Inflation/National Debt/Deficit ??

[lyghtningbyrd]

A rather basic economic question:


Economics is not my strong suit. I don't understand exactly how inflation works. I was unable to find anything that explained it in depth.

I have never really understood the national debt. All I know is that the government has borrowed money from other parts of the government ( Social Security Surplus?) to fund projects. So its money that was never really there to use. Correct? :confused:

But I think I'm perhaps missing a larger global perspective to inflation.

Is inflation a direct result of national debt, or is it a result of a combination of things not limited to national debt?

If so, what are those things exactly?

Are there countries that are "deflated?

Please help if you can. By the way, I have asked a lot of people about this, and a lot of people realize that they don't really get it either. It's something I really should know.

[corplinx]

Heres how it works. The government not being content to rob you with high income taxes also makes you pay a SS/Medicare taxes. That way you pay much more in taxes than your actual "rate". All the money goes into the same coffers and it usually all gets spent. Most of the time, they spend more than they can fool you into giving. When they do this, they usually issue bonds to cover the "deficit". The bonds are considered the most stable investment there is. The amount of outstanding bonds/bills/etc is the "national debt". All of these bonds/bills/etc come due at some point, which means that if the budget stays balanced the debt will shrink if they issue no new bonds.

This is why I am in favor of something called "honesty in taxation", it gets rid of all government to invidual taxes except the income tax. To accomadate the loss and reduce the cost of processing taxes, all deduction are then removed from the income tax. of course, this makes too much sense and would be seen as the first move to a flat tax so it will never happen.

[lyghtningbyrd]

Thanks, but I'm still a bit confused. Who are these "bonds" issued to? Foriegn investors? Domestic? I don't understand

[Tony]

I got a question, What effect does a high deficit have on the economy?

[Underemployed]

Shanek, a poster whose views I highly respect, should probably come in here and explain things in laymans terms as he has done before. But until then, here is roughly how it goes:

The Government is essentially run like a vast corporation. It has employees, assets, costs, income and so on. Like any company it must pay its employees, maintain its assets, keep up with the water bill....you get the idea. This money must come from somewhere. It does not appear by magic.

A lot of this money comes from taxes. Individuals and private companies pay taxes, in one form or another, to the government. So it is useful (but not necessarily truthful) to imagine governments as big companies which 'own' a country and charges humans for livng there.

However, the services provided by the government are not cheap. The police force, the military, roads, the vast swathes of civil servants - they might cost more in strict dollar terms than the 'income' (tax receipts) a government receives. In this case there are three basic choices: reduce the bill by cutting services, increase taxes to cover the discrepancy, or borrow a pile of cash from whoever will give it to you.

Cutting services and raising taxes tends to be unpopular.

So the government must borrow money. Bonds are just a word used to refer to legal agreements between private investors and the government. It means the Government is under a legal contract (a bond) to pay the bearer a fixed amount, usually after a set period of time. You might buy a bond for five dollars, on the face of which it says that in five years time you get six back. Because you have a lot of faith in the integrity of the government, you are confident that you will receive the six dollars.

And so the government raises huge sums like this. But at some point, those bonds must be honoured. The money loaned to them must be repaid. And if, in the meantime, they have decided:

a) not to raise taxes, and
b) not to cut services

...then, there isn't going to be any extra money to honour the bonds. Which means....you've guessed it....

....MORE bonds issued!

At some point, there won't be anyone around to buy more bonds. The debt will grow so large that the economy falls into a death spiral, cutting everything in a vain attempt to honour contractual obligations to bondholders (who could be anyone and everybody in the whole world - in fact, it makes more economic sense for them to be bought by foreigners than domestic buyers for reasons too lengthy to go into here.)

This is what happened in Argentina. It just wasn't earning enough to cover its debts. The CEOs of Argentina Inc. had not kept an eye on the books.

It is possible that this could happen to any country. That is why it is not good policy to increase the national debt beyond the amount which could be paid for by selling off a few assets, while still maintaining acceptable levels of service. Especially as in recent years you will note almost all (Western) governments have already flogged everything of value.

[lyghtningbyrd]

Thank you very much. I think I get it now! I read something recently about the Japanese mafia, known as the Yakuza. I remember it mentioned they could at any time, crash our economy or stock market because they own so many U.S. bonds.. Is this true?

[a_unique_person]

Originally posted by lyghtningbyrd
Thank you very much. I think I get it now! I read something recently about the Japanese mafia, known as the Yakuza. I remember it mentioned they could at any time, crash our economy or stock market because they own so many U.S. bonds.. Is this true?

