WEBVTT 00:00:00.000 --> 00:00:02.359 Welcome to the Deep Dive, the only show that 00:00:02.359 --> 00:00:04.960 takes a huge stack of research material you wish 00:00:04.960 --> 00:00:08.259 you had time to read and, well, distills it into 00:00:08.259 --> 00:00:11.000 immediate structured knowledge. We don't just 00:00:11.000 --> 00:00:12.580 skim the headlines. We give you the foundations. 00:00:13.000 --> 00:00:16.920 Today, we are deep diving into inflation. And 00:00:16.920 --> 00:00:19.699 I mean, it is the single most important concept 00:00:19.699 --> 00:00:22.820 in macroeconomics. It's the force that governs 00:00:22.820 --> 00:00:24.879 everything from your retirement savings and the 00:00:24.879 --> 00:00:29.739 price of oil to. geopolitical stability and national 00:00:29.739 --> 00:00:32.140 elections. Absolutely. It is the universal signal 00:00:32.140 --> 00:00:35.000 for the health of any modern economy. It really 00:00:35.000 --> 00:00:38.579 is. Inflation dominates the news, yet the underlying 00:00:38.579 --> 00:00:41.100 mechanisms, the history, the conflicts over how 00:00:41.100 --> 00:00:43.200 we measure it, the intellectual battles over 00:00:43.200 --> 00:00:45.479 what causes it, all of that is often lost in 00:00:45.479 --> 00:00:47.840 the noise. Our listeners ask for a thorough, 00:00:48.020 --> 00:00:51.920 a rapid understanding that moves way beyond simple 00:00:51.920 --> 00:00:54.000 definitions. And that's our mission today. We 00:00:54.000 --> 00:00:56.060 have to establish the core concept right away. 00:00:56.509 --> 00:00:58.630 Inflation is defined as a sustained increase 00:00:58.630 --> 00:01:00.890 in the average price of goods and services over 00:01:00.890 --> 00:01:02.829 time. OK, the average price is a key distinction. 00:01:03.030 --> 00:01:05.250 It's the critical takeaway. This doesn't mean 00:01:05.250 --> 00:01:07.629 everything costs more. It means the currency 00:01:07.629 --> 00:01:10.930 itself has lost purchasing power. Each dollar 00:01:10.930 --> 00:01:14.430 or pound or euro just buys less than it did yesterday. 00:01:14.750 --> 00:01:17.209 OK, so let's unpack this and set the stage for 00:01:17.209 --> 00:01:20.400 our journey. We've analyzed a really comprehensive 00:01:20.400 --> 00:01:23.040 body of source material spanning centuries of 00:01:23.040 --> 00:01:24.959 economic thought. A lot to get through. A lot. 00:01:25.000 --> 00:01:28.400 We'll tackle three major areas. First, the surprising 00:01:28.400 --> 00:01:31.359 ancient roots of this, of currency devaluation 00:01:31.359 --> 00:01:34.120 and why the terminology itself has shifted. Second, 00:01:34.280 --> 00:01:36.599 the contentious debate about how we measure this 00:01:36.599 --> 00:01:39.500 force and, you know, what competing theories 00:01:39.500 --> 00:01:42.079 claim causes it. And that's where the real intellectual 00:01:42.079 --> 00:01:44.659 fights are. Exactly. Right. And third, the double 00:01:44.659 --> 00:01:47.819 -edged sword. The dramatic negative effects contrasted. 00:01:47.849 --> 00:01:50.269 with the surprising upsides that make central 00:01:50.269 --> 00:01:52.530 banks actively target moderate price increases. 00:01:52.790 --> 00:01:55.069 Our goal is to move you past simply knowing that 00:01:55.069 --> 00:01:57.310 prices are rising. We want to give you the intellectual 00:01:57.310 --> 00:01:59.870 tools to understand the crucial why and the how. 00:02:00.049 --> 00:02:02.670 This means grasping the foundational theories 00:02:02.670 --> 00:02:05.489 from classical quantity theory all the way up 00:02:05.489 --> 00:02:08.770 to the modern synthesis and understanding where 00:02:08.770 --> 00:02:11.330 economists genuinely disagree about the levers 00:02:11.330 --> 00:02:13.870 of control. Let's start by tightening up the 00:02:13.870 --> 00:02:17.389 language because even economists and Definitely 00:02:17.389 --> 00:02:20.810 politicians misuse the term inflation all the 00:02:20.810 --> 00:02:23.050 time. That's essential. We have to be clear that 00:02:23.050 --> 00:02:26.189 inflation is the general trend of prices, which 00:02:26.189 --> 00:02:28.590 signals a change in the value of the currency 00:02:28.590 --> 00:02:31.189 itself. OK. It is not, for example, when the 00:02:31.189 --> 00:02:33.370 price of gasoline goes up because a refinery 00:02:33.370 --> 00:02:36.090 shuts down. Or avocados get more expensive because 00:02:36.090 --> 00:02:38.030 of a drought in one region. Exactly. Those are 00:02:38.030 --> 00:02:40.090 specific price shifts. They're driven by very 00:02:40.090 --> 00:02:43.009 localized supply and demand imbalances. They 00:02:43.009 --> 00:02:45.590 might nudge the overall average, sure, but they 00:02:45.590 --> 00:02:48.050 are not the... general systemic devaluation of 00:02:48.050 --> 00:02:49.930 the dollar. So the inflation we're talking about 00:02:49.930 --> 00:02:52.229 is when the currency itself, kind of like a commodity, 00:02:52.449 --> 00:02:55.189 just becomes less valuable relative to everything 00:02:55.189 --> 00:02:58.669 else. Precisely. And if we trace the word back, 00:02:58.770 --> 00:03:01.169 it comes from the Latin inflare, which means 00:03:01.169 --> 00:03:04.930 to blow into or to inflate. But the economic 00:03:04.930 --> 00:03:07.449 meaning, it went through this fascinating historical 00:03:07.449 --> 00:03:10.550 shift in the 19th century. Oh, really? Initially, 00:03:10.550 --> 00:03:13.050 in places like the United States, inflation referred 00:03:13.050 --> 00:03:17.030 strictly to currency depreciation. So it wasn't 00:03:17.030 --> 00:03:19.430 about the price of bread going up. It was about 00:03:19.430 --> 00:03:22.150 the dollar, or I guess in the context of the 00:03:22.150 --> 00:03:25.530 American Civil War, the various private banknotes 00:03:25.530 --> 00:03:28.289 losing its value. You've got it. It was because 00:03:28.289 --> 00:03:31.629 the supply of those notes exceeded the redeemable 00:03:31.629 --> 00:03:34.099 metal backing, like gold or silver. Oh, I see. 00:03:34.259 --> 00:03:36.340 During periods like the Civil War, private banks 00:03:36.340 --> 00:03:38.319 would often issue bank notes far beyond their 00:03:38.319 --> 00:03:42.240 metallic reserves. The term inflation was used 00:03:42.240 --> 00:03:45.020 to describe this swelling, this inflation of 00:03:45.020 --> 00:03:47.439 the money supply relative to its hard backing. 00:03:47.680 --> 00:03:50.020 So the rising prices of goods was seen as a symptom 00:03:50.020 --> 00:03:52.520 of that currency problem. Exactly. Not the problem 00:03:52.520 --> 00:03:55.020 itself. And this original view, it aligns very 00:03:55.020 --> 00:03:57.000 closely with classical economists like David 00:03:57.000 --> 00:03:59.379 Ricardo, who really stressed the importance of 00:03:59.379 --> 00:04:02.800 backing your currency with real assets. That 00:04:02.800 --> 00:04:05.759 relationship, that the volume of money relative 00:04:05.759 --> 00:04:09.659 to its value is the core issue, is ancient. But 00:04:09.659 --> 00:04:12.960 the language keeps evolving. Okay, so let's quickly 00:04:12.960 --> 00:04:14.960 equip our listener with the essential vocabulary 00:04:14.960 --> 00:04:18.100 they'll need to follow any macro debate. Certainly. 00:04:18.199 --> 00:04:21.600 We know inflation is the general rise. Its precise 00:04:21.600 --> 00:04:25.100 opposite is deflation. A sustained fall in the 00:04:25.100 --> 00:04:27.300 general price level. Right. And that's often 00:04:27.300 --> 00:04:29.459 viewed very negatively by economists, and we'll 00:04:29.459 --> 00:04:32.470 definitely explore why later. Then there's disinflation. 00:04:32.629 --> 00:04:34.949 This is a term we hear a lot when central banks 00:04:34.949 --> 00:04:38.269 are trying to claim a victory. Yes. And disinflation 00:04:38.269 --> 00:04:40.509 is crucial for distinguishing effective policy. 00:04:40.769 --> 00:04:43.410 It is not a price reversal. Prices are still 00:04:43.410 --> 00:04:45.730 rising, but the rate of that rise is slowing 00:04:45.730 --> 00:04:48.490 down. So if inflation goes from, say, 7 % down 00:04:48.490 --> 00:04:50.949 to 3%, that's disinflation. That's disinflation. 00:04:50.990 --> 00:04:54.329 If it goes from 3 % to minus 1%, that's deflation. 