Day 244: Transforming Currency into Money with Living Income Guaranteed

In the video "Hidden Secrets Of Money - Ep1 'Currency Vs Money'" Mike Maloney and others present one of the problems we are facing in our current economic system and that is - how the value of our currency is able to change over time - where it can both appreciate and depreciate - but throughout history it has mainly depreciated until it becomes worthless and then a new currency is introduced. The video explains the problem, but it doesn't offer a real solution - which I will be discussing in this blog.

Now - when I said 'the value of our currency is able to change over time' - with 'our currency' I am not referring to a specific currency such as Dollar or Euro or Rand - I am referring to fiat currency. For those who are not aware of the history of our currencies: paper bills were introduced as IOUs - a piece of paper stating that: I owe you 5 gold coins, for instance. Say that you deposited 5 gold coins at the bank. The bank would then write you a claim check that specifies that with that piece of paper, you can at a later time come and claim those 5 gold coins back. Now - over time what started happening, is that when people would go to the market place and wanted to buy something for 7 gold coins, but they only had 2 on them - they would go: "You know, I only have 2 gold coins on me, but I've got 5 at the bank, how about I give you the 2 gold coins plus the claim check for the 5 gold coins at the bank, and then you can just go and claim them." And from there, the ball started rolling and less and less people went to actually collect gold at the bank and started simply trading with the paper claims - which is what we currently know as paper bills. From there, it didn't take long before banks would just start printing money that was no longer 'backed up' by any gold at the bank. From this point onwards - we started trading with fiat currency - a currency that is not limited by the resources that is 'backing up' the value of the currency.

Why does that matter? It matters from the perspective that the amount of gold in the world is limited and therefore, the value of gold stays round about the same over time. What determines the value of gold? It's determined by how much of it is in circulation, and thus - by consequence, how much we are able to buy with it. So - let's take an example of a little village where 10 people live and there are in total 10 gold bars in circulation in this mini-economy. These 10 people have certain goods they want to buy and each a certain amount of gold that they are willing to spend on it. This determines the demand for the goods in the village. The suppliers balance their costs with profits - where they know that if they charge a high price, there will be less villagers able to buy the product, and if they charge a lower price it will become harder to make a profit and eventually even difficult to cover their costs. So - balancing demand and supply - a price for the goods is determined. Now - let's say that suddenly - instead of 10 bars of gold, there are 20 bars of gold - what will happen to the prices? They will go up because the demand goes up. Herein - understand that demand means: people want it and they can pay for it. So - when there is more money - it doesn't mean that people suddenly want more of something - it means they always wanted that amount, but they couldn't demand it because they didn't have the money to demand it. So - with demand increasing - the suppliers will realize that they can now charge a higher price - and so the prices of the goods in the village go up. What has happened to the value of gold? The value of gold decreased, because with the same amount of gold, people are now able to buy less of the goods - because the price went up.

So - with currency initially being backed up by gold - it limited how much money was in circulation - and so, it kept the value of money stable - because it was tied to the amount of gold that was available in the world. Gold is not something we can create - we can melt gold down and change the form but we cannot make new gold. So - the amount of gold we have in the world today is the same amount of gold that we had centuries ago. With fiat currency, however, reserve banks are able to simply print more paper money, increase the money supply - and in turn prices increase and the value of the money depreciates.

So far the reasoning of the economists seems sound - however, it is not - because they are misusing the term 'inflation'.

When they discuss inflation they assume that it means: the prices of all goods and services in an economy go up as a result of an increase in the money supply - and therefore, money becomes worth less and people can buy less and less stuff.

But what is not considered is the following: with inflation - the price of literally EVERYTHING in the economy goes up - and that includes the price of labor. So - from that perspective - if the prices of 'stuff' doubles, it's not a problem, because your wage would have doubled as well. And so - technically - yes - the nominal value of money depreciates - but the real value remains the same: you can buy less with one dollar, but you can still buy the same amount with your wage.

So - this reveals a problem in our current economic system - and how it is deviating from how things should be done. Let's take again the example of a village where there are 10 people and there are 100 dollars in circulation. If the money supply suddenly increases to 200 dollars, suppliers will up their price because the demand increased. Now - this higher price has to also increase the wages of those who work for the suppliers - and when their wage increase, they will have no problem paying the higher price. The wage of the workers would go up simply because they will demand a higher wage through their labor unions because otherwise they cannot pay the higher prices. But instead - what's been happening: the suppliers keep the wages of the laborers the same or only give them a slight increase - and instead: just make a lot more profit. And have a look - that's exactly what's been happening in the world. Why? Because when laborers demand higher wages - what do the bosses say? Well - if you don't want to work for that wage - I let you go and I will find someone worse off than you and have them do the work. That is why we have so many companies that closed down in Europe and America that moved to China and the third world in general - because they could profit from people being worse off there than in their country, that were willing to work for much lower wages.