I think you give them credit for having a little too much economic muscle than they really have.

However, apart from the fact that they are criminals, they are also investors. Why would they want to destroy one of their major investments. I don't think Al Capone ever wanted a revolution, just to be left in peace and make lots of illegal money.

[lyghtningbyrd]

But if they wanted to negatively affect our economy, hypothetically, how would they go about doing it? Sell them all at once?

[Ladewig]

Who are these "bonds" issued to? Foriegn investors? Domestic? I don't understand

How the U.S. Department of the Treasury issues debt is covered here (http://www.publicdebt.treas.gov/)

[Ladewig]

Thank you very much. I think I get it now! I read something recently about the Japanese mafia, known as the Yakuza. I remember it mentioned they could at any time, crash our economy or stock market because they own so many U.S. bonds.. Is this true?
------------------------------------------------------------------------------------

But if they wanted to negatively affect our economy, hypothetically, how would they go about doing it? Sell them all at once?



While U.S. bonds and notes have a specified due date it is possible to sell them before they mature. If an exceptionally large group of bond holders decided to sell a great number of bonds all at once, the laws of supply and demand would kick in. If fewer people want to hold U.S. finacial instruments, then their "price" would go up; that is to say that the interest rate offered by the government would rise until that rate became attractive enough to attract enough investors to cover whatever debt the government was trying to cover that week. Conversely, if there were enough uncertainity to drive investors to seek safer places to place their money, then the number of people trying to buy government debt would rise and drive the prevailing rate (or more precisely, the auction rate) downwards until all debt were covered.

So, could a group of people use their economic power to adversely impact the U.S. government? Perhaps. It would be foolish to attempt such action by selling their U.S. government issue holdings. There is no way that any single group could have a large enough share of the $3.7 trillion of publicly held debt to influence bond prices to the point that it would hurt the government. On the other hand, if a group of people (or governments) could convince the world that the U.S. were unable to meet future obligations, then there might be an adverse reaction. Achieving that goal would require less upfront investment but would also be impossibly difficult and incredibly stupid because national economies are so inter-related that the negative effects would be felt world-wide.

[Zombified]

Bonds are issued to whomever wants to buy them. You could buy some any time you liked, becoming a creditor to the government, and gaining some of your tax back as interest. When you get older and need your money in a safe income bearing investment, your investment advisor may have you do exactly that.

Now, I'm not an economics expert, but my understanding of the effect of government debt is this: lots of people want to borrow money (demand). Lots of people have money to lend (supply). When the government needs to borrow a lot of money, they are in effect competing with all the other people who also want to borrow money. How do you compete? By offering a higher price to the person who has the item you want. The price you pay for borrowing is interest. So when more people need money, interest rates tend to go up.

Who are these other people who are trying to borrow money? Well, lots of people, but the big problem economically is that many of them are businesses. Businesses borrow money in order to fund expansion. This involves investing in R&D, in physical plant, and in staff, creating jobs, new products, and improving productivity.

Therefore, the net effect of increased government borrowing is a reduction in business growth, fewer jobs, lower productivity, and a poorer standard of living.

As a secondary effect, that interest has to be paid by the government. In other words, the interest on those bonds have to be paid by tax money, additional borrowing, or spending cuts. Spending cuts could include your favorite social program, government contracts to private businesses that create jobs, military spending, etc.

There isn't anyone who could foreclose on the government. The Yakuza, what do they have, 9mm and katanas? The government has nuclear weapons. More seriously, bonds are contracts; so long as the government pays the interest, no one can "foreclose."

This leads to a third possible effect. The government can always pay its bills. Always. How? Simple: by printing more money. That is, the government can always make its payments by increasing the money supply. That, however, can lead to inflation, because you have more dollars chasing the same products and services. Also bad.

[lyghtningbyrd]

Originally posted by Ladewig


...Conversely, if there were enough uncertainity to drive investors to seek safer places to place their money, then the number of people trying to buy government debt would rise and drive the prevailing rate (or more precisely, the auction rate) downwards until all debt were covered. ...



Thanks, I understand everthing except for the above. The "incertainty" you speak of is what? Uncertainty in the stock market or the bonds? What is the auction rate?

Sorry for all the questions...I usually try to look things up at the library or online, but it's so much easier when someone explains it to you simply. thanks.

[lyghtningbyrd]

* "uncertainty" rather...