00:04:54.550 --> 00:04:56.810 Got it. And what about the worst case scenario, 00:04:57.029 --> 00:04:59.500 the one that defines monetary catastrophe? That 00:04:59.500 --> 00:05:02.660 is hyperinflation, an out -of -control inflationary 00:05:02.660 --> 00:05:05.339 spiral. Our sources highlight Venezuela, which, 00:05:05.420 --> 00:05:08.720 as of October 2018, experienced an annual inflation 00:05:08.720 --> 00:05:15.019 rate of 833 ,997%. That number is just, it's 00:05:15.019 --> 00:05:17.160 hard to even comprehend. It is essentially a 00:05:17.160 --> 00:05:19.879 total collapse of faith in the currency. Money 00:05:19.879 --> 00:05:22.720 loses all utility as a store of value or a medium 00:05:22.720 --> 00:05:25.399 of exchange. And then there's the dreaded combination 00:05:25.399 --> 00:05:29.129 that haunted the 1970s. Stagflation. This is 00:05:29.129 --> 00:05:31.370 arguably the most challenging economic environment 00:05:31.370 --> 00:05:33.990 for policymakers. Why is that? Because it combines 00:05:33.990 --> 00:05:36.310 high inflation with two symptoms of a recession. 00:05:36.790 --> 00:05:39.870 Slow economic growth and high unemployment. The 00:05:39.870 --> 00:05:42.350 traditional tools just don't work. So the tools 00:05:42.350 --> 00:05:44.149 you'd use to fight a recession like stimulating 00:05:44.149 --> 00:05:46.430 demand would just make inflation worse. And the 00:05:46.430 --> 00:05:48.230 tools you'd use to fight inflation like raising 00:05:48.230 --> 00:05:49.990 interest rates would just make unemployment worse. 00:05:50.069 --> 00:05:51.850 You're stuck. We also need to distinguish between 00:05:51.850 --> 00:05:54.790 that core inflation and price changes in specific 00:05:54.790 --> 00:05:57.500 sectors, right? Right. We have... Asset price 00:05:57.500 --> 00:05:59.639 inflation, where the prices of financial assets 00:05:59.639 --> 00:06:02.759 like stocks, bonds, real estate, they're all 00:06:02.759 --> 00:06:05.199 increasing rapidly. Often because there's a lot 00:06:05.199 --> 00:06:07.339 of liquidity, a lot of cash in the system. Exactly. 00:06:07.540 --> 00:06:10.360 But the prices of everyday consumer goods, the 00:06:10.360 --> 00:06:12.459 stuff in the CPI, they don't necessarily follow 00:06:12.459 --> 00:06:15.160 immediately. And then you have terms like agflation. 00:06:15.519 --> 00:06:17.920 Agflation. Which describes a disproportionate 00:06:17.920 --> 00:06:20.019 increase in the price of food and agricultural 00:06:20.019 --> 00:06:22.860 crops compared to the general rate of inflation. 00:06:23.279 --> 00:06:26.279 Okay, so... If the concept of currency devaluation 00:06:26.279 --> 00:06:29.220 is that old, let's trace its historical mechanisms. 00:06:29.439 --> 00:06:31.620 The earliest forms of inflation weren't about 00:06:31.620 --> 00:06:34.420 central banks or monetary policy. They were about, 00:06:34.560 --> 00:06:38.040 well, the physical governmental manipulation 00:06:38.040 --> 00:06:40.879 of currency. Indeed. The earliest documented 00:06:40.879 --> 00:06:43.160 inflation, it occurred in Alexander the Great's 00:06:43.160 --> 00:06:46.759 empire around 330 B .C. driven by his massive 00:06:46.759 --> 00:06:49.540 expansion and this sheer volume of coins he minted. 00:06:49.579 --> 00:06:52.519 But the Roman Empire, that provides the classic 00:06:52.519 --> 00:06:55.000 crystal clear example of how the mechanism works, 00:06:55.220 --> 00:06:57.600 debasement. Okay, tell us how the Roman government 00:06:57.600 --> 00:07:00.300 effectively manufactured inflation and funded 00:07:00.300 --> 00:07:02.620 its operations through the coin itself. It was 00:07:02.620 --> 00:07:06.319 a simple, profitable, and ultimately disastrous 00:07:06.319 --> 00:07:09.139 cycle. When the Roman government needed more 00:07:09.139 --> 00:07:12.160 money to fund its army or its bureaucracy, it 00:07:12.160 --> 00:07:15.019 would recall silver coins. The ones already in 00:07:15.019 --> 00:07:18.079 circulation. Yes. They'd melt them down and then 00:07:18.079 --> 00:07:20.500 mix the silver with cheaper metals like copper 00:07:20.500 --> 00:07:23.100 or lead. Then they would reissue a greater number 00:07:23.100 --> 00:07:25.439 of coins at the same face value. So the government 00:07:25.439 --> 00:07:28.259 was secretly reducing the real metallic content 00:07:28.259 --> 00:07:30.459 of the currency while telling everyone it was 00:07:30.459 --> 00:07:33.160 worth the same. The citizens still had a coin 00:07:33.160 --> 00:07:35.839 called a denarius, but the intrinsic value of 00:07:35.839 --> 00:07:38.920 that coin had just plummeted. Exactly. When Nero 00:07:38.920 --> 00:07:41.939 was emperor around AD 54, the... Denarius was 00:07:41.939 --> 00:07:46.019 more than 90 % silver. By the 270s, during all 00:07:46.019 --> 00:07:49.060 the military crises and internal chaos, the coin 00:07:49.060 --> 00:07:51.939 contained hardly any silver at all. Wow. By that 00:07:51.939 --> 00:07:54.339 point, citizens needed exponentially more of 00:07:54.339 --> 00:07:56.500 these worthless coins to purchase the same amount 00:07:56.500 --> 00:07:58.939 of grain or oil. And the profit the government 00:07:58.939 --> 00:08:01.899 made from this process is called seniorage, right? 00:08:02.279 --> 00:08:04.339 Could you clarify that term for our listener? 00:08:04.720 --> 00:08:06.779 Seniorage is the difference between the face 00:08:06.779 --> 00:08:09.439 value of the currency and the cost to produce 00:08:09.439 --> 00:08:13.149 it. When a coin was 90 % silver, the seniorage 00:08:13.149 --> 00:08:15.189 profit was pretty small. Right. But when they 00:08:15.189 --> 00:08:18.490 diluted that silver content down to 5%, the cost 00:08:18.490 --> 00:08:21.310 of production dropped dramatically and the government's 00:08:21.310 --> 00:08:24.350 profit, the seniorage, exploded. This was effectively 00:08:24.350 --> 00:08:27.329 a hidden tax. A non -interest -bearing loan extracted 00:08:27.329 --> 00:08:29.889 from the populace just by manipulating the money 00:08:29.889 --> 00:08:33.120 supply itself. It's a pure state -driven increase 00:08:33.120 --> 00:08:36.059 in the money supply that led directly to a rapid 00:08:36.059 --> 00:08:38.919 loss of purchasing power millennia before we 00:08:38.919 --> 00:08:41.539 had modern fiat currencies. And we see the inverse 00:08:41.539 --> 00:08:44.220 effect with commodity money supply changes, too. 00:08:44.320 --> 00:08:46.820 You have to consider the gold shock of 1324. 00:08:47.059 --> 00:08:50.259 Ah, Mansa Musa. Exactly. When the Malian king 00:08:50.259 --> 00:08:53.059 embarked on his famous Hajj to Mecca, he traveled 00:08:53.059 --> 00:08:55.559 with this vast retinue and quite literally gave 00:08:55.559 --> 00:08:58.919 away and spent enormous quantities of gold. So 00:08:58.919 --> 00:09:01.480 much gold in Cairo that its price was significantly 00:09:01.480 --> 00:09:03.899 depressed for over a decade. That's a perfect 00:09:03.899 --> 00:09:06.779 real -world example of a sudden, rapid increase 00:09:06.779 --> 00:09:09.600 in the supply of a commodity money leading to 00:09:09.600 --> 00:09:12.980 immediate inflation. Or, in this case, a dramatic 00:09:12.980 --> 00:09:15.259 reduction in the purchasing power of gold itself. 00:09:15.620 --> 00:09:17.740 The historian who observed it noted the value 00:09:17.740 --> 00:09:20.039 of the gold myth quell fell significantly and 00:09:20.039 --> 00:09:22.539 it just stayed cheap afterward. And this leads 00:09:22.539 --> 00:09:25.019 us to the most significant inflationary cycle 00:09:25.019 --> 00:09:27.539 of early modern Europe. the price revolution 00:09:27.539 --> 00:09:31.179 between the 15th and 17th centuries. Over a period 00:09:31.179 --> 00:09:35.360 of 150 years, prices in Western Europe rose sixfold. 00:09:35.500 --> 00:09:38.039 Sixfold. What were the key drivers of such a 00:09:38.039 --> 00:09:41.389 massive, sustained inflation? Well, the sources 00:09:41.389 --> 00:09:43.950 cite two dominant and compounding factors. The 00:09:43.950 --> 00:09:46.570 first and the most famous was the massive influx 00:09:46.570 --> 00:09:49.190 of silver and gold from the New World into Habsburg, 00:09:49.230 --> 00:09:51.269 Spain. And from Spain, it spread into the rest 00:09:51.269 --> 00:09:53.450 of Europe. Yes, it literally flooded a previously 00:09:53.450 --> 00:09:55.809 cash -starved continent with precious metal, 00:09:55.970 --> 00:09:58.649 expanding the monetary base significantly. So 00:09:58.649 --> 00:10:00.750 a pretty straightforward quantity theory of money 00:10:00.750 --> 00:10:03.570 explanation seems to hold true there. More money 00:10:03.570 --> 00:10:06.169 chasing the same amount of goods. It does, but 00:10:06.169 --> 00:10:09.190 the second factor complicates the picture. The 00:10:09.190 --> 00:10:12.029 European population was rebounding robustly after 00:10:12.029 --> 00:10:15.090 the devastation of the Black Death. So more people. 