And this is why within Living Income Guaranteed - we suggest that prices be determined according to the value that was put into it - which includes your labor. And valuing labor means: your workers must have a wage that allows them a certain lifestyle. This should be enshrined in the Constitution as a Human Right - otherwise one creates cycles of abuse where some win and most lose. And so - if all prices in the economy go up because of an increase in the money supply - your wages will have to increase simultaneously - otherwise you're committing a crime against life.

Herein, then - it doesn't matter whether you have fiat currency or not - becaue the real value of the currency remains the same. In the video they explain how the difference between currency and money is that money is a store of value - its value remains the same over time - and with currency this is not part of the definition. So - with making this one adjustment to the economic system, so that it would function how it is intended to function - we would be able to say that our fiat currency is in fact money - because the real value of the currency remains the same over time.

Is it a solution to step away from fiat currency and go back to silver and gold? No! Why not? Exactly because the amount of gold and silver in the world is limited - it doesn't change. But what does change? The amount of people in your economy. So - if you take  again the village of 10 people with 10 gold bars and let's say each owns one gold bar, but now they all make babies and suddenly there are 20 villagers and still the same 10 gold bars - you obviously have a problem - because now each villagers (assuming an egalitarian society) only owns half a gold bar. And yes - the value of gold remains the same: you can still buy the same amount of stuff with one gold bar before there were babies as you can after there were babies - but not everyone has a gold bar anymore - so the standards of living goes down anyway as you can suddenly buy less stuff.

So - to have your money supply absolutely the same over time, regardless of a change in population, is also counterproductive. When it comes to money creation - it should be calculated according to two points:
- available resources
- population

Furthermore - which is quite fascinating - in the video the economists point to history and how throughout history every fiat currency reverted back to zero - and therefore we should use gold/silver instead. But they ignore the fact that throughout history people have always also gone back to fiat currency - simply because it is much more convenient to carry around paper or a plastic card with a chip than a bunch of gold bars. I mean - making gold/silver the currency would eventually lead to history repeating itself, just because it's not practical to transport gold for transactions.

Therefore - instead of telling people to invest in gold and silver because currency will become worthless - and then at least you have something to trade with - rather correct the problem with fiat currency so that it works for everyone.

We continue in the next blog with our discussion on money and currencies where we'll have a look at the nonsense of having currencies with different values.

Related articles

• Day 251: Living Income Guaranteed and Market Mechanics
• Day 252: The Rich Be Cursed, The Rich Be Blessed
• Day 247: Only in a Broken System does Misery equal Profit
• Day 226: Living Income Guaranteed will Prevent Destruction of Homes
• Day 339: Why the CommonWealth was Never the Common Good

Read More

Day 240: A Bank for the People

We have an interesting point being taught in economy books - which is that an increase in investment spending has an expansionary effect on the economy - because money is invested in certain products and therefore, people are being paid or jobs being created, which means an increase in income, which means more consumption spending and so a multiplier effect sets in - because, in turn, consumption spending increases income, which increases consumption spending, where of course the increase each time becomes smaller and smaller and eventually 'dies out'. However, on the flip side - what is not spoken about in the text books, is how, at the same time as a multiplier effect is in progress - there is also a growing debt - because interest rates cause a debt to increase over time as well. And this debt, which is eventually a multiple of the initial loan, must be repaid, and so money again disappears from the economy, causing the economy to shrink.

So, within Living Income Guaranteed, we suggest banking will still be relevant from the perspective of big capital investments such as housing or cars. In some countries, we see a rising trend of loans being taken out, not for such big capital expenditure, but for day-to-day living costs, such as food and clothing. Such points will stop within Living Income Guaranteed, because one will be guaranteed to have an income that is sufficient to provide oneself with these basic necessities.

So - when it comes to loans, banks will herein make money through asking for a once-off fee rather than an interest rate - where this fee must cover labor costs and a profit markup - where the fee is reasonable from the perspective of what is required for banking to be profitable without creating a monopoly on money. And of course loans must only be undertaken if the capacity exists for the debt to be repaid.