[lyghtningbyrd]

This leads to a third possible effect. The government can always pay its bills. Always. How? Simple: by printing more money. That is, the government can always make its payments by increasing the money supply. That, however, can lead to inflation, because you have more dollars chasing the same products and services. Also bad.

That's a really short-sighted solution to the problem, is it not? They have enough money to pay their investors if they print more money, but now costs are inflated to cover it? If the investor bought a 20 dollar US bond, he would get back 25 after a year let's say, but inflation makes that 25 worth the 20 it was a year ago?? So its sort of a simulation that the investor is getting more money than he put in. Or am I confused again?

[Zombified]

Originally posted by lyghtningbyrd
That's a really short-sighted solution to the problem, is it not?Quite. It's rather bad for the investor, obviously, because it makes the income from the interest worth less than it seems to be (the real rate of return is interest minus inflation). It's bad for anybody who saves money, because it wipes out their savings (example: post-Soviet Russia). If you owe a big pile of money, like the government, inflation is a get-out-of-debt-free card, though.

[shanek]

Originally posted by lyghtningbyrd
I don't understand exactly how inflation works.

Inflation occurs when the amount of money in an economy grows faster than the amount of goods and services. This can happen naturally at the apex of the business model, or it can happen when government puts money into the economy.

I have never really understood the national debt. All I know is that the government has borrowed money from other parts of the government ( Social Security Surplus?) to fund projects. So its money that was never really there to use. Correct? :confused:

Half correct. The government does issue bonds to cover the debt, money they would then owe to investors. But a good portion of the national debt is, as you say, the government borrowing money from itself. This creates money out of nowhere with no corresponding increase in the number of goods and services in the economy. Hence, inflation.

Is inflation a direct result of national debt, or is it a result of a combination of things not limited to national debt?

Most of the inflation in the US is due to government debt and the Federal Reserve attempting to manipulate the economy.

Are there countries that are "deflated?

We were deflated during the Depression. In 1929, the Federal Reserve, fearing upcoming inflation, put the brakes on the money supply, directly causing the stock market crash of 1929 and leading to the banking crisis of 1933 (both things the Fed was created to prevent; it was also supposed to stop inflation).

Here's a graph showing the Consumer Price Index (CPI) from both before and after the creation of the Fed. Note that before the Fed, and slightly afterwards while the Fed continued to do nothing, we had the normal cycle of inflation and deflation and the economy was in balance like it's supposed to be. Then, after the Fed finally released the money supply during WWII, notice how we've had runaway inflation.

http://harrybrowne.org/articles/LandOf1.gif

[shanek]

Originally posted by Underemployed
Shanek, a poster whose views I highly respect, should probably come in here and explain things in laymans terms as he has done before. But until then, here is roughly how it goes:

You seemed to do a pretty good job explaining it.

[shanek]

This talk about enemies crashing the economy reminded me of something I read about that happened during WWII.

Basically, the Nazis decided to levy an economic war against Britain. They found a paper stock close to what the Brits were using for their paper money, the proper ink, they even figured out their serial number scheme. They then went about printing vast amounts of counterfeit money and spread it around the British economy. They had over 100 agents spending the money in the British economy, putting the money into circulation. By the time the Brits figured out what was going on, the Nazis had put about £135 million into the economy and caused the British economy, in a span of 46 months, to increase inflation by a factor of 520 million!!!

Britain only reigned this in by redesigning and reprinting the money since no one could tell the fake bills from the real ones.

[Smalso]

shanek: Half correct. The government does issue bonds to cover the debt, money they would then owe to investors. But a good portion of the national debt is, as you say, the government borrowing money from itself. This creates money out of nowhere with no corresponding increase in the number of goods and services in the economy. Hence, inflation.

I heard a guy on PBS explaining this. He was making the point that the national debt is not a bad thing. I don't get it though. For instance, money is borrowed from the Social Security trust fund. Now, the government owes money to itself. When the money is needed to fund Social Security, the government has to borrow it again. And the maintenance of the national debt is a large chunk of the budget; and that contributes to even more deficits.

(Does anyone really know how much $3,000,000,000,000 is?

[Michael Redman]

Originally posted by Smalso
And the maintenance of the national debt is a large chunk of the budget; and that contributes to even more deficits. I think that's an absolutely critical point that is usually ignored by deficit spending proponents. If we didn't have this huge debt, we could increase spending and lower taxes a good deal at the same time. Or, we could choose one or the other. Hundreds of billions in interest payments are not the best way for our nation to use that money.