00:10:15.250 --> 00:10:17.809 A rebounding population means dramatically increased 00:10:17.809 --> 00:10:20.389 aggregate demand, particularly for essential 00:10:20.389 --> 00:10:23.590 goods like food and land. This demand pull inflation 00:10:23.590 --> 00:10:26.450 combined powerfully with the monetary shock from 00:10:26.450 --> 00:10:28.750 the New World silver, making the overall price 00:10:28.750 --> 00:10:31.509 rise even worse in the 16th century. So even 00:10:31.509 --> 00:10:33.789 in pre -industrial history, inflation was already 00:10:33.789 --> 00:10:36.610 a multi -factor problem. It was a mix of money 00:10:36.610 --> 00:10:39.330 supply shocks and real economic activity shocks. 00:10:39.470 --> 00:10:41.250 That's right. So if that's how the historical 00:10:41.250 --> 00:10:44.269 route set the stage, the... challenge now in 00:10:44.269 --> 00:10:46.590 our fiat currency world is how we accurately 00:10:46.590 --> 00:10:49.029 measure this ever -changing force. Moving into 00:10:49.029 --> 00:10:51.409 the modern era, the first requirement of any 00:10:51.409 --> 00:10:54.090 central bank is accurate measurement. Inflation 00:10:54.090 --> 00:10:56.409 is defined by the annualized percentage change 00:10:56.409 --> 00:10:58.490 in a general price index, and the most common 00:10:58.490 --> 00:11:01.610 one is a consumer price index, or CPI. The CPI 00:11:01.610 --> 00:11:03.350 is designed to approximate the price changes 00:11:03.350 --> 00:11:05.850 for an average urban consumer. Let's make that 00:11:05.850 --> 00:11:08.570 calculation tangible using the U .S. CPI numbers 00:11:08.570 --> 00:11:11.879 from 2007 -2008 that our research provided. Okay, 00:11:11.899 --> 00:11:15.840 so if the index starts at 2802 .416 the beginning 00:11:15.840 --> 00:11:20.059 of the year, and it rises to 211 .080 by the 00:11:20.059 --> 00:11:22.220 end of the year, the calculation involves finding 00:11:22.220 --> 00:11:24.399 the percentage change. You take the difference, 00:11:24.559 --> 00:11:27.980 which is 8 .664, and divide it by the starting 00:11:27.980 --> 00:11:31.960 number. 2 over 2 .416, then multiply by 100. 00:11:32.259 --> 00:11:35.580 And that gives us 4 .28%. The takeaway for you 00:11:35.580 --> 00:11:38.240 is that this 4 .28 % is the official measure 00:11:38.240 --> 00:11:40.279 of how much the purchasing power of the dollar 00:11:40.279 --> 00:11:43.000 declined for a typical consumer in that 12 -month 00:11:43.000 --> 00:11:45.500 period based on their hypothetical basket of 00:11:45.500 --> 00:11:47.740 goods. But central bankers need more than just 00:11:47.740 --> 00:11:49.720 the historical CPI, don't they? They use a whole 00:11:49.720 --> 00:11:52.159 suite of tools, leading and lagging indicators. 00:11:52.580 --> 00:11:54.580 That's right. The CPI is a lagging indicator. 00:11:54.879 --> 00:11:56.460 It tells you what happened to the consumer in 00:11:56.460 --> 00:11:59.710 the past month or year. Exactly. Which is why 00:11:59.710 --> 00:12:02.850 the producer price indices, PPIs, are so closely 00:12:02.850 --> 00:12:04.490 watched they're considered a leading indicator 00:12:04.490 --> 00:12:07.070 for inflation. Why leading? The PPI measures 00:12:07.070 --> 00:12:09.350 the change in prices received by domestic producers 00:12:09.350 --> 00:12:11.460 for their output. So think of it as measuring 00:12:11.460 --> 00:12:13.559 the cost of raw materials, intermediate inputs, 00:12:13.759 --> 00:12:16.019 wholesale components, if the cost of those inputs 00:12:16.019 --> 00:12:18.720 surged. That's a supply shock. It's the definition 00:12:18.720 --> 00:12:21.299 of a supply shock, creating immense cost pressure 00:12:21.299 --> 00:12:24.000 on manufacturers. And eventually, those manufacturers 00:12:24.000 --> 00:12:26.519 have to pass those costs along to the consumer 00:12:26.519 --> 00:12:29.759 to maintain their margins. Precisely. There is 00:12:29.759 --> 00:12:32.500 a time lag. So a surge in the PPI suggests that 00:12:32.500 --> 00:12:35.519 consumer prices, the CPI, are likely to follow 00:12:35.519 --> 00:12:37.879 suit in the coming months. It gives the central 00:12:37.879 --> 00:12:40.539 bank an early warning. Then we have the metric 00:12:40.539 --> 00:12:42.779 that really dominates the internal discussions 00:12:42.779 --> 00:12:46.200 at central banks. Core inflation. Why is the 00:12:46.200 --> 00:12:48.620 Federal Reserve, for instance, willing to exclude 00:12:48.620 --> 00:12:51.919 crucial everyday expenses like food and energy? 00:12:52.250 --> 00:12:54.389 This goes back to their goal of long term stability. 00:12:54.809 --> 00:12:57.409 Food and energy prices are notoriously volatile. 00:12:57.669 --> 00:13:00.389 They're affected by specific, often temporary 00:13:00.389 --> 00:13:03.190 shocks, a hurricane in the Gulf, a cartel decision 00:13:03.190 --> 00:13:06.309 on oil supply, a crop failure. So they move sharply, 00:13:06.450 --> 00:13:08.389 but they don't necessarily reflect the underlying 00:13:08.389 --> 00:13:10.750 generalized monetary pressure in the economy. 00:13:10.990 --> 00:13:13.769 Exactly. So by stripping out that noise, the 00:13:13.769 --> 00:13:15.870 Fed believes it gets a clearer picture of the 00:13:15.870 --> 00:13:18.490 persistent long term future inflation trend. 00:13:18.789 --> 00:13:21.370 The trend driven by things like expectations. 00:13:21.580 --> 00:13:24.460 and overall aggregate demand. So core inflation 00:13:24.460 --> 00:13:27.399 is seen as a better predictor of where inflation 00:13:27.399 --> 00:13:29.559 will settle over the next year or two. That's 00:13:29.559 --> 00:13:32.000 the goal, making it the preferred target for 00:13:32.000 --> 00:13:34.000 policy adjustments like interest rate hikes. 00:13:34.139 --> 00:13:36.679 Now here is where we get into the real intellectual 00:13:36.679 --> 00:13:40.200 friction. Despite all these sophisticated tools, 00:13:40.460 --> 00:13:43.379 virtually all economists agree on one thing. 00:13:43.980 --> 00:13:46.980 Measuring true inflation is exceptionally difficult. 00:13:47.360 --> 00:13:49.820 It really is. And research consistently suggests 00:13:49.820 --> 00:13:52.860 that the official rate, while it's the best we 00:13:52.860 --> 00:13:56.740 have, often contains significant biases. The 00:13:56.740 --> 00:13:59.240 problem lies in the design of that basket of 00:13:59.240 --> 00:14:01.620 goods. It contains weighted prices reflecting 00:14:01.620 --> 00:14:05.059 typical consumer purchases. But this fixed basket 00:14:05.059 --> 00:14:07.799 introduces two major sources of bias that can 00:14:07.799 --> 00:14:10.080 distort the official rate. And the first one 00:14:10.080 --> 00:14:12.700 is the substitution effect. Explain why that 00:14:12.700 --> 00:14:14.960 might make the official rate overstated. OK, 00:14:15.019 --> 00:14:17.279 so when statisticians calculate the index, they 00:14:17.279 --> 00:14:19.360 track the price of a fixed quantity of items. 00:14:19.600 --> 00:14:21.860 If the price of gasoline spikes, the average 00:14:21.860 --> 00:14:23.860 consumer doesn't just keep buying the same amount 00:14:23.860 --> 00:14:25.980 of gas. Of course not. They drive less. They 00:14:25.980 --> 00:14:28.200 take the train. They substitute. They substitute 00:14:28.200 --> 00:14:30.519 the expensive good for a cheaper alternative. 00:14:31.529 --> 00:14:34.250 But the index assumes they continue buying that 00:14:34.250 --> 00:14:37.029 now expensive gas at the same weight. So their 00:14:37.029 --> 00:14:39.649 actual cost of living rises, but not as quickly 00:14:39.649 --> 00:14:42.730 as the fixed basket index suggests it does. Exactly. 