The creation of money through fractional reserve banking would have to be revised and a way of money-creation be devised so that it stands in relation to supporting the rate at which the economy is growing - which must take into account population growth as well as available resources.

So - herein, banking becomes an actual life-support system where big investments can be paid over time and where it will increase and support the value of the citizen in terms of their life. And thus, the banking system becomes a means to truly supports economic growth as well as the growth in value of a citizen's life.

Related articles

• Money for Nothing: Switzerland Eyes a Basic Income Guarantee
• Switzerland's Proposal to Pay People
• Day 251: Living Income Guaranteed and Market Mechanics
• Day 226: Living Income Guaranteed will Prevent Destruction of Homes

Read More

Day 94: How is Money Created?

Also read Day 71: The Money Supply for additional Context

When someone takes out a loan from the bank, we believe (and most of the time have been taught) that this money is money that has been entrusted to them by depositors. This is not what happens in reality. The money that is received as a loan is actually created by the bank. This money does not come from what people have deposited and it also does not come from the banks own revenue. It is created from the borrower’s promise to repay.

When you sign a loan agreement, you agree to pay back the bank the amount borrowed, plus interest. You also agree that in the event that you are unable to pay back your loan, the bank has the right to confiscate your car, your house or whatever asset that was pledged as surety. The only thing of real value that is involved in a loan transaction, are the assets one has pledged to the bank in the event one fails to pay back the loan. (This loan agreement now carries value. The promise that sometime in the future you will pay off your loan means that at some point in the future, the bank will have this money. And even though the bank does not have the money now, it will use this loan agreement as if it is worth the amount of money owed – and use/spend it as such.)

Once the loan agreement has been signed, the bank is allowed to summon into reality the amount of the loan and just insert it into the borrower’s account.

The concept of lending out more money than you actually have stored is called “fractional reserve banking”.
This concept emerged during the 17th and 18th centuries in Europe. Halfway through the 17th century, as a consequence of the civil war, goldsmiths were making less money with their traditional way of doing business as forging objects out of gold and silver. As a way to survive, they started accepting other people their precious metals and keep it safe for them in their vaults at a particular fee. The goldsmith would then issue a receipt for the deposit made to the depositor. These receipts started circulating as a form of money, functioning as a representation of the actual physical precious metals that were stored in the vaults. As time went on, the goldsmiths realised that not all of the depositors would use their receipts to claim their gold and silver at the same time. The goldsmiths would thus be able to lend out more money as receipts than what he actually had in stock, and nobody would notice. Fractional reserve banking was born.

Fractional reserve banking is where only a fraction of bank deposits are backed by actual cash that is present and available for withdrawal. This system started with the goldsmiths and is currently still being applied in most countries all over the globe.

When the people realised what the goldsmiths were up to, it was already too late. Their money making mechanism had become a vital and essential part to the expansion of European commerce. So instead of banning fractional reserve banking, the government decided to regulate it instead.

Over the years, the fraction of gold backing the debt money has gradually declined to zero. Presently, paper or digital money can only be redeemed for another piece of paper or digital money.

In the past, the amount of money that was in circulation was limited and in accordance to whatever physical commodity was used and valued as money (e.g. gold, silver). For there to be more money, there had to be more of the particular commodity (e.g. more gold and silver).

Nowadays, money is created as debt. Using the fractional reserve banking method, new money is created through issuing loans. The only limit to the money supply is the total level of debt.

The most common ratio by which money is created is 9 to 1. Where for each actual dollar the bank has, it can bring 9 more “fictional” dollars into being. If this ‘new money’ then circulates between individuals and banks, even more ‘new’ money can be created from the previously ‘new money’.

This practically implies that money can only come into being through debt, and that essentially money is debt.
This has the even more disturbing implication that without debt, there will be no money.

Let use some simply mathematics to illustrate this point.
We start with zero ( 0 ) amount of money.

Now we want to take out a loan of let’s say, 500 dollars.

By taking out a loan of (+) 500 dollars, we are creating debt for the amount of (-) 500 dollars.

If we now pay off our loan, the money count will simply go back to zero, as the equation has been balanced out again. And the money is gone. We are thus completely dependent on debt for the existence and circulation of money! If everyone in the world would pay off their debts -- which sounds like a ‘good thing’ and considered by most to be a form of ‘improvement’ -- then there will be no more money!

“This is a staggering thought. We are completely dependent on the Commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money, we are prosperous; if not, we starve. We are, absolutely, without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is.”

