The Real Story Behind Inflation

Heritage Explains

The Real Story Behind Inflation

What it means for your pocket book, your gas tank, and your grocery bill

What do you know about inflation? Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Of course, we all know the driver of the quantity of money is government spending priorities, and recently the government has been spending a lot. So what does that mean for the American people? On this episode, we talk about the basics of inflation, what it means for your pocket book, your gas tank, and your grocery bill. This episode shows what happens when too many dollars chase too few goods.

Tim Doescher: From the Heritage Foundation, I'm Tim Doescher. And this is Heritage Explains.

Doescher: Remember that scene in the movie Annie Hall when Woody Allen is standing in line at the movie theater with Diane Keaton and a pedantic blowhard is standing behind them mansplaining to his date about the work of the famous professor Marshall McLuhan? Well, when Woody Allen had enough, he brings Marshall McLuhan onscreen just long enough to shame the pedantic gentleman about how wrong he was.

Woody Allen: What do you do when you get stuck on a movie line with a guy like this behind you?

Man: Wait a minute, why can't I have my opinion. Isn't this is a free country?

Woody Allen: You can, but do you have to give it so loud? I mean, aren't you ashamed to pontificate like that? And the funny part of it is, that you don't know anything about Marshall McLuhan's work.

Man: Really? Really? I happen to teach a class at Columbia called TV, media, and culture. So I think that my insights into Mr. McLuhan will have a great deal of validity.

Woody Allen: Oh, do you?

Man: Yeah.

Woody Allen: You know, That's funny because I happen to have Mr. McLuhan right here. So, yeah, just let me... Come over here second.

Marshall McLuhan: Oh, I heard what you're saying. You know nothing of my work. You mean my whole fallacy is wrong. How you ever got to teach a course in anything is totally amazing.

Woody Allen: Boy, if only life were only like this.

Doescher: Boy, if only life were like this.

Doescher: Well, if you log onto your favorite news website, typically stories about inflation are not the most read stories. It's a topic that's seemingly so complex and often surrounded with bad news that reading and writing compounded is not ideal. But recently, more and more stories are popping up about inflation, so maybe it's time to take it back to the basics and define it. So instead of all these pedantic people standing behind you in a movie line, pontificating and misquoting things they know very little about, I figured we go right to the source. Milton Friedman famously said inflation is a monetary phenomenon. Our friends at Free to Choose Network have a great video posted of Friedman explaining.

Doescher: Maybe we can pretend like this is our movie line moment.

Milton Friedman: It is always and everywhere, a monetary phenomenon. It's always and everywhere, a result of too much money, of a more rapid increase in the quantity of money than an output. Moreover, in the modern era, the important next step is to recognize that today, governments control the quantity of money. So that as a result, inflation in the United States is made in Washington and nowhere else.

Friedman: If you listen to people in Washington and talk, they will tell you that inflation is produced by greedy businessmen or it's produced by grasping unions or it's produced by spendthrift consumers, or maybe, it's those terrible Arab Sheikhs who are producing it. Now, of course, businessmen are greedy. Who of us isn't? Trade unions are grasping. Who of us isn't? And there's no doubt that the consumer is a spendthrift. At least every man knows that about his wife.

Friedman: But none of them produce inflation for the very simple reason that neither the businessman, nor the trade union, nor the housewife has a printing press in their basement on which they can turn out those green pieces of paper we call money.

Doescher: Boy, if only life were like this. But it isn't. We can't pull out our favorite academic mind whenever we need to correctly portray a complex issue. So, since inflation is one of those issues, we're going to do our best to explain it on this episode. We recently spoke with Joel Griffith. He covers issues like inflation as a research fellow in the Roe Institute here at the Heritage Foundation. This week, Griffith gives us the basics on this very important issue and places it in context to the issues happening today.

Doescher: Okay, Joel, we're starting to see headlines increase. Actually, I saw one today from The New York Times, it says, "Inflation is here. What now?" So apparently, it's coming back in a real way. And I know that there are probably zero questions that you can answer simply with a yes or a no when talking about a matter like inflation, but I'm going to ask you a yes or no question. Is The New York Times right that inflation is here?

Joel Griffith: As a lawyer, it is difficult to answer that with-

Doescher: Well, and that's the answer: as a lawyer.

Griffith: Yes.

Doescher: Okay.

Griffith: But let's qualify that.

Doescher: Okay. All right, go ahead.

Griffith: The headline is, is a bit misleading because it suggests that up until this point inflation wasn't here. Well, in fact, ablation is here almost each and every year. In fact, going all the way back to 1955, the mid 1950s, there is only one year in that entire stretch that dates back to the time that our parents, for you and me, our parents are born, there's only been one time that we did not have inflation in a given year. That was back in 2009. So inflation is with us almost each and every year. Now the inflation rate that we see right now over the last 12 months, if this continues, this will be the most inflation we've seen in a given year dating back to 1991.

Doescher: Wow.

Griffith: So it's not in our imagination. Prices are going up at a dramatically higher fashion.