00:14:42.730 --> 00:14:46.250 The official CPI overstates the true impact of 00:14:46.250 --> 00:14:49.070 those price rises on a consumer who rationally 00:14:49.070 --> 00:14:51.409 changes their purchasing habits. The second major 00:14:51.409 --> 00:14:54.519 issue is the challenge of quality. or unobserved 00:14:54.519 --> 00:14:57.159 quality improvements? This is a tricky one. If 00:14:57.159 --> 00:15:00.220 a laptop costs 5 % more this year, but it has 00:15:00.220 --> 00:15:03.539 twice the memory, a better screen, and a faster 00:15:03.539 --> 00:15:06.539 processor, has the real price of that functionality 00:15:06.539 --> 00:15:09.960 gone up or down? That's a great question. Statisticians 00:15:09.960 --> 00:15:12.019 struggle mightily to fully account for these 00:15:12.019 --> 00:15:14.620 quality improvements in existing products and 00:15:14.620 --> 00:15:17.100 the introduction of entirely new valuable goods. 00:15:17.360 --> 00:15:19.740 And the sources suggest this leads to an overestimation 00:15:19.740 --> 00:15:22.840 of the price rise because the index just registers 00:15:23.019 --> 00:15:25.220 a higher nominal cost without fully adjusting 00:15:25.220 --> 00:15:27.320 for the massive increase in utility the consumer 00:15:27.320 --> 00:15:29.399 is getting. And that's before you even consider 00:15:29.399 --> 00:15:32.139 brand new products. Think of a life -saving medicine 00:15:32.139 --> 00:15:35.059 or some revolutionary software. If it wasn't 00:15:35.059 --> 00:15:37.700 available last year at any price, its introduction 00:15:37.700 --> 00:15:40.820 is like an infinite improvement in quality at 00:15:40.820 --> 00:15:43.580 a finite price. It's almost impossible to fully 00:15:43.580 --> 00:15:46.240 quantify in an index. So we have minimum issues 00:15:46.240 --> 00:15:48.740 and we have perception issues. Yeah. There's 00:15:48.740 --> 00:15:51.399 a clear divide between the official rate and 00:15:51.399 --> 00:15:53.620 what people feel in their wallets, the perceived 00:15:53.620 --> 00:15:56.529 inflation gap. Why do people generally feel that 00:15:56.529 --> 00:15:58.750 inflation is higher than the government reports? 00:15:59.230 --> 00:16:01.950 There are a couple of major psychological factors 00:16:01.950 --> 00:16:05.129 at play. First is frequency bias. People focus 00:16:05.129 --> 00:16:07.370 overwhelmingly on the prices of things they buy 00:16:07.370 --> 00:16:10.129 all the time, like food and fuel. The volatile 00:16:10.129 --> 00:16:12.830 stuff. The most volatile stuff. They buy a refrigerator 00:16:12.830 --> 00:16:15.529 maybe once a decade and forget the price, but 00:16:15.529 --> 00:16:17.710 they remember the price of eggs from last week. 00:16:17.889 --> 00:16:20.690 And second, it's the compound effect. We often 00:16:20.690 --> 00:16:23.750 think of 2 % inflation as modest. But we forget 00:16:23.750 --> 00:16:26.929 what happens over time. A low, steady 2 percent 00:16:26.929 --> 00:16:30.669 inflation rate for, say, 35 years. A typical 00:16:30.669 --> 00:16:33.009 career span results in prices nearly doubling. 00:16:33.649 --> 00:16:36.529 People deeply feel that cumulative inflation, 00:16:36.710 --> 00:16:39.370 the compound pain of the erosion of purchasing 00:16:39.370 --> 00:16:42.809 power over decades, even if the annual rate itself 00:16:42.809 --> 00:16:45.350 has been stable. To wrap up our discussion on 00:16:45.350 --> 00:16:48.629 measurement, it's worth noting the more whimsical 00:16:48.629 --> 00:16:50.929 indices that show how tailored price tracking 00:16:50.929 --> 00:16:53.470 can be. They really demonstrate the complexity 00:16:53.470 --> 00:16:56.679 of translating these abstract economic concepts 00:16:56.679 --> 00:16:59.200 into lived reality. Right, like the globally 00:16:59.200 --> 00:17:01.960 recognized Big Mac Index. It's used to compare 00:17:01.960 --> 00:17:04.500 the relative purchasing power of currencies by 00:17:04.500 --> 00:17:06.619 tracking the price of an identical standardized 00:17:06.619 --> 00:17:09.839 product, the Big Mac, across dozens of countries. 00:17:10.140 --> 00:17:12.079 Or the hyper -local ones like the Jollof Index 00:17:12.079 --> 00:17:14.859 in West Africa or the Two Dishes, One Soup Index 00:17:14.859 --> 00:17:17.559 in Hong Kong. These measure the true cost of 00:17:17.559 --> 00:17:19.839 living and eating for specific populations, which 00:17:19.839 --> 00:17:21.759 can feel much more relevant than a centralized 00:17:21.759 --> 00:17:24.680 CPI. And of course, the famous Lipstick Index. 00:17:25.069 --> 00:17:27.690 was popularized after the 9 -11 downturn. The 00:17:27.690 --> 00:17:29.609 idea that when people can't afford big luxuries, 00:17:29.609 --> 00:17:31.569 they turn to small affordable ones like lipstick. 00:17:31.829 --> 00:17:34.289 Exactly. It's an indicator of consumer sentiment 00:17:34.289 --> 00:17:36.789 and substitution behavior during tough times. 00:17:37.009 --> 00:17:38.890 So if that's how we track the value of the currency, 00:17:39.130 --> 00:17:42.329 the next monumental question for economists is 00:17:42.329 --> 00:17:44.690 figuring out what actually moves that needle. 00:17:45.130 --> 00:17:47.390 This is where the real battle of ideas begins. 00:17:47.809 --> 00:17:49.890 Historically, the debate over the cause of inflation 00:17:49.890 --> 00:17:53.089 has been dominated by one central question. Is 00:17:53.089 --> 00:17:56.210 inflation primarily a monetary phenomenon driven 00:17:56.210 --> 00:17:58.910 by the supply of money, or is it a real phenomenon 00:17:58.910 --> 00:18:01.150 driven by the supply and demand for goods and 00:18:01.150 --> 00:18:03.849 services? And the oldest and perhaps most elegant 00:18:03.849 --> 00:18:06.049 answer comes from the quantity theory of money, 00:18:06.289 --> 00:18:10.490 QTM. This theory, revived and championed by the 00:18:10.490 --> 00:18:13.130 monetarist school, led by Milton Friedman, gave 00:18:13.130 --> 00:18:15.430 us that famous assertion. Inflation is always 00:18:15.430 --> 00:18:18.190 and everywhere a monetary phenomenon. QTM is 00:18:18.190 --> 00:18:21.109 rooted in the equation of exchange. MV equals 00:18:21.109 --> 00:18:24.170 PQ. M is the nominal quantity of money circulating 00:18:24.170 --> 00:18:27.069 in the economy. V is the velocity of money, how 00:18:27.069 --> 00:18:29.970 often money changes hands. P is the general price 00:18:29.970 --> 00:18:32.789 level, what we measure with CPI. And Q is the 00:18:32.789 --> 00:18:35.349 real economic output, or GDP. So if the total 00:18:35.349 --> 00:18:38.470 amount spent, MV, must equal the total value 00:18:38.470 --> 00:18:42.210 of goods sold, PQ, What are the assumptions that 00:18:42.210 --> 00:18:44.690 make QTM so powerful in saying that money supply 00:18:44.690 --> 00:18:47.970 growth causes inflation? Well, monetarists assume 00:18:47.970 --> 00:18:51.089 that in the long run, both V velocity and Q output 00:18:51.089 --> 00:18:54.109 are stable or determined independently of the 00:18:54.109 --> 00:18:56.630 money supply. Velocity tends to be relatively 00:18:56.630 --> 00:18:59.670 stable and real output Q is determined by the 00:18:59.670 --> 00:19:02.250 economy's productive capacity, technology, labor, 00:19:02.450 --> 00:19:04.970 capital. So if you increase M, the money supply, 00:19:05.230 --> 00:19:07.289 substantially faster than the economy can grow 00:19:07.289 --> 00:19:11.150 Q. its output. Then P, prices, must increase 00:19:11.150 --> 00:19:13.549 proportionally to balance the equation. It's 00:19:13.549 --> 00:19:16.130 money chasing too few goods. The rival approach 00:19:16.130 --> 00:19:18.690 historically was the real bills doctrine, RBD, 00:19:18.809 --> 00:19:21.369 also known as the backing theory. Adam Smith 00:19:21.369 --> 00:19:23.730 and many 19th century thinkers laid out this 00:19:23.730 --> 00:19:26.450 idea. It argues that inflation only results if 00:19:26.450 --> 00:19:28.309 the money issued is not backed by sufficient 00:19:28.309 --> 00:19:31.450 real assets or real bills of value. So if a bank 00:19:31.450 --> 00:19:34.109 issues a loan creating money against a tangible 00:19:34.109 --> 00:19:36.509 asset that is short term and valuable, that new 00:19:36.509 --> 00:19:38.250 money is legitimate and won't cause inflation 00:19:38.250 --> 00:19:40.680 even if the quantity of money goes up. Correct. 00:19:40.779 --> 00:19:43.240 The RBD supporters believed that money should 00:19:43.240 --> 00:19:45.559 be issued based on the legitimate needs of trade. 