Inflation

A key issue in today's economic climate is inflation. Inflation is the rate of change that the CPI (Consumer Price Index) increases at. So basically, inflation is the increase in overall prices in the economy.

Most people just assume that inflation is a naturally occurring phenomenon. This is far from true. Inflation is a policy which the government chooses.

Media pundits usually describe inflation as the government printing money and injecting it into the economy. Unfortunately, it isn't that simple. It would be too easy to be critical of that policy, so the process of inflation is much more complicated. If people can't understand it, it's harder to be critical of it.

There are different ways for the government to cause inflation, and I'll discuss two of them. These techniques are performed by the Federal Reserve.

The first thing to understand is the reserve requirement set by the Federal Reserve.

This is the percentage, or ratio of deposits, which the government can loan out. Right now, the reserve requirement is set at 10%. That means for every $100 deposited into the bank, it can loan out $90. The lower the requirement, the more money is created resulting in a higher inflation rate.

The second tool used, is open market operations.

The Federal Reserve buys or sells government securities. By doing this, it increases or decreases the reserves of commercial banks. The money is not literally printed. Instead, it is all done electronically.

By increasing the reserve of banks, they have more money to lend. This is how the rates are set. The more funds in a bank's reserves, the lower the interest rates. The lower the interest rates, the more loans are taken out.

This is how inflation occurs. The money supply is expanded by the Federal Reserve.

There are many consequences of inflation. The most obvious is the increase in prices.

The greater the money supply, the higher the prices.

This becomes a big problem when your income is fixed, but the prices are rising dramatically. The older population is hurt the worst by inflation.

When prices increase, the value of the currency decreases. If a piece of candy cost $1, a dollar was worth a piece of candy. If it costs $2, then a dollar is worth half a piece of candy. It loses its purchasing power.

Lastly, inflationary bubbles are created. As I mentioned before, inflation means lower interest rates. These low interest rates are responsible for bubbles in the economy, and ultimately responsible for the business cycle.

Inflation is devastating to all people.

Unlike many economic issues, this is completely controlled. But as long as the government can create money out of thin air, it will take advantage of it.

Who wouldn't want a legal monopoly on counterfeiting?