[RandFan]

Originally posted by Smalso
shanek:

I heard a guy on PBS explaining this. He was making the point that the national debt is not a bad thing. I don't get it though. For instance, money is borrowed from the Social Security trust fund. Now, the government owes money to itself. When the money is needed to fund Social Security, the government has to borrow it again. And the maintenance of the national debt is a large chunk of the budget; and that contributes to even more deficits.

(Does anyone really know how much $3,000,000,000,000 is? Good question,

I am unable to truly fathom such a number, but that is no reason not to try.

If you spent $1,000 a day for 1,000 days (just under 3 years) you would spend a million dollars.

If you spent $1,000,000 (one million) a day for the same period you would spend $1,000,000,000 dollars (one billion, that is spelled with a "B")

If you had started to spend $3,000,000 dollars a day in year 1 (2,000 years ago) you would only be just over 2/3rds of the way through $3,000,000,000,000)

365 x 2,000 x 3,000,000 = 2,190,000,000,000

[Victor Danilchenko]

Smalso

I heard a guy on PBS explaining this. He was making the point that the national debt is not a bad thing. I don't get it though. For instance, money is borrowed from the Social Security trust fund. Now, the government owes money to itself. When the money is needed to fund Social Security, the government has to borrow it again.SS payoffs are funded mostly from on-going contributions. has the SS funds simply been sitting there, they would be doing nothing; as it is, they get invested, creating more benefits and jobs and economic activity. Had SS funds been invested explicitly (instead of being kept in the 'strongbox'), the effect would have been much the same. The only difference between current arrangement and stock-market investment of SS funds, is the increased risk (which is balanced by the increased payoff) of the latter approach.

And the maintenance of the national debt is a large chunk of the budget; and that contributes to even more deficits.Well, this is the bad part. much of the deficit maintenance goes to pay off the acruing interest on bonds and stuff, and bonds are usually held by the richer segments of the population; so effectively servicing the national debt amounts to monetary transfer from the poorer taxpayers to the richer taxpayers, thus countering the explicitly progressive income taxation.

or at least this is what I understand from my recent reading-up on economics.

[shanek]

Originally posted by Smalso
I heard a guy on PBS explaining this. He was making the point that the national debt is not a bad thing. I don't get it though. For instance, money is borrowed from the Social Security trust fund. Now, the government owes money to itself. When the money is needed to fund Social Security, the government has to borrow it again. And the maintenance of the national debt is a large chunk of the budget; and that contributes to even more deficits.

Let's back up a step and talk about how money is generally created in the economy.

When you make a deposit into your checking account, that's called a "demand deposit"—meaning you can get the money back any time you want. But the bank is going to take advantage of the fact that not everyone is going to take out all their money at once, so they set a minimum reserve rate—a percentage of all demand deposits that they're going to keep in assets, and loan the rest out (one of the ways the Fed manpulates the economy is by setting a "minimum reserve rate." Banks have to keep at least that amount in reserve). Let's say that rate is 10%, and you deposit $100. It's going to keep 10%, or $10, of your money, and loan the rest out. Now, whomever they loan the money to is going to deposit it in a bank.

We've just created an additional $90 in the economy. Since both you and the lender consider that you have the $90, you will act in the market accordingly. And the bank is going to keep $9 of the new deposit and loan the rest out, creating another $81, and so on.

This is going to peter out at n*1/r, n being the original amount deposited and r being the reserve rate. So in this case, it'll end up being $100 * 1/10%, or $100 * 1/.1, or $100 * 10...in other words, by simply making that $100 deposit you have created $1000 in the economy!

Why doesn't that result in inflation? Because the bank is only going to loan or invest the money in areas that are likely to give them a proper return. If they don't, they can foreclose on the debt and gain the assets that way. Either way, the creation of this money also creates additional goods and services in the economy to match it.

Example: When I built my house, I had to go get a mortgage loan. The money from that loan was used to pay landscapers, builders, a plumber, an electrician, etc., all of whom did work—work which would not have been available had I not taken out the loan. So yes, that money was created, but it also created more goods and services in the economy.

The government is a different matter entirely. When the government borrows from itself, what they effectively end up doing is ordering the Fed to print more money that they can spend. But there's not any greater amount of goods or services created in the economy; it's just money for them to spend, exactly as if I had printed up $140,000 in phony money to pay for my house. It's really legalized counterfeiting.