00:19:45.839 --> 00:19:48.619 If money creation is backed by real value, it 00:19:48.619 --> 00:19:51.480 holds its value regardless of the sheer quantity. 00:19:51.680 --> 00:19:54.180 Whereas the QTM supporters were all about the 00:19:54.180 --> 00:19:56.299 quantity. They said the sheer quantity mattered 00:19:56.299 --> 00:19:59.400 most, not the quality of the backing. This conflict 00:19:59.400 --> 00:20:02.500 was the first great monetary debate. This debate 00:20:02.500 --> 00:20:05.200 then shifted dramatically with the rise of Keynesian 00:20:05.200 --> 00:20:08.059 economics in the mid -20th century. Right. John 00:20:08.059 --> 00:20:10.339 Maynard Keynes' crucial insight was that in the 00:20:10.339 --> 00:20:13.519 short run, that QTM assumption that prices, P, 00:20:13.700 --> 00:20:16.599 will adjust quickly, is false. He emphasized 00:20:16.599 --> 00:20:19.519 sticky wages and prices. So when demand falls, 00:20:19.779 --> 00:20:22.140 firms don't immediately cut wages or prices. 00:20:22.319 --> 00:20:24.180 No. They first cut production and employment. 00:20:24.460 --> 00:20:27.380 Therefore, demand shocks affect output. Q first, 00:20:27.559 --> 00:20:30.619 not prices P. This led to the empirical observation 00:20:30.619 --> 00:20:33.900 in 1958 of the Phillips curve, which showed an 00:20:33.900 --> 00:20:36.539 inverse relationship between inflation and unemployment. 00:20:36.779 --> 00:20:39.720 And early Keynesians interpreted this as a stable, 00:20:39.859 --> 00:20:43.240 exploitable tradeoff. They believed policymakers 00:20:43.240 --> 00:20:45.559 could literally choose a point on the curve. 00:20:46.140 --> 00:20:48.299 a little more inflation for a lot less unemployment 00:20:48.299 --> 00:20:51.779 or vice versa. This informed policy all through 00:20:51.779 --> 00:20:54.700 the 1960s. But the stable Phillips curve was 00:20:54.700 --> 00:20:57.059 demolished by the monitor's challenge in the 00:20:57.059 --> 00:21:00.220 late 1960s, led by Friedman and Edmund Phelps. 00:21:00.420 --> 00:21:02.400 They argued that tradeoff was only temporary 00:21:02.400 --> 00:21:05.079 because it ignored the crucial role of human 00:21:05.079 --> 00:21:07.819 expectation. Expectations. If the government 00:21:07.819 --> 00:21:10.599 consistently stimulates demand to keep unemployment 00:21:10.599 --> 00:21:13.640 low, the resulting higher inflation eventually 00:21:13.640 --> 00:21:16.380 becomes built in. Firms and workers aren't fooled 00:21:16.380 --> 00:21:18.660 forever. They start to expect it. So workers 00:21:18.660 --> 00:21:21.000 demand higher nominal wages to maintain their 00:21:21.000 --> 00:21:23.759 purchasing power. And firms raise prices to cover 00:21:23.759 --> 00:21:26.019 those labor costs, leading to a self -fulfilling 00:21:26.019 --> 00:21:28.700 wage price spiral. The consequence of this realization 00:21:28.700 --> 00:21:31.380 was the introduction of two transformative concepts 00:21:31.380 --> 00:21:35.440 in modern macroeconomics, NARU and rational expectations 00:21:35.440 --> 00:21:39.079 theory. NARU stands for the non -accelerating 00:21:39.079 --> 00:21:41.880 inflation rate of unemployment. It is the lowest 00:21:41.880 --> 00:21:44.440 level of unemployment the economy can sustain 00:21:44.440 --> 00:21:47.980 without causing inflation to continually accelerate. 00:21:48.380 --> 00:21:51.940 So if you try to push unemployment below NRU. 00:21:52.140 --> 00:21:54.240 You'll just get perpetually higher inflation 00:21:54.240 --> 00:21:56.440 as people constantly raise their expectations. 00:21:56.920 --> 00:21:59.240 This is what explained the stagflation of the 00:21:59.240 --> 00:22:01.660 1970s high inflation and high unemployment at 00:22:01.660 --> 00:22:04.000 the same time. And rational expectations theory 00:22:04.000 --> 00:22:06.700 reinforced the importance of central bank behavior. 00:22:07.240 --> 00:22:09.859 It posits that economic agents look rationally 00:22:09.859 --> 00:22:12.119 into the future and use all available information 00:22:12.119 --> 00:22:14.799 to predict what policy will do. This is why central 00:22:14.799 --> 00:22:17.859 bank credibility is absolutely key. If a central 00:22:17.859 --> 00:22:20.160 bank has a reputation for being soft, for being 00:22:20.160 --> 00:22:22.440 willing to tolerate inflation to boost short 00:22:22.440 --> 00:22:24.619 -term employment. People just expect high inflation. 00:22:24.819 --> 00:22:26.660 And they'll build that expectation into contracts, 00:22:26.880 --> 00:22:29.680 making the bank's job harder. Conversely, a tough 00:22:29.680 --> 00:22:32.259 reputation allows the bank to manage expectations 00:22:32.259 --> 00:22:35.819 quickly and lower inflation with much less economic 00:22:35.819 --> 00:22:39.619 pain. The 1970s show that neither pure Keynesianism 00:22:39.619 --> 00:22:42.960 nor pure monetarism provided a complete answer. 00:22:43.339 --> 00:22:46.359 The solution adopted by the mainstream came to 00:22:46.359 --> 00:22:48.900 be known as the modern synthesis, epitomized 00:22:48.900 --> 00:22:51.299 by Robert J. Gordon's triangle model. This model 00:22:51.299 --> 00:22:53.720 asserts that inflation is almost always caused 00:22:53.720 --> 00:22:56.200 by a dynamic mix of three interwoven factors. 00:22:56.740 --> 00:23:00.140 First, demand shocks or demand pull inflation. 00:23:00.750 --> 00:23:04.049 This is where aggregate demand exceeds the economy's 00:23:04.049 --> 00:23:06.529 capacity. Classic too much money chasing too 00:23:06.529 --> 00:23:09.349 few goods, often caused by expansionary monetary 00:23:09.349 --> 00:23:12.890 or fiscal policy. Second, supply shocks or cost 00:23:12.890 --> 00:23:14.849 push inflation. This is where aggregate supply 00:23:14.849 --> 00:23:17.990 suddenly drops or the cost of key inputs skyrockets. 00:23:18.049 --> 00:23:21.210 Like the OPEC oil crisis in the 70s or more recently 00:23:21.210 --> 00:23:23.549 global shipping bottlenecks. And the third factor, 00:23:23.650 --> 00:23:26.250 connecting back to that monetarist insight. Expectations. 00:23:26.349 --> 00:23:28.869 Inflation expectations. Even if there are no 00:23:28.869 --> 00:23:31.670 immediate shocks to demand or supply, if consumers 00:23:31.670 --> 00:23:34.069 and firms believe inflation will be high, they 00:23:34.069 --> 00:23:36.329 act on that belief workers demand higher wages, 00:23:36.549 --> 00:23:39.509 firms raise prices, and that expectation feeds 00:23:39.509 --> 00:23:41.849 the wage. price spiral, embedding inflation into 00:23:41.849 --> 00:23:44.609 the economy. The modern consensus also cites 00:23:44.609 --> 00:23:48.309 several structural real economy factors complicating 00:23:48.309 --> 00:23:50.650 the picture in the 21st century. Things like. 00:23:51.000 --> 00:23:53.819 chronic housing shortages, shifts in immigration 00:23:53.819 --> 00:23:56.940 affecting labor supply, and climate change. Climate 00:23:56.940 --> 00:23:59.400 change is increasingly cited as a driver because 00:23:59.400 --> 00:24:02.200 recurring extreme weather events translate directly 00:24:02.200 --> 00:24:04.599 into supply shocks for agriculture and commodities, 00:24:04.880 --> 00:24:07.500 causing unpredictable spikes in food and input 00:24:07.500 --> 00:24:10.630 prices that then feed into the broader CPI. The 00:24:10.630 --> 00:24:14.349 2021 -2022 inflation spike provides a perfect 00:24:14.349 --> 00:24:16.450 case study for this triangle model synthesis. 