 -       -   Robert H. Hemphill, Credit Manager of Federal Reserve Bank, Atlanta, Georgia

But now, as you may have noticed, we have not yet addressed the point of paying back interest.

Banks will borrow you the principle amount of your loan, but where does the money come from to pay off the additional interest? The only way borrowers can pay the additional interest is by using money from the overall money supply in circulation. But now as we’ve just seen, most of this money has been created through debt which also has to be paid back with more than that which was created/borrowed.

We are faced with a situation where many (if not everyone) has to pay back both the original amount borrowed - plus interest - using money from the overall money supply. But this overall money supply consists of only the sum of all the principle amounts borrowed. It is thus impossible for everyone to pay back the original / principle amount and pay back the additional interest (unless the interest that is being paid to the banks gets spend immediately so others can use it to pay off their interest as well). Unless a vast amount of extra money is created to pay off the interest, a high level of foreclosure will be prominent in society. For a society to function at an effective level, foreclosure rates require to stay low. To be able to achieve this, more and more money needs to be created (= more and more debt), just to be able to meet the plea for money to be able to pay off the previous debt. We are literally taking out loans just to pay off our previous loans. This results in to a never-ending cycle of going into more debt to be able to pay off previous debts. The only thing that keeps the system going is the time lag between money being created and the loans being paid off over time. If this time lag was not in place, the whole system would collapse instantaneously.

It is an unsustainable system that eats itself up from the inside out.

 

Related articles

• Day 71: The Money Supply - Part 1
• Day 72: The Money Supply - Part 2
• Day 78: Monetary Policy - Part 1
• Day 79: Monetary Policy - Part 2
• Day 73: The Money Supply - Part 3
• Day 75: The Demand for Money - Part 1
• Day 84: Fiscal Policy and the Budget
• Day 68: The Functions of Money - Part 2
• Day 80: Monetary Policy - Part 3
• Day 70: Feedback on Inflation and Purpose of This Blog

Read More

Day 78: Monetary Policy - Part 1

Now that we know what is involved with the supply for money and the demand for money - let's have a look at one of the policies used to influence the money supply in a certain economy.

Note that there are several policies, but we limit the discussion here to the accommodation policy.

Accommodation policy

In The Demand for Money - Part 1 it was mentioned how the interest rate will influence the demand for money. If the interest rate goes up - and thus, loans become more expensive - the demand for money will go down and, in turn, the supply of money will go down as well. Why do I say that the supply of money will go down if the demand for money goes down? Because money is mostly created through loans and loans are only created when there is a demand for it. We therefore speak of a 'demand-determined money supply'.

If the interest rate of individual banks has such an influence on the money supply - then what influences the interest rate? What influences the interest rate is the repo-rate.

The repo-rate

What is the repo-rate?

When banks are having liquidity problems - meaning: they don't have enough cash - they will usually borrow funds from other banks on 'the interbank market'. However, if all the banks are simultaneously experiencing liquidity problems, they turn to the central bank. We say that the central bank acts as 'lender of last resort'. Borrowing from the central bank is done by means of repurchase agreements. A repurchase agreement is the sale of securities together with an agreement that the seller will buy the securities back after a specified period of time - for instance, 7 days. So, in terms of banks requiring liquidity: they will sell securities to the central bank - with the money obtained from the sale, the individual banks relieve their liquidity shortage. However, the indivudal banks must agree to repurchase those same securities from the central bank after, for instance, 7 days. You can see that repurchase agreements are in essence the same thing as a loan - where money is given to the individual banks (in exchange for securities) and the individual banks have to pay this money back after a specific amount of time (after which they also get back their securities).

Now - in the same way as individual banks charge a 'fee' for their lending services by charging interest, so does the central bank make use of the repo-rate. The repo-rate is basically the interest rate that the central bank uses. It means that the amount at which the individual banks repurchase the securities from the central bank, will be higher than the initial amount. And this higher amount is determined by the repo-rate.

So - what does the repo-rate have to do with the money supply?

Well - we're dealing with a domino-effect. If the repo-rate is high, it means that it costs a lot for individual banks to get funds.
If banks are faced with higher costs, they will 'pass the cost down' to their clients, by making their interest rates higher as well. And if the interest rate is higher, the demand for money will go down, as it becomes less interesting for individuals to get a loan at a bank, knowing it will cost more to pay the loan back.