Doescher: Okay. So let's start there. We know that inflation is a rise in the general price level, and we go a step further and talk generally about the things that cause the general price level to increase. So let's start there, Joel, explain that.

Griffith: Yeah, so at an individual business level, you can have inflation. It can be a new hot product. It can be a new hot service where there's not a lot of it and people are clamoring to get their hands on it. Think of the cupcake craze that happened a few years ago. And you saw these businesses charging seven, eight, $9 or more for a cupcake.

Doescher: Right.

Griffith: Well, that was a localized phenomenon. And people wanted that. Now, in that type of environment, usually you'll have competitors that enter the marketplace and there'll begin servicing the public and you'll actually see that price come down. And those businesses will try to become more productive as well and maybe make those cupcakes more cheaply or spend less on the advertising. So that's localized and product specific. We can also have instances like we see right now with the gas spike over the past week, not the past year, but the past week because we have the pipeline that's been out of commission across the Eastern United States.

Doescher: Yeah, there's been a significant increase in gas prices we've noticed.

Griffith: Yeah. So that can be a temporary pause in supply in that instance. But in general, when we hear the term inflation, we're usually referring to this phenomenon where you see the general price level increase. And that's what we see right now, pretty much in every category, whether it's your housing, whether it's your rent, whether it's your vehicle, your food, we see that general level increasing at a higher rate than we've seen in many years. And that's caused by some broader reasons I think all of us should be much more concerned about.

Doescher: Joel, we've spent a lot of money over the last year through the COVID situation. We have seen an unspeakable amount of money being spent. And that's only on top of what we've spent in the past 10 to 20 years, all piling up on each other. With what's happening right now with inflation, is that lending to the rise of inflation?

Griffith: Oh, without a doubt, this is contributing to the very large burst of inflation. Think about what's happened over the past year. You've had not only the federal reserve printing enormous amounts of money buying assets, but you also have individuals that have been mostly enjoying the stimulus checks that have been deposited in their accounts or the student loan moratorium. If you look at the savings rate, for instance, the savings rate right now for families over the past year has been at an all time high. People have been actually saving money, sometimes paying down debt.

Griffith: But now, people are getting back to normal. They're beginning to spend all of this money that has been printed and borrowed and deposited. And this is starting to drive up the costs of all these goods. And on top of that, you have governments suppressing the supply of labor by paying people not to work. And so the cost of labor is going up, which then causes the cost of business. And businesses have to raise their prices to pay for the labor cost. And then we're ending up with a spiral now of higher prices and all these items.

Griffith: And suddenly, people that were enjoying the extra cash in their checking account, they're realizing, "Wow, I'm having to pay a lot more to fill up my car, to go grocery shopping, to pay the heat, the air conditioning for my home." It's catching up with us already.

Doescher: Wow. Okay. My next question is, is this going to just get worse?

Griffith: Well, governments often get away with inflation. Remember the governments have a vested interest in being able to have their central banks print these resources because as the value of that dollar declines relative to the goods that can purchase it, that also means the relative value of the government debt has gone down. It makes it easier for the government to service that debt. But we all pay that with the higher cost of our goods. We just don't notice it and that part is really a hidden tax because most people don't connect the dots. They just think it is a law of nature that prices are going to increase one or 2% a year.

Doescher: It's so funny. I mean, inflation is another tax that doesn't get debated in Congress. It doesn't have to go through the rigmarole.

Griffith: And here's something. In our country, we live in a relatively free economy, one of the freest in the world and because of that, each and every year, almost each and every year, we become more productive. We're able to do more with each hour that we work. We're able to do more with the technology that we have employed. And so we each and every year, we usually see an increase in our standard of living because those resources produce more.

Griffith: So over the last 10 years, for instance, we've seen prices have risen overall close to 20%.

Doescher: Right.

Griffith: But most people are living better lives because the typical wage has increased roughly 30%, but we need to ask ourselves absent the government manipulation of the money supply, absent that how much better would our lives be? And a big part of those increases in overall prices, that didn't happen because of mother nature, this isn't just some economic law that we're born with. No, that 20% decrease really in the amount of goods that each dollar buys, that's been a direct result of the actions of our government and of the central bank.

Doescher: So what are we going to see here? How are families, how are people going to be impacted? I mean, we've seen the photos of baskets of currency in Germany back in the thirties. That was to pay for a loaf of bread kind of a thing. My question is, what does inflation look like now in 2021?

Griffith: Well, I don't believe that we will end up in a situation we've seen in Zimbabwe or in Venezuela, where you have prices increasing by thousands of percent each year. But think about the damage that's done, even with think about over 50 years? At 2% per year over a 20 year or 30 year period, your dollar's value is cut in half.

Griffith: Well, think about what happens. If you have a stretch of even three or four years of eight or 9% inflation, it doesn't take long to erode a quarter of the value of your dollar. And if you are a saver, if you've been preparing for the future and been prudent, that means that your savings buy a lot less than they would have otherwise, even if we don't have those super high inflation rates that you've seen in some of these countries like Zimbabwe or Venezuela.