00:24:16.829 --> 00:24:19.190 We saw all three elements operating at the same 00:24:19.190 --> 00:24:21.710 time after the COVID -19 pandemic. It really 00:24:21.710 --> 00:24:24.130 was textbook. We had massive demand shocks from 00:24:24.130 --> 00:24:26.710 unprecedented fiscal support stimulus checks, 00:24:26.910 --> 00:24:29.190 government aid. Combined with highly accommodative 00:24:29.190 --> 00:24:31.390 monetary policy, low interest rates, quantitative 00:24:31.390 --> 00:24:34.150 easing. And at the same time, we had severe supply 00:24:34.150 --> 00:24:36.690 shocks. Lockdowns, logistics bottlenecks, and 00:24:36.690 --> 00:24:38.609 later the energy crisis from the Russian invasion 00:24:38.609 --> 00:24:41.420 of Ukraine. But during this period, a new critical 00:24:41.420 --> 00:24:44.140 argument gained traction. The idea of sellers 00:24:44.140 --> 00:24:47.000 inflation. What is this theory asserting? This 00:24:47.000 --> 00:24:48.920 argument suggests that the demand and supply 00:24:48.920 --> 00:24:51.519 shocks provided cover for highly consolidated 00:24:51.519 --> 00:24:54.660 firms to significantly increase their profit 00:24:54.660 --> 00:24:59.059 margins to price gouge. contributing disproportionately 00:24:59.059 --> 00:25:02.099 to the inflation spike. So they were exploiting 00:25:02.099 --> 00:25:04.279 the price inelasticity that resulted from the 00:25:04.279 --> 00:25:06.660 supply chain constraints. Right. The argument 00:25:06.660 --> 00:25:09.160 goes that when a market has fewer players, those 00:25:09.160 --> 00:25:12.099 major corporations can raise prices and consumers 00:25:12.099 --> 00:25:14.759 who lack alternatives just have to pay the higher 00:25:14.759 --> 00:25:17.250 price. They choose to take increased profits 00:25:17.250 --> 00:25:19.930 rather than absorbing the cost increases. That's 00:25:19.930 --> 00:25:22.470 the core claim. However, this is where that intellectual 00:25:22.470 --> 00:25:25.529 friction is essential. Critics of the seller's 00:25:25.529 --> 00:25:27.849 inflation theory argue that high corporate profits 00:25:27.849 --> 00:25:30.109 are often just a symptom of supply constraints, 00:25:30.369 --> 00:25:32.950 not the primary cause. So how do they distinguish 00:25:32.950 --> 00:25:35.329 between those two explanations? They look at 00:25:35.329 --> 00:25:37.789 the source of the price change. If prices are 00:25:37.789 --> 00:25:40.109 rising primarily because input costs are rising, 00:25:40.289 --> 00:25:43.509 that's classic cost push. If prices are rising 00:25:43.509 --> 00:25:45.799 and firms profit margin. are also increasing 00:25:45.799 --> 00:25:48.759 at an unusual rate, that strengthens the seller's 00:25:48.759 --> 00:25:50.920 inflation argument. It remains a very ongoing, 00:25:51.160 --> 00:25:54.059 highly political debate. It shows that even with 00:25:54.059 --> 00:25:57.420 modern tools, diagnosing the specific cause of 00:25:57.420 --> 00:26:00.039 an inflationary surge is incredibly complex. 00:26:00.400 --> 00:26:02.359 Finally, let's address the monetarist resurgence 00:26:02.359 --> 00:26:05.839 after the pandemic. M2 money supply growth surged 00:26:05.839 --> 00:26:08.539 post -COVID, and many linked it directly to the 00:26:08.539 --> 00:26:11.180 inflation that followed. Yet we noted former 00:26:11.180 --> 00:26:14.589 Fed shares downplayed that link. Why? This is 00:26:14.589 --> 00:26:16.490 a sophisticated point about the current state 00:26:16.490 --> 00:26:19.309 of monetary transmission. Former Fed leaders 00:26:19.309 --> 00:26:21.289 have acknowledged that the one strong direct 00:26:21.289 --> 00:26:24.410 link between the money supply, M2, and consumer 00:26:24.410 --> 00:26:27.430 price inflation effectively ended about 40 years 00:26:27.430 --> 00:26:30.289 ago. Because of financial deregulation and innovation. 00:26:30.769 --> 00:26:32.950 So why has the equation changed so much? The 00:26:32.950 --> 00:26:35.569 key concept here is the velocity of money, V. 00:26:36.200 --> 00:26:38.720 If the money supply M increases, but that money 00:26:38.720 --> 00:26:40.720 isn't quickly spent and circulated through the 00:26:40.720 --> 00:26:44.519 consumer economy, if velocity is low, its inflationary 00:26:44.519 --> 00:26:47.420 impact on consumer goods P is dampened. And where 00:26:47.420 --> 00:26:49.400 did all that money go post -COVID if it wasn't 00:26:49.400 --> 00:26:51.920 immediately fueling consumer prices? A significant 00:26:51.920 --> 00:26:54.420 portion was held in the financial system, in 00:26:54.420 --> 00:26:57.900 bank reserves, excess deposits or concentrated 00:26:57.900 --> 00:27:00.579 in asset markets like stocks and real estate, 00:27:00.759 --> 00:27:03.619 which fueled asset price inflation. It wasn't 00:27:03.619 --> 00:27:05.440 circulating rapidly in the hands of the average. 00:27:05.519 --> 00:27:08.079 consumer buying groceries, the whole system has 00:27:08.079 --> 00:27:10.819 changed. So understanding the cause of inflation 00:27:10.819 --> 00:27:14.059 requires us to be economic historians, psychologists, 00:27:14.559 --> 00:27:17.539 and systems analysts all at once. Now let's turn 00:27:17.539 --> 00:27:20.460 to the critical question. What happens when inflation 00:27:20.460 --> 00:27:22.940 is too high and what happens when it's too low? 00:27:23.309 --> 00:27:25.789 The general effect of inflation is clear reduced 00:27:25.789 --> 00:27:28.609 purchasing power, but the specific consequences 00:27:28.609 --> 00:27:31.369 are often uneven, creating winners and losers. 00:27:31.690 --> 00:27:34.190 We must first analyze the significant hidden 00:27:34.190 --> 00:27:36.930 costs and negative effects of high or unpredictable 00:27:36.930 --> 00:27:39.950 inflation. And one of the most insidious effects 00:27:39.950 --> 00:27:42.930 is that inflation acts as a powerful redistributor 00:27:42.930 --> 00:27:44.970 of wealth and purchasing power. That's right. 00:27:45.269 --> 00:27:47.589 Inflation shifts purchasing power from those 00:27:47.589 --> 00:27:50.049 who hold financial assets denominated in currency 00:27:50.049 --> 00:27:53.009 like cash, savings accounts, fixed nominal incomes 00:27:53.009 --> 00:27:55.930 toward those who hold physical assets like property, 00:27:56.089 --> 00:27:59.069 gold or inflation index stocks and critically 00:27:59.069 --> 00:28:02.539 toward debtors. Precisely. If I took out a fixed 00:28:02.539 --> 00:28:05.440 rate 30 -year mortgage 10 years ago and inflation 00:28:05.440 --> 00:28:08.779 is suddenly 10%, the real value of the debt I 00:28:08.779 --> 00:28:11.180 owe the bank is effectively being inflated away. 00:28:11.460 --> 00:28:14.720 I win. The lender loses. And it hurts those on 00:28:14.720 --> 00:28:17.400 fixed nominal incomes, like many pensioners whose 00:28:17.400 --> 00:28:19.460 benefits aren't perfectly indexed to inflation 00:28:19.460 --> 00:28:22.769 as their monthly checks buy less and less. Beyond 00:28:22.769 --> 00:28:25.750 redistribution, high inflation gums up the smooth 00:28:25.750 --> 00:28:28.450 operation of the economy, leading to economic 00:28:28.450 --> 00:28:31.089 inefficiency. How so? Unpredictable inflation 00:28:31.089 --> 00:28:33.390 makes long -term investment planning extremely 00:28:33.390 --> 00:28:35.670 difficult for businesses. They have to divert 00:28:35.670 --> 00:28:38.210 resources and attention away from core activities 00:28:38.210 --> 00:28:40.910 like boosting productivity and instead spend 00:28:40.910 --> 00:28:43.369 time focusing on managing constant currency profit 00:28:43.369 --> 00:28:46.250 and loss fluctuations. It's a severe drag on 00:28:46.250 --> 00:28:48.329 growth. And it creates confusion in the marketplace 00:28:48.329 --> 00:28:50.250 that leads to a loss of allocative efficiency. 00:28:50.589 --> 00:28:52.730 Can you use a conversation? example to explain 00:28:52.730 --> 00:28:55.970 that complex idea. Absolutely. When prices are 00:28:55.970 --> 00:28:58.509 stable, a change in a specific product's price 00:28:58.509 --> 00:29:01.549 sends a clear signal. For instance, if the price 00:29:01.549 --> 00:29:03.890 of lumber suddenly jumps 20 percent while everything 00:29:03.890 --> 00:29:06.430 else stays the same, that's a signal to consumers 00:29:06.430 --> 00:29:08.950 to conserve lumber and to producers to invest 00:29:08.950 --> 00:29:11.440 in more logging capacity. That's efficient. But 00:29:11.440 --> 00:29:14.019 if general inflation is raging at 15 percent 00:29:14.019 --> 00:29:16.980 and lumber rises 20 percent, it's hard to tell 00:29:16.980 --> 00:29:20.119 if lumber is genuinely scarce or if its price 00:29:20.119 --> 00:29:22.259 is just rising slightly faster than the general 00:29:22.259 --> 00:29:25.740 background noise. That confusion leads to misallocating 00:29:25.740 --> 00:29:28.460 capital and resources. We mentioned earlier that 00:29:28.460 --> 00:29:30.960 inflation is often called a hidden tax. It acts 00:29:30.960 --> 00:29:33.400 as a hidden tax on holding currency, just eroding 00:29:33.400 --> 00:29:36.319 its value passively. Furthermore, if tax brackets 00:29:36.319 --> 00:29:38.880 aren't indexed to inflation, a phenomenon known 00:29:38.880 --> 00:29:41.779 as bracket creep. Inflation can push you into 00:29:41.779 --> 00:29:44.519 higher marginal income tax rates, even if your 00:29:44.519 --> 00:29:47.059 real purchasing power has an increase. A subtle 00:29:47.059 --> 00:29:50.319 non -legislated tax increase. Exactly. The sources 00:29:50.319 --> 00:29:53.380 also cited a profound, severe consequence, the 00:29:53.380 --> 00:29:56.059 direct link between food inflation and social 00:29:56.059 --> 00:29:59.200 and political fallout. It's a critical. High 00:29:59.200 --> 00:30:01.920 food inflation directly impacts the most vulnerable 00:30:01.920 --> 00:30:04.619 populations globally. For instance, high food 00:30:04.619 --> 00:30:06.880 costs were cited as a major underlying cause 00:30:06.880 --> 00:30:09.180 of the widespread demonstrations and revolts 00:30:09.180 --> 00:30:11.900 that fueled the 2010, 2011 Tunisian and Egyptian 00:30:11.900 --> 00:30:14.680 revolutions. When people cannot afford basic 00:30:14.680 --> 00:30:17.339 sustenance, economic metrics become immediate 00:30:17.339 --> 00:30:20.380 drivers of political instability. We also need 00:30:20.380 --> 00:30:23.160 to define the two classic microeconomic costs 00:30:23.160 --> 00:30:25.339 that illustrate these subtle inefficiencies. 