Thoughts on the 'flations!

I’m just trying to sort out my thoughts on the current economic circumstances, and in particular on inflation and deflation. It seems to me there are several sides to both of these phenomena, some of which are beyond our usual attempts to control things…

Inflation… classic inflation involves the ‘cheapening’ of the money – each dollar buys less and less of anything. This can extend into a cycle of both prices and wages going up and up, leading to consumer behavior where there is no savings, and people spend their income as soon as possible. This seems to be a monetary event, and also seems to frequently involve asset bubbles, as there is plenty of speculation that prices will continue to rise.

Yet there are times when prices can go up for certain things for simple reasons of supply and demand; oil may well be one of these items which will generally go up in price for a good long time now due to high demand and limited supply. Because oil is used for so many purposes, it will tend to push prices up for many items. But this is not so much monetary inflation as a reflection of reality!

In part this explains why the U.S. measures both overall price inflation and then subtracts food and energy prices to come up with a ‘core’ inflation rate. From the monetary standpoint it makes sense to attempt to separate the two price phenomena, but I’m not sure this approach is quite right… I’m not sure how well you can separate out the energy price impacts from the monetary inflation.

Deflation… the potentially destructive cycle involves money becoming more and more valuable, which can then lead to behavior changes where people wait to buy things since it will be cheaper later. This can lead to economic slowdown, and seems to be an overall monetary event.

But again, there are other reasons for money being ‘more valuable’ at least in terms of some items; the incredible productivity gains in the personal computer business comes to mind. This productivity deflation generally seems like a good thing… we get more for our money. Likewise the China manufacturing productivity give the U.S. many price benefits.

So… it seems to me that in the U.S. we may be seeing all four movements in different areas at the same time, and it will be quite a task to make monetary decisions in this environment. Bernanke seems to be a deflation fighter, but I’m not sure how much ‘bad’ deflation there really is out there… and no matter what they do with interest rates, the oil market will continue to be volatile.

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