On the other hand - if the repo-rate goes down, individual banks can afford to lower their interest rate as well and will do so to become more competitive. With lower interest rates, the demand for money will go up, and thus also the supply for money, because it is more interesting to take out a loan at a low cost (low interest rate) than at a high cost (high interest rate).

So - the accommodation policy refers to the decision of the central bank to make the repo-rate higher or lower. Because - if the repo-rate changes, other interest rates will follow and if the interest rate changes, the amount of money in circulation changes.

For instance, if the central bank wishes to avoid inflation - it can raise its repo-rate, which in turn raises interest rates, which will refrain people from taking out loans and increasing the money supply to a point where all prices increase and keep on increasing.

Read More

Day 71: The Money Supply - Part 1

What is 'Money Supply'?

The money supply refers to the liquid assets that are held by individuals - it includes coins, notes and demand deposits (cheque accounts). What notes and coins are is clear - but what are demand deposits? If you have a cheque account in which money was deposited - the bank has to pay out deposits in cash on demand, or has to transfer it immediately on demand to another bank or account holder. So - demand deposits - the money in your cheque accounts, is as good as notes due to immediacy with which the money becomes available. The money supply, in simple terms, refers to all the money that is in circulation in an economy, that is available to individuals to purchase goods or services with.

Why does it matter how much money is in circulation?

The amount of money available in circulation has an influence on the prices of goods and services. Remember the following from the blog-post 'Inflation - Part 1':

"In other words - whenever the amount of money in circulation increases in an economy, the prices will go up. Check: the more money is available in an economy, the less it is worth, which is reflected in higher prices - because with the same amount of money in your pocket, you can now purchase less stuff, which means that your money is not worth as much as it used to anymore."

If the money supply keeps on increasing - so will prices - and the result will be inflation. Why?

Because - more money in circulation means more money available to people to buy goods and services with. In other words: the demand for goods and services goes up. If the demand for goods and services goes up (more people are willing and able to buy goods and services), so do their prices.

What factors influence the Money Supply?

1. Banks

The supply of money can be increased by increasing either the amount of notes, coins or demand deposits. Banks play a crucial role within the latter: banks have the ability to create money by increasing the amount of demand deposits.

The question, then, is:

How are demand deposits created?

Firstly: if a person deposits, for instance, $100 in banknotes with a bank, the bank will in return give the person a cheque book, which will give the person the right to write out cheques to the value of $100.

Secondly - and more importantly: Banks noticed that the demand deposits held by them were never all claimed/withdrawn at the same time. They would always have demand deposits 'laying around'. They figured that, instead of leaving the money to collect dust, they could lend this money to other people and charge interest on the loan. This means: the bank would give money to people who hadn't put money in the bank beforehand.

In the First case, nothing actually happened to the money supply: $100 was deposited into a bank - and thus removed out of circulation. This means the money supply decreased by $100. However, the bank issued a cheque book of the value of $100, thereby again increasing the money supply by $100. The money supply before the creation of the demand deposit is thus the same as afterwards.

In the Second case, however, the money supply does change. Using the same amount as an example: Someone deposits $100 into a bank. The bank issues a cheque book of $100 - the money supply balances out. However, of the $100 deposited, the bank decides to lend out $80 to someone who needs and seems creditworhty enough (showing the capability to pay back loans). Now the money supply has increased with $80. At first there was just one person with $100 in their pocket, after the bank did its magic: there was one person with a $100 cheque book and another person with $80 of credit.

Is there a limit to the amount of money a bank can create?

Although small, there are limitations to the amount of money a bank can create.

At any time, a bank must have sufficient cash reserves to be able to provide for cash withdrawals. Secondly, a bank must be able to provide for claims of other banks. What does this mean?

Remember our example of someone bringing in $100 in his bank and receiving a cheque book of the value of $100. If this person writes a cheque of $100 to his landlord, the landlord will go to his bank to cash the cheque and receive $100 for it. The thing is that the landlord's bank and the bank of the person who wrote the cheque, are not necessarily the same one. A bank must therefore always make sure that it is able to provide for the claims of other banks.

Individual banks don't decide how big a percentage of received deposits they keep aside in the form of cash reserves - this is the job of the monetary authorities: the central banks.

Let's say that the central bank dictates that at all times a bank is obliged to hold 2.5% of their total demand deposits in the form of cash resrves. We say that 2.5% or 0.025 is the 'cash reserve ratio'.

Taking again our example of someone depositing $100 at his bank - what implication does a cash reserve ratio of 2.5% have in terms of limiting the bank's ability to increase the money supply?