Bonds are different. This is money directly owed to the holders. In a way, it's like the situation above—the holders expect a return on their investment. But again, their "investment" is just giving the government money to spend. When it comes time to pay the bonds back, the government either has to sell more bonds (in which case it's a pyramid scam), get more tax money, or counterfeit more money. Again, no new goods or services are created in the economy; hence, inflation, although not as drastic as when the government borrows money from itself.

I've heard people make the "national debt is a good thing" argument, but they can only do so by completely ignoring the inflationary aspects of government debt. It's not free money at all. Everything government spends we pay for. We either pay for it now in the form of taxes, or we pay for it later in inflation. When milk is $2.50 instead of $2.00, essentially that 50¢ can be thought of as a hidden tax. (Not totally; as I mentioned above, there's a natural amount of inflation in any economy. But the overwhelming majority of it is due to government overspending.)

[shanek]

Originally posted by Victor Danilchenko
SS payoffs are funded mostly from on-going contributions. has the SS funds simply been sitting there, they would be doing nothing; as it is, they get invested, creating more benefits and jobs and economic activity.

That is the biggest load of crap I've ever heard you spew out—and that's saying a lot!

No, the money would NOT be "just sitting there," as you say. It would be in a bank, creating money in the economy as I elucidated above! By pilfering SS funds, the government is essentially counterfeiting that money!

Let me go back to my house example. If I had counterfeited the $140,000 I needed, there would have been the jobs I mentioned: builders, plumbers, etc. Does that make the counterfeiting of $140,000 all right? No, obviously not! And it would lead to a certain amount of inflation because there would be an additional $140,000 in the economy without a comparable gain in the amount of goods and services because I would not have to work to earn the $140,000 plus interest the way I do when I get a mortgage loan.

or at least this is what I understand from my recent reading-up on economics.

Go read up more. Your knowledge of economics is still as miniscule as it was before.

[Ladewig]

...Conversely, if there were enough uncertainity to drive investors to seek safer places to place their money, then the number of people trying to buy government debt would rise and drive the prevailing rate (or more precisely, the auction rate) downwards until all debt were covered. ...

------------------------------------------------------------------------

Thanks, I understand everthing except for the above. The "uncertainty" you speak of is what?

Uncertainty in the stock market e.g. fear of airlines going bankrupt or going out of business.

The auction rate refers to how the government issues new bonds. On a regular basis they decide how much money they need to borrow and then allow people and institutions to make bids on lending the momey to the government. A gross simplification: One source might say, "I'll lend you $2,000,000 at 2.0%." Another might offer the same amount at 2.1% and a third at 2.2%. The government ranks these bids in increasing order of interest rate and then starts accepting them one by one until it has raised the targeted amount of money. The Treasury is auctioning off the debt in such a way that the bidders with the lowest interest rates are awarded the right to lend money to the government.

Because government auctions are single-price auctions, all accepted bids are awarded the highest interest rate from the accepted bids. The interest rate on the last accepted bid is considered the auction rate for that time period.

[lyghtningbyrd]

This is why I think education is in need of major reform in America. I do all my learning outside of school. Thanks for taking the time to explain all of that to me.

[shanek]

Originally posted by lyghtningbyrd
That's a really short-sighted solution to the problem, is it not? They have enough money to pay their investors if they print more money, but now costs are inflated to cover it? If the investor bought a 20 dollar US bond, he would get back 25 after a year let's say, but inflation makes that 25 worth the 20 it was a year ago?? So its sort of a simulation that the investor is getting more money than he put in. Or am I confused again?

If it happened in a vacuum, then yes, it would. Inflation would make the $25 worth what $20 was before. Of course, this takes place in a large and complex economy, so the inflation gets spread around enough that people can actually have the illusion that the interest is coming with no detrimental effects to the economy. But, of course, they look around the economy and see inflation, and wonder what causes it.

[Q-Source]

Originally posted by shanek


The government is a different matter entirely. When the government borrows from itself, what they effectively end up doing is ordering the Fed to print more money that they can spend. But there's not any greater amount of goods or services created in the economy; it's just money for them to spend, exactly as if I had printed up $140,000 in phony money to pay for my house. It's really legalized counterfeiting.

Borrow money from itself = investing public resources

In theory, there is no need to print more money because the Government is just transfering a financial resources from (let's say) a public entity with a surplus to another with a deficit balance.

It is just an optimal resource allocation.

Depending on where the investment goes, and how productive it is, then we can determine whether or not goods and services were created. But you cannot assume that public debt does not create output. That is just simply a lie.


Bonds are different. This is money directly owed to the holders.