00:30:25.680 --> 00:30:28.759 First, the shoe leather cost. High inflation 00:30:28.759 --> 00:30:31.200 dramatically increases the opportunity cost of 00:30:31.200 --> 00:30:33.799 holding cash. The term theoretically references 00:30:33.799 --> 00:30:36.180 the energy and time, the shoe leather, spent 00:30:36.180 --> 00:30:37.980 by people running back and forth to the bank 00:30:37.980 --> 00:30:40.319 to minimize their cash holdings and keep their 00:30:40.319 --> 00:30:42.440 money in interest bearing accounts. It's wasted 00:30:42.440 --> 00:30:45.200 time and effort managing cash instead of doing 00:30:45.200 --> 00:30:47.579 productive activity. And the second is the menu 00:30:47.579 --> 00:30:50.680 cost. This is the explicit or implicit cost for 00:30:50.680 --> 00:30:52.859 firms that have to constantly change their prices. 00:30:53.079 --> 00:30:55.480 A restaurant having to reprint its physical menus 00:30:55.480 --> 00:30:58.539 every month is an explicit cost. And the implicit 00:30:58.539 --> 00:31:01.619 cost includes time spent updating computer systems, 00:31:01.880 --> 00:31:04.240 changing price tags, negotiating with suppliers. 00:31:04.660 --> 00:31:07.339 Both costs consume resources that could otherwise 00:31:07.339 --> 00:31:09.960 be used to increase output. OK, now we flip the 00:31:09.960 --> 00:31:13.019 coin. Why do central banks consistently target 00:31:13.019 --> 00:31:16.059 a low but positive inflation rate, typically 00:31:16.059 --> 00:31:18.680 2 percent in the developed world? Because inflation 00:31:18.680 --> 00:31:21.440 has some powerful upsides. The primary positive 00:31:21.440 --> 00:31:23.779 effect is related to greasing the labor market. 00:31:24.000 --> 00:31:26.319 This addresses a fundamental truth about human 00:31:26.319 --> 00:31:30.210 behavior. Nominal wages are sticky downward People 00:31:30.210 --> 00:31:33.589 hate pay cuts Workers strongly resist pay cuts, 00:31:33.789 --> 00:31:36.630 even if inflation is zero and a pay cut is economically 00:31:36.630 --> 00:31:39.690 rational. So if the economy needs wages to drop 00:31:39.690 --> 00:31:41.710 to clear the market, say during a recession, 00:31:41.990 --> 00:31:44.690 but workers refuse nominal pay cuts, the result 00:31:44.690 --> 00:31:47.150 is prolonged disequilibrium and higher unemployment. 00:31:47.589 --> 00:31:49.990 Precisely. Moderate inflation provides a mechanism 00:31:49.990 --> 00:31:52.730 to allow real wages, the actual purchasing power 00:31:52.730 --> 00:31:55.490 of the paycheck, to fall slowly, even if the 00:31:55.490 --> 00:31:57.430 nominal dollar amount of the wage stays the same. 00:31:57.549 --> 00:31:59.750 It acts as a necessary lubricant for economic 00:31:59.750 --> 00:32:02.299 adjustment. Inflation also grants the central 00:32:02.299 --> 00:32:05.180 bank essential policy flexibility or room to 00:32:05.180 --> 00:32:07.599 maneuver. This prevents the central bank from 00:32:07.599 --> 00:32:09.579 hitting the feared liquidity trap. Right, where 00:32:09.579 --> 00:32:11.519 you can't cut interest rates any further because 00:32:11.519 --> 00:32:14.180 they're already at zero. Exactly. If moderate 00:32:14.180 --> 00:32:17.660 inflation is built into the system, say 2%, then 00:32:17.660 --> 00:32:20.279 a zero nominal rate still equates to a negative 00:32:20.279 --> 00:32:23.539 2 % real interest rate, providing stimulus and 00:32:23.539 --> 00:32:25.599 ensuring the central bank retains its policy 00:32:25.599 --> 00:32:28.180 tools. We also have the academic argument for 00:32:28.180 --> 00:32:30.779 why moderate inflation might actually spur investment, 00:32:31.160 --> 00:32:33.819 known as the Mundell -Tobin effect. The Nobel 00:32:33.819 --> 00:32:36.400 laureate Robert Mundell argued that when inflation 00:32:36.400 --> 00:32:39.079 is expected, it raises the opportunity cost of 00:32:39.079 --> 00:32:42.309 holding non -interest -sparing money. Why hoard 00:32:42.309 --> 00:32:45.150 cash that is constantly losing value? It encourages 00:32:45.150 --> 00:32:47.849 you to invest it instead. It encourages savers 00:32:47.849 --> 00:32:50.470 to substitute money hoarding for capital formation. 00:32:50.769 --> 00:32:53.309 They invest in loans, stocks, productive capital. 00:32:53.609 --> 00:32:56.589 This substitution leads to a fall in real interest 00:32:56.589 --> 00:32:59.490 rates and increased investment, thereby stimulating 00:32:59.490 --> 00:33:01.990 long -term growth. And finally, the ultimate 00:33:01.990 --> 00:33:05.190 justification for avoiding zero inflation, the 00:33:05.190 --> 00:33:07.470 inherent instability that comes with deflation. 00:33:07.839 --> 00:33:10.599 This ties back to economist S .C. Chang's compelling 00:33:10.599 --> 00:33:14.000 argument. Expected deflation is dangerous because 00:33:14.000 --> 00:33:16.660 it encourages money hoarding, as money is constantly 00:33:16.660 --> 00:33:19.859 increasing in value. This hoarding euthanizes 00:33:19.859 --> 00:33:22.640 financial markets. And Tsang warned that if this 00:33:22.640 --> 00:33:25.359 massive pile of hoarded money is suddenly triggered 00:33:25.359 --> 00:33:28.279 into circulation by some panic or change in expectation. 00:33:29.019 --> 00:33:31.460 The resulting mass movement to spend would become 00:33:31.460 --> 00:33:34.319 a tremendous avalanche causing rapid inflation 00:33:34.319 --> 00:33:37.039 and severe disruption as the financial system 00:33:37.039 --> 00:33:40.769 just cannot cope. So stability is the key. Moderate, 00:33:40.769 --> 00:33:43.490 stable inflation prevents that fear of deflation 00:33:43.490 --> 00:33:46.130 and provides the necessary mechanism for markets 00:33:46.130 --> 00:33:48.529 to operate smoothly and for central banks to 00:33:48.529 --> 00:33:50.990 manage employment and demand. The modern objective 00:33:50.990 --> 00:33:53.029 of central banks is not just to manage interest 00:33:53.029 --> 00:33:55.650 rates, but to manage inflation expectations to 00:33:55.650 --> 00:33:57.670 keep the rate low and stable, typically around 00:33:57.670 --> 00:34:00.990 2%. And to achieve this, economies have historically 00:34:00.990 --> 00:34:04.069 relied on various nominal anchors. The classic 00:34:04.069 --> 00:34:06.829 anchor, dominant globally before World War I, 00:34:06.910 --> 00:34:09.210 was the gold standard. Under the gold standard, 00:34:09.369 --> 00:34:12.110 a country tied its currency to a fixed preset 00:34:12.110 --> 00:34:15.510 quantity of gold. The long term inflation rate 00:34:15.510 --> 00:34:17.730 for the economy was effectively determined by 00:34:17.730 --> 00:34:19.769 the rate of growth of the global gold supply. 00:34:20.070 --> 00:34:22.530 What were the major criticisms that led to its 00:34:22.530 --> 00:34:25.869 abandonment? Critics argue it forced arbitrary 00:34:25.869 --> 00:34:28.530 fluctuations in the inflation rate, totally dependent 00:34:28.530 --> 00:34:31.329 on gold discoveries, not on the needs of the 00:34:31.329 --> 00:34:34.639 domestic economy. And more critically, it made 00:34:34.639 --> 00:34:37.300 it incredibly difficult to stabilize employment 00:34:37.300 --> 00:34:39.900 and avoid deep recessions because the government 00:34:39.900 --> 00:34:42.019 couldn't independently adjust the money supply. 