Firstly - consider what would happen without there being a cash reserve requirement:

Step 1: A person (Person A) deposits $100 at the bank and receives a cheque book of the value of $100.
--------> Money Supply: Nothing changed
Step 2: The bank lends out the $100 that was deposited to someone else (Person B).
--------> Money Supply: + $100.
Step 3: Person B deposits the $100 at his bank and receives a cheque book of the value of $100.
--------> Money Supply: still + $100.
Step 4: The bank lends the deposit Person B made and lends it out to Person C.
--------> Money Supply: + $200.

As you can see - the process could just keep on repeating itself until an endless amount of money is created.

What happens then in case of there being a cash reserve ratio of 2.5%?

Step 1: A person (Person A) deposits $100 at the bank and receives a cheque book of the value of $100.
--------> Money Supply: Nothing changed
Step 2: The bank keeps $2.5 dollars in reserve and lends out $97.5 to someone else (Person B).
--------> Money Supply: + $97.5
Step 3: Person B deposits $97.5 at his bank and receives a cheque book of the value of $97.5 in exchange.
--------> Money Supply: still sitting at +$97.5
Step 4: Bank keeps 2.5% of Person B's deposit in the form of cash reserves ($2.44) and lends out $95.06 to Person C.
--------> Money Supply: + $192.56

As you can see, with each deposit, the amount a bank can lend out decreases in comparison to the initial amount of $100. There is thus a limit to the amount of money that can be created this way. We can actually calculate how much money will be in circulation if this process is continued until there is nothing more to lend:

$100 * 1/0.025 = $100 * 40 = $4000

The initial $100 that was in circulation, the fractional reserve banking system (which is what this banking system is called) can turn into $4000 in circulation.


We continue on the subject of the money supply within the next blog.

Read More

Day 64: Inflation - Part 1

What is this thing called inflation?

Inflation simply refers to the continuous increase of prices in an economy. So - two points are important to note: if prices go up and then remain stable for a while, we don't refer to it as inflation, as inflation only applies to a continuous increase in prices. Secondly - if the price of petrol keeps rising, but all other prices remain somewhat stable, we're also not dealing with inflation, because in the case of inflation all prices keep rising.

Measuring Inflation

One of the most common ways to measure inflation is by making use of the consumer price index (CPI). Remember from the previous blogs, that CPI reflects the cost of a representative basket of goods and services. To obtain the inflation rate, we calculate the percentage change int he CPI from one period to the next. Meaning - if the inflation rate is 7.5%, it means that the cost of purchasing a representative basket of goods and services increased by 7.5% from one year to the next.

Effects of Inflation

One of the major economic effects of inflation is that what a country is trying to sell to other countries, eg. exporting, will be more expensive for foreign countries to buy. Therefore, an economy loses its competitive edge on the international market and the performance of the economy generally goes down - in turn, affecting everyone operating within it. Another more obvious effect, of course, is that the cost of living increases, people become fearful and agitated and start throwing accusations around about who's to blame for the inflation. Some, however, claim that the greatest danger about inflation is that it will cause more inflation. When inflation occurs, people expect prices to keep on rising - therefore, they will quickly go and buy as much as they can now, before prices get even higher. Because more products are suddenly demanded, prices go up and thus, the inflation rate often increases, even pushing the economy in some cases towards 'hyperinflation'.

The Causes of Inflation

There are two main causes of inflation: demand-pull inflation and cost-push inflation.

Demand-pull inflation

The term speaks for itself - demand-pull inflation occurs when increased aggregate demand for goods and services pushes prices up. Aggregate demand can go up in any of the following cases, or combination of cases:
- when consumption spending increases
- when firms increase their investment spending
- when governments increase their spending
- when export earnings increase
In other words - whenever the amount of money in circulation increases in an economy, the prices will go up. Check: the more money is available in an economy, the less it is worth, which is reflected in higher prices - because with the same amount of money in your pocket, you can now purchase less stuff, which means that your money is not worth as much as it used to anymore.

Cost-push inflation

Cost-push inflation occurs whenever an increase in production costs is responsible for pushing up the price level. In other words:
- when wages and salaries increase
- when the cost of imported capital and imported goods increases
- when profit margins increase
- when productivity decreases
- when natural disasters occur, such as droughts or floods
In the case of cost-push inflation, we don't only have to deal with an increase in prices, but we also have to deal with a decrease in income and productivity. This is referred to as 'stagflation'.

Read More