Bonds have exactly the same effect, the only difference is that at the end of the day, the Government has to pay an interest rate. Bonds are usually used when there are no public funds where to get the money from or when it is considered to be strategically inefficient.

Q-S

[shanek]

Originally posted by Q-Source
Bonds have exactly the same effect, the only difference is that at the end of the day, the Government has to pay an interest rate.

Along with the original value if the person cashes in their bonds. THIS is the big difference, and exactly what keeps it from being counterfeiting. The money must be replenished before it can be reused.

But that's not the case at all when the government borrows from itself. The increased spending gets into the economy and requires the Fed to print more money to cover the new cash flow among the banks. Remember that we're talking about a fiat currency here, which is backed up by nothing other than the government's sayso. The more of it there is in the economy, the greater the rate of inflation. The gold standard is what previously kept this in check. Now, it's just spinning out of control.

[Victor Danilchenko]

Shane,

Oh come on, inflation is not spinning out of control. The Fed has done a fairly good job of controlling it.

[shanek]

Originally posted by Victor Danilchenko
Oh come on, inflation is not spinning out of control. The Fed has done a fairly good job of controlling it.

Compared to what it was doing before the Fed started "controlling it"? It most certainly is! CPI is consistantly going up, up, up...which is completely unprecedented.

[shanek]

Okay...I've made the claim a few times that we can expect income, when adjusted for inflation, to remain more or less the same in the absence of any other factors than the inflation itself. I've found a chart that demonstrates this:

http://www.census.gov/hhes/www/img/incpov99/fig02.gif

Note that it does, in fact, remain more or less steady regardless of what the CPI is doing. There is a slight overall increase, due to the overall expansion of the economy, but when compared to the previously submitted CPI graph I don't see how any sane person can claim that inflation rate is any measure of economic growth.

[lyghtningbyrd]

Does that chart indicate that regardless of inflation, the average American income is the same? ie - if a hamburger costs 3 dollars now instead of 5 cent in the 50s, we don't make more money every year to cover it?

Also, is a "household MEDIAN" more appropriate than say a national average income?

[shanek]

Originally posted by lyghtningbyrd
Does that chart indicate that regardless of inflation, the average American income is the same?

It's the median income. That means that there are exactly as many housholds above that income level as there are below it. It's better than an average (mean), because you don't have people like Bill Gates skewing it.

ie - if a hamburger costs 3 dollars now instead of 5 cent in the 50s, we don't make more money every year to cover it?

Nominally, we need to make more money because of inflation. In real value, no, there's virtually no change. You still have to work just as hard to get that amount of money.

Don't fall into the trap, though, of thinking of it in terms of individual products like hamburgers. The price, even adjusted for inflation, can rise or fall. For example, even the nominal price of computers has fallen (even as their real value increased by becoming more powerful), even moreso when adjusted for inflation. It's an index. Overall, it's what prices in the economy do.

[lyghtningbyrd]

I think the reason its such a hard concept for people ( like me) to grasp is because were talking about the entire country, which is a gigantic system that is all interrelated. For instance, like when I said a hamburger costs 3 dollars now, mcdonald's gets 2.95 more than it would have recieved in 1950 when it was 5 cents. so basically its like the entire economy just changes its scale, so to speak. Is that accurate?

I guess it makes me wonder though, who benefits from inflation, and who suffers the most? Bond holders?

BTW - I'm going to the library today cause its too hot here to do anything else. I'm going to look for some books on this subject. Someone recommend some books on Economics/ Inflation/ National debt... It's really interesting.

[Zombified]

My (layman's) understanding is that CPI is based on a "basket of goods," that is, the sum of all the stuff an "average American" buys in the course of a year, as determined by economic experts somewhere. This basket changes from time to time. The definition of CPI didn't include computers or VCRs in 1967, but I think it does today.

Also, the CPI does not change based on the quality of goods; as Shane points out the utility of a computer has gone up significantly even as the price has fallen (I say utility because in my head "value" is ambiguous). So even if, when all is said and done, the buying power of the dollar relative to the "basket of goods" is the same, there's more stuff and better stuff in the basket today.

Someone who knows more about economics than I do can explain to me why we would even expect buying power to change at all over time, given the way CPI is defined. If we periodically adjust the CPI to reflect what people are actually buying, doesn't that tend to force Shane's graph to a nearly flat trend?

I'm tempted to believe, then, that the actual economic growth is hidden under the basket.

[lyghtningbyrd]

I know what you mean, I think I would tend to agree. Anyone