Overview

Grandpa always says, “In my day, a movie ticket cost a nickel.” Now it costs $15. That is inflation. It is the invisible thief that makes your money worth less every year. It is why you need a raise just to stay in the same place.

Core Idea

The core idea is Too Much Money Chasing Too Few Goods. If everyone suddenly became a millionaire overnight, but the number of houses and cars stayed the same, the price of houses and cars would skyrocket.

Formal Definition

A sustained increase in the general price level of goods and services in an economy over a period of time. CPI (Consumer Price Index): The “basket of goods” (milk, gas, rent) used to measure inflation.

Intuition

  • The Balloon: The economy is a balloon. Money is the air. If you blow too much air (print money) into the balloon, it expands (prices go up). If you blow too much, it pops (Hyperinflation).

Examples

  • Germany (1923): Hyperinflation. Prices doubled every 3 days. People brought wheelbarrows of cash to buy bread. Kids used stacks of money as building blocks because it was cheaper than toys.
  • Zimbabwe (2008): They printed a 100 Trillion Dollar bill. It wasn’t enough to buy a bus ticket.
  • The Fed: The Federal Reserve’s main job is to keep inflation at exactly 2%. Not 0%, not 10%, but 2%. A little bit of inflation encourages people to spend money now (before it loses value), which helps the economy grow.

Common Misconceptions

  • Inflation is always bad: Deflation (falling prices) is actually worse. If prices are falling, you wait to buy a car because it will be cheaper tomorrow. If everyone waits, the economy freezes (The Great Depression).
  • Purchasing Power: How many Big Macs you can buy with $100.
  • Stagflation: The nightmare scenario. High inflation + High unemployment. (The 1970s).

Applications

  • Investing: If inflation is 3% and your bank account pays 0.1%, you are losing money. You need to invest in stocks or real estate to beat inflation.

Criticism / Limitations

  • Shrinkflation: Companies keeping the price the same ($5) but making the bag of chips smaller. It’s hidden inflation.

Further Reading

  • Friedman, Milton. Money Mischief: Episodes in Monetary History.