00:34:42.199 --> 00:34:44.500 It forced rigidity. A rigidity that was ultimately 00:34:44.500 --> 00:34:46.840 abandoned after the Great Depression. After World 00:34:46.840 --> 00:34:49.400 War II, many nations adopted a different anchor, 00:34:49.539 --> 00:34:51.760 fixed exchange rates under the Bretton Woods 00:34:51.760 --> 00:34:54.260 system. This system involves pegging a currency 00:34:54.260 --> 00:34:57.400 to a major low inflation currency, historically 00:34:57.400 --> 00:35:01.039 the U .S. dollar. Today, only a handful of nations 00:35:01.039 --> 00:35:03.639 like Denmark maintain a fixed rate against an 00:35:03.639 --> 00:35:06.219 anchor like the euro. The benefit is you import 00:35:06.219 --> 00:35:08.679 the anchor country's price stability. But the 00:35:08.679 --> 00:35:11.079 cost is the loss of policy independence. Right. 00:35:11.219 --> 00:35:13.699 You can't use your own independent domestic monetary 00:35:13.699 --> 00:35:16.599 policy setting your own interest rates to manage 00:35:16.599 --> 00:35:19.639 local business cycles or unemployment. You sacrifice 00:35:19.639 --> 00:35:22.440 domestic control for external stability. A more 00:35:22.440 --> 00:35:25.260 drastic and much less popular control mechanism 00:35:25.260 --> 00:35:28.039 is wage and price controls. These are temporary 00:35:28.039 --> 00:35:30.260 exceptional measures. They can theoretically 00:35:30.260 --> 00:35:32.820 be effective at speeding up disinflation and 00:35:32.820 --> 00:35:35.159 breaking those entrenched expectations quickly. 00:35:35.500 --> 00:35:38.570 But economists generally advise. caution. Because 00:35:38.570 --> 00:35:40.989 they create severe market distortions, shortages, 00:35:41.409 --> 00:35:44.329 black markets, misallocation of resources. As 00:35:44.329 --> 00:35:46.809 seen in the failure of the 1972 U .S. attempt 00:35:46.809 --> 00:35:50.210 to impose controls, they only work if the controls 00:35:50.210 --> 00:35:52.489 allow the central bank time to tackle the underlying 00:35:52.489 --> 00:35:54.989 causes, like excessive demand. Let's look at 00:35:54.989 --> 00:35:57.650 another alternative idea that focuses on structural 00:35:57.650 --> 00:36:01.070 monetary reform, the de Mirage currency from 00:36:01.070 --> 00:36:03.179 Freiberg's Chef Theory. This is a fascinating 00:36:03.179 --> 00:36:05.880 theoretical construct. It proposes a currency 00:36:05.880 --> 00:36:08.139 designed to inherently decrease in value over 00:36:08.139 --> 00:36:10.639 time, a demurrage cost like a storage fee. So 00:36:10.639 --> 00:36:12.940 it discourages hoarding. Right. And since it 00:36:12.940 --> 00:36:15.219 discourages hoarding, the central bank could 00:36:15.219 --> 00:36:17.800 theoretically issue new money at a similar rate 00:36:17.800 --> 00:36:20.320 to the demurrage cost to achieve a precise zero 00:36:20.320 --> 00:36:23.440 inflation target. The theory posits this also 00:36:23.440 --> 00:36:25.760 replaces the need for interest costs to be built 00:36:25.760 --> 00:36:28.360 into prices. But the undisputed global standard 00:36:28.360 --> 00:36:31.019 today, the framework used by most developed economies. 00:36:31.670 --> 00:36:34.530 is inflation targeting. This approach was pioneered 00:36:34.530 --> 00:36:37.389 by New Zealand in 1990 and is now prevalent across 00:36:37.389 --> 00:36:40.650 the G7. It involves the central bank explicitly 00:36:40.650 --> 00:36:43.269 committing to continually adjust its primary 00:36:43.269 --> 00:36:46.409 tool, the central bank lending rate, to steer 00:36:46.409 --> 00:36:48.949 the country's actual inflation rate toward a 00:36:48.949 --> 00:36:52.389 specific published target, typically 2%. And 00:36:52.389 --> 00:36:54.469 the mechanism by which those interest rate changes 00:36:54.469 --> 00:36:56.630 affect the economy is called the monetary transmission 00:36:56.630 --> 00:36:59.269 mechanism. How does that link work in practice? 00:36:59.900 --> 00:37:01.820 When a central bank raises its target interest 00:37:01.820 --> 00:37:04.079 rate, it raises the cost of borrowing for commercial 00:37:04.079 --> 00:37:06.679 banks. This increased cost is then passed on 00:37:06.679 --> 00:37:08.599 to consumers and businesses through higher loan 00:37:08.599 --> 00:37:11.639 rates, like mortgages and corporate bonds. That 00:37:11.639 --> 00:37:13.900 makes borrowing money more expensive, which slows 00:37:13.900 --> 00:37:17.380 spending. Exactly. Higher borrowing costs decrease 00:37:17.380 --> 00:37:20.199 aggregate demand. Both consumers and businesses 00:37:20.199 --> 00:37:23.579 spend less. Lower demand reduces the pressure 00:37:23.579 --> 00:37:26.380 on existing supply, which puts downward pressure 00:37:26.380 --> 00:37:29.260 on prices, thus influencing the inflation rate 00:37:29.260 --> 00:37:32.199 back toward that 2 % target. And lowering rates 00:37:32.199 --> 00:37:34.969 does the opposite. stimulating demand. It's all 00:37:34.969 --> 00:37:37.650 designed to anchor those crucial inflation expectations. 00:37:38.090 --> 00:37:40.389 It truly is incredible, if you step back, to 00:37:40.389 --> 00:37:43.590 trace this journey from Nero's crude debasement 00:37:43.590 --> 00:37:46.289 of the denarius for quick government profit through 00:37:46.289 --> 00:37:48.630 the intellectual battles over the quantity theory 00:37:48.630 --> 00:37:51.010 and the Phillips curve. Right up to the highly 00:37:51.010 --> 00:37:54.250 sophisticated debate over the NARU and the credibility 00:37:54.250 --> 00:37:56.409 of a single announcement from a central banker. 00:37:56.800 --> 00:37:59.280 Inflation isn't just an economic metric. It's 00:37:59.280 --> 00:38:01.860 a reflection of the trust in the underlying value 00:38:01.860 --> 00:38:04.780 of a society's promise of exchange and the competence 00:38:04.780 --> 00:38:07.340 of the institutions managing that promise. So 00:38:07.340 --> 00:38:09.139 what does this all mean for you, the informed 00:38:09.139 --> 00:38:12.000 learner? We've established that unstable inflation 00:38:12.000 --> 00:38:15.019 causes enormous social and economic harm from 00:38:15.019 --> 00:38:17.300 redistributing wealth and discouraging investment 00:38:17.300 --> 00:38:20.539 all the way to fueling revolutions. We also noted 00:38:20.539 --> 00:38:22.400 that the instability that comes with deflation 00:38:22.400 --> 00:38:26.039 can cause savers to hoard and that a sudden panic 00:38:26.039 --> 00:38:28.639 driven movement to spend those hoards could become 00:38:28.639 --> 00:38:31.440 a tremendous avalanche. That concept of the Shang 00:38:31.440 --> 00:38:35.000 avalanche, a sudden mass realization that money 00:38:35.000 --> 00:38:37.400 hoarding is no longer safe, leading to panic 00:38:37.400 --> 00:38:40.059 spending, is a powerful warning. It really is. 00:38:40.199 --> 00:38:42.579 So given the immediate, highly emotional effects 00:38:42.579 --> 00:38:45.420 of inflation on consumers, which we saw vividly 00:38:45.420 --> 00:38:48.360 in the social unrest of 2010 and 2011, and the 00:38:48.360 --> 00:38:50.909 fact that we now live. a world of instant digital 00:38:50.909 --> 00:38:53.789 communication, flash trading and globalized assets. 00:38:54.050 --> 00:38:56.889 What happens when this avalanche of money hoarding 00:38:56.889 --> 00:38:59.030 and the subsequent rush to trade money for real 00:38:59.030 --> 00:39:02.170 goods is amplified and accelerated by social 00:39:02.170 --> 00:39:04.789 media narratives and the speed of modern financial 00:39:04.789 --> 00:39:07.780 flows? This raises the ultimate question for 00:39:07.780 --> 00:39:10.099 contemporary central banks. Is inflation today 00:39:10.099 --> 00:39:12.820 as much a psychological and communications challenge, 00:39:12.880 --> 00:39:15.059 a battle to manage public narratives and expectations 00:39:15.059 --> 00:39:18.619 digitally and instantly, as it is a purely monetary 00:39:18.619 --> 00:39:21.119 one, controlled by the relatively slow mechanisms 00:39:21.119 --> 00:39:23.679 of interest rate adjustments? The battle for 00:39:23.679 --> 00:39:26.360 stable prices may well be won or lost in the 00:39:26.360 --> 00:39:27.340 realm of public perception.