Doescher: Talk a little bit about what that's going to do for Americans.

Griffith: Well, if you look at what's happened over the past year, we've had a lot of commodity prices, the inputs, a lot of the products we enjoy increased dramatically. Think about corn. Now, a lot of us aren't eating corn every day, but it's used in our cereal. It's used in many products. It's used in our vehicles the government forces in ethanol.

Doescher: Corn to be true. We won't get down that road, but yeah.

Griffith: If you like to eat a good hamburger, well, yeah, chances are that, that cow is eating the corn. So we've seen corn prices for instance, increase about roughly 80% over the past year.

Doescher: Wow.

Griffith: But it's not just corn. It's lumber. Lumber has more than doubled in the last 12 months or so, which is used for not just your furniture is used for your homes as well. So a lot of these items that it trickles down into many other areas of our lives.

Doescher: So we're seeing also a lot of job openings right now. We have way more job openings and we have people that are in the workforce right now, willing to take those jobs. That's partially because of government decisions to pay more for unemployment benefits, things like that. What is that going to do to inflate? Does that contribute to inflation? Talk about some of the more contributing factors.

Griffith: Oh absolutely. When you look at the employment situation, in effect, now you have the government competing with private enterprises. Private enterprises are trying to purchase labor to work at their businesses. And meanwhile, you have the federal government that is, in effect, paying people not to work.

Doescher: Right.

Griffith: And you end up with a bidding war. And so you see wages going up, but in the long run, or even in the medium run, that doesn't mean that we're all going to be better off because the labor costs are going up because those businesses have to raise their prices to pay for that labor. Some businesses ended up going under completely.

Doescher: Right.

Griffith: And a lot of the costs that are going to end up being born for this artificial increase, and by artificial, I mean, when you have the federal government bidding with companies. The government paying someone not work, business trying to pay them to work. Well, those costs are going to often be born by the middle and lower income earners because a lot of those items that are being produced are consumer items that are consumed by those in the middle and lower class. And we have to remember that for those of larger amounts of wealth, they're often not consuming that wealth they're actually investing it. So these costs, when you see these items rise in price, it disproportionately impacts those that are middle-class and lower middle-class.

Doescher: Milton Friedman talks about how inflation is political. How it doesn't just happen. These are choices made by government officials saying, "Okay, well we need to subsidize first time house buyers," kind of a thing. So they inject more in. Or, "We need to do whatever policy that we need to do. We can't cut unemployment. So we have to print more money to pay for that." These are political choices that they make and he referred to it, Milton Friedman referred to it as a disease. So my question to you is how do you cure this disease?

Griffith: Well, curing this disease requires a public that becomes a more informed. And then that can translate into choosing the right people representing us. Because what politicians often want to deliver, more goodies to the public, which costs money. They also, usually don't like raising taxes.

Doescher: Right.

Griffith: So what is the end run around that? Well, that's what we see right now where you have a central bank that obliges the government by buying the debts of the government can then go ahead and spend the money. And then they hope that people don't realize that the resulting economic havoc or the slower growth or the higher prices, they hope the public won't recognize it. And usually they get away with it because with a free market, you more productivity, you have more wealth created and people don't realize that their life could be even better off and could be accelerating even more quickly were it not for the politicians doing this to the money supply. And usually they get away with it.

Griffith: In situations like this, it gives us a rare opportunity to explain to the public at a moment when their awareness is elevated because everyone is noticing that it costs more to fill up the car, to fill up the grocery cart, to pay their bills. People are noticing that something is awry. And as Milton Friedman once said, inflation always and everywhere is a monetary phenomenon.

Griffith: This problem is largely caused by the federal government and the politicians in DC really at this point, working hand in hand with the central bank to allow them to spend enormous quantities of money without, right now, raising taxes outright. And we're realizing now that this has consequences. My hope is that people, even after this episode passes, that people will begin to wonder how much better their lives could be each and every year because of the hard work that they're doing and all the investment that's being made in new technology and new businesses. How much better could their standard of living be each and every year were it not for this persistent inflation that each and every year, since 1955, each and every year, has inflicted its scourge on the American people? Perhaps the recognize that it indeed is a scourge going forward.

Doescher: Well, Joel, this is a huge one. You've tackled it and you have beat it into the ground very, very well. So thank you so much for joining us on this episode. I really appreciate it.

Griffith: Thank you, Tim.

Doescher: And that's it for this week's episode of heritage explains. It's a wrap. Now I've gone ahead and I've linked to great information in the show notes, including that great video featuring Milton Friedman. Go ahead and like us. Go ahead and leave us a comment. Send us an email at [email protected]. We read them. We respond to them. We appreciate them.

Doescher: I'll be back next week and we'll see you then.

Heritage Explains is brought to you by more than half a million members of The Heritage Foundation. It is produced by Michelle Cordero and Tim Doescher, with editing by John Popp.

Show Notes:

Heritage Foundation Q&A on Inflation

Specter of Rising Inflation Threatens Future Economic Freedom

Milton Friedman Speech on Inflation