Ok, let’s start simple and work our way to inflation. Let’s imagine a world where the government prints a certain amount of money, to make things easier let’s say 1 trillion dollars, and no more will ever be printed, this makes it so that in absolute terms you can think as 1$ as a 1/1 trillion so you can buy stuff relatively to how common they are, if we produced 1 trillion kg of rice, then 1kg of rice should cost 1$, but if we produced 2 trillions then the price drops to 50 cents.
Cool, things make sense, however there are some problems with this approach, money gets destroyed, or otherwise lost forever, so in the long run $1 becomes rarer than 1/1 trillion, let’s exaggerate that and imagine there are now only $1000, it doesn’t make sense that a 1$ buys only 1kg of rice anymore. This is called a deflationary currency, and this is bad, because if you know this is the way money works you wouldn’t spend your money because it will be more in the future.
Ok, let’s try to combat that, let’s then say that the government prints a certain fixed amount of money every year. Some years less money would be lost, those years the value of money would decrease, other years more money would be destroyed, and those years the money would be worth more.
What happens now? Well, people would speculate, and not spend in some years, overspend in others, and the economy would be a wild mess because some years people would hoard money because it would be worth more next year.
Ok, what if the government tried to estimate exactly how much money got lost and printed the same amount, so you (in theory) always have the same amount of money going around.
Turns out this also is a bad idea in the long run. Because while money won’t increase in value because there’s a limited amount it becomes a 0-sum game. Why is that a bad thing? Well, if there are only 1 trillion dollars in circulation, each dollar I hold and refuse to use increases the value of every other dollar I have, so people with lots of money would hoard their money as much as possible to make the rest worth more, allowing him to earn more and store more and turn the currency into a deflationary currency again.
This leaves us with only one option, the government has to print more money than what’s lost, this makes money be worth less with time, but also forces people to invest their money instead of hoarding it, because otherwise it’s worth less, and if they invest it it’s circulating in the economy so in theory everyone wins.
Good illustrative answer, but some points are way oversimplified. Two main points you touched:
Pricing. How goods are priced is a very complex subject. Your trillion rice vs trillion dollars kinda works but really isn’t doing it justice. Like, who produce the rice? If there is a singular rice producer making all the rice, then it doesn’t make sense to price the rice any value. Because even if you pay them, there’s no way to spend that money - there’s just nothing else to buy. If that trillion kg of rice is produced by us each individually, and we each have enough rice for ourselves (i.e. we don’t have desire for anymore rice), then rice would the priced at 0 no matter how much money there is. because there is no demand for it. Another scenario, I have 50 apples, and you have 50 kg of rice, let’s say I have $50, and that’s all the money in the system (fancy jargon: M0 = $50). I pay you $50 for your rice, and you pay me $50 for my apples, and we think that’s a fair trade. Would that mean each kg of rice is 1/50 of all goods? And we can keep going, I can have trillion apples, and you can have trillion kg of rice. We will still be able to exchange all of them with a single $50 bill, it’s just going to take tons of transactions.
Basically, price is determined by supply and demand (caveats apply), and how money supply plays into that is complicated and way above my pay grade. I just want to note that price increases aren’t always caused by more money, it could also mean an increase of demand, or a decrease in supply.
Is inflation good? You mentioned people might hoard money to drive up value, but that’s not the only thing. First of all, inflation drives people to spend money (or at least that’s what’s commonly believed anyway), because you’d want to spend money today if it’s going to worth less tomorrow. This drives demand, and if there’s more demand people try to create more supply to meet it, thus the economy grows (I have to emphasis this is an extreme oversimplification). Secondly, even if there is no hoarding, as the productivity of the society grows, money inherently becomes more valuable - no hoarding needed. So you need to create more money to keep price stable anyway.
Also, when people talk about printing money, I feel they mostly are thinking about like printing more physical money? That’s just not the case these days. In fact, most of the money in circulation nowadays isn’t even physical. The primary way central bank creates money is by creating debt. Say I have the only $50 bill, and I wasn’t planning to spend it. So I lend it to you, now you have a $50 bill, and I am entitled to get that $50 back in the future. Now the money supply doubles, without printing anymore physical money. When the central bank and the government do it, it’s called Quantitative easing.
Holy crap, that was great. I never really even thought about it until OP asked the question. I just accepted it as a fact if life. But bottom line is, like most things, it’s because people suck.
Ok, let’s start simple and work our way to inflation. Let’s imagine a world where the government prints a certain amount of money, to make things easier let’s say 1 trillion dollars, and no more will ever be printed, this makes it so that in absolute terms you can think as 1$ as a 1/1 trillion so you can buy stuff relatively to how common they are, if we produced 1 trillion kg of rice, then 1kg of rice should cost 1$, but if we produced 2 trillions then the price drops to 50 cents.
Cool, things make sense, however there are some problems with this approach, money gets destroyed, or otherwise lost forever, so in the long run $1 becomes rarer than 1/1 trillion, let’s exaggerate that and imagine there are now only $1000, it doesn’t make sense that a 1$ buys only 1kg of rice anymore. This is called a deflationary currency, and this is bad, because if you know this is the way money works you wouldn’t spend your money because it will be more in the future.
Ok, let’s try to combat that, let’s then say that the government prints a certain fixed amount of money every year. Some years less money would be lost, those years the value of money would decrease, other years more money would be destroyed, and those years the money would be worth more.
What happens now? Well, people would speculate, and not spend in some years, overspend in others, and the economy would be a wild mess because some years people would hoard money because it would be worth more next year.
Ok, what if the government tried to estimate exactly how much money got lost and printed the same amount, so you (in theory) always have the same amount of money going around.
Turns out this also is a bad idea in the long run. Because while money won’t increase in value because there’s a limited amount it becomes a 0-sum game. Why is that a bad thing? Well, if there are only 1 trillion dollars in circulation, each dollar I hold and refuse to use increases the value of every other dollar I have, so people with lots of money would hoard their money as much as possible to make the rest worth more, allowing him to earn more and store more and turn the currency into a deflationary currency again.
This leaves us with only one option, the government has to print more money than what’s lost, this makes money be worth less with time, but also forces people to invest their money instead of hoarding it, because otherwise it’s worth less, and if they invest it it’s circulating in the economy so in theory everyone wins.
Good illustrative answer, but some points are way oversimplified. Two main points you touched:
Pricing. How goods are priced is a very complex subject. Your trillion rice vs trillion dollars kinda works but really isn’t doing it justice. Like, who produce the rice? If there is a singular rice producer making all the rice, then it doesn’t make sense to price the rice any value. Because even if you pay them, there’s no way to spend that money - there’s just nothing else to buy. If that trillion kg of rice is produced by us each individually, and we each have enough rice for ourselves (i.e. we don’t have desire for anymore rice), then rice would the priced at 0 no matter how much money there is. because there is no demand for it. Another scenario, I have 50 apples, and you have 50 kg of rice, let’s say I have $50, and that’s all the money in the system (fancy jargon: M0 = $50). I pay you $50 for your rice, and you pay me $50 for my apples, and we think that’s a fair trade. Would that mean each kg of rice is 1/50 of all goods? And we can keep going, I can have trillion apples, and you can have trillion kg of rice. We will still be able to exchange all of them with a single $50 bill, it’s just going to take tons of transactions.
Basically, price is determined by supply and demand (caveats apply), and how money supply plays into that is complicated and way above my pay grade. I just want to note that price increases aren’t always caused by more money, it could also mean an increase of demand, or a decrease in supply.
Is inflation good? You mentioned people might hoard money to drive up value, but that’s not the only thing. First of all, inflation drives people to spend money (or at least that’s what’s commonly believed anyway), because you’d want to spend money today if it’s going to worth less tomorrow. This drives demand, and if there’s more demand people try to create more supply to meet it, thus the economy grows (I have to emphasis this is an extreme oversimplification). Secondly, even if there is no hoarding, as the productivity of the society grows, money inherently becomes more valuable - no hoarding needed. So you need to create more money to keep price stable anyway.
Also, when people talk about printing money, I feel they mostly are thinking about like printing more physical money? That’s just not the case these days. In fact, most of the money in circulation nowadays isn’t even physical. The primary way central bank creates money is by creating debt. Say I have the only $50 bill, and I wasn’t planning to spend it. So I lend it to you, now you have a $50 bill, and I am entitled to get that $50 back in the future. Now the money supply doubles, without printing anymore physical money. When the central bank and the government do it, it’s called Quantitative easing.
Great answer. I thought I had a grasp, but you helped flesh out my understanding, thanks
Holy crap, that was great. I never really even thought about it until OP asked the question. I just accepted it as a fact if life. But bottom line is, like most things, it’s because people suck.