decides to divvy up the dollars equally: $25 to each of you.

What happens?

Well, the amount of stuff, of value, on the island didn’t magically double overnight. The only thing that changed is that the amount of money doubled.

But money isn’t value.

Money is just the accounting method we use to track what stuff is worth in relation to other stuff.

Money tells us that a chicken costs about $5 and a (dairy) cow can cost about $1,000, so one cow is worth 200 chickens.

If the amount of money doubles without any other changes, that changes nothing about what stuff is worth in relation to other stuff.

In other words, if the amount of dollar bills on the island doubles, the only thing we should expect to happen is that the price of everything doubles. After all, a coconut is still worth the same fraction of money that it always was - it’s just that 1/25 * $50 = $2, whereas 1/25 * $25 = $1.

In The Real World

In the real world, value is created all the time. People invent new stuff, people offer new services, science makes new discoveries, etc.

In order to account for this, the government consistently prints more money, so that the ratio of value/dollar stays relatively stable over time. They’re not perfect at it, but perfection here is impossible. Instead of perfection, the government has a choice of which side to err on: do they print too little new money, making individual dollars trade for more value, or do they print too much new money, making individual dollars trade for less value?

For reasons that I don’t fully understand but believe have a lot to do with the national debt, the government reliably chooses to err on the side of printing too much new money. This causes a small but controllable amount of inflation, on the order of 2% per year.

So what happens when the government just prints a ton of new money and dumps it on the economy?

COVID Relief

When COVID hit, the US government responded with a massive stimulus package to the economy. In effect, they invented/printed a ton of new money and handed it out to everyone to keep the economy going.

From what I can tell, this was the correct decision. The US economy got through COVID, and we’re currently doing better than many other economies that had more austere responses.

That being said, this stimulus was not without cost.

The government added money to the economy without adding new value, just like the extra $100 that washed up on shore of the deserted island.

The result, in both cases, is inflation. With more dollars chasing the same amount of value, the amount of value per dollar has decreased. To repeat:

Inflation is a decrease in the value of money.

The inflation that we’re now dealing with is a result of the stimulus.

Note: inflation depends upon the ratio of value/dollar. This means that there are two ways to cause inflation - by increasing the amount of dollars in the economy, or decreasing the amount of value in the economy. COVID did both.

Greedflation Is Dumb

Greedflation, as far as I understand it, is the idea that greedy corporations are using inflation as a cover to increase their prices and thus make more money.

I’m not going to sugarcoat this:

This. Is. Dumb.

And it’s not dumb because that’s not how markets work, even though that’s not how markets work. It’s not dumb because corporations are saints and wouldn’t do that, because they aren’t and they would.

It’s dumb because it implies that corporations weren’t that greedy before the recent inflation.

Corporations try to maximize their profits. It’s what they do. It’s what they’ve always done. They’ve always been greedy. This is how the market has always worked.

The counterbalancing force - why corporations don’t just raise their prices all the time - is that other corporations would undercut them on price, thus selling more, capturing market share, and making more of a profit.

To put it bluntly, the price level is determined by a bunch of factors, but basically always boils down to the highest level the corporation can get away with.

That’s been true since the beginning of capitalism. It’s not new.

Prices don’t keep going up indefinitely because of competition in the market, not because corporations aren’t greedy.

For common goods in competitive industries, corporate profit winds up being maximized by prices that are only a little higher than costs, because otherwise corporations lose customers to competitors.

That’s it.

Now, have corporations raised prices in response to inflation? Of course.

Money became less valuable relative to stuff across the whole economy, so you need more money to buy the same stuff. That applies to corporations too - their costs went up, so their prices went up. And if they make record profits, remember: profits are counted in money.

You know, the thing that just became less valuable.

Greedflation Steelmanned

If I wanted to defend the idea of greedflation, I’d say this:

The recent bout of inflation created a Schelling point for raising prices, allowing competitive corporations in the same industry to raise prices together in a way that normally only a monopoly could. This pseudo-monopoly power has been used to increase corporate profits to new heights.

This might be possible; it would require an actual economist to look at the data and study the question.

Greedflation’s Steelman Is Rusty

What the above doesn’t say is that corporations were greedy before this Schelling point, corporations will be greedy after this Schelling point, and if any corporation involved could increase its profits by lowering its prices, they would do so.

Thus the fact that they haven’t serves as evidence - not proof, but evidence - that these corporations find themselves back at a competitive equilibrium, with prices not that far above costs.

The idea that corporations raised prices recently out of greed for profit not only misunderstands how markets work, it ironically underestimates the greed of corporations. Price and profit are not the same thing. Higher price does not always equal higher profit, and higher profit does not always mean higher price.

Additionally, most of these large corporations are publicly traded, which means that record profits increase the value of their stock, which in turn enriches the people who own that stock. And while I would expect such gains to favor the already wealthy, technically speaking anyone can participate in them. In fact, quite a lot of 401k and retirement funds depend upon the stock market doing well, so quite a lot of ordinary people do benefit from corporations being greedy.

Conclusion

I’ve been a little harsher here than I usually like to be, perhaps because I’ve been unable to express this in person to those who hold these beliefs for too long. It got bottled up, and this essay is the result.

That being said, I don’t think these concepts are difficult to understand, even though they haven’t been taught to most people. Money and value are not the same, and adding money to an economy without adding value will reliably cause inflation. That inflation causes prices to go up, because a price is an amount of money tradeable for a unit of value. When prices go up everywhere, profits will go up, because profits are counted in money, whose value has just decreased.

It’s economics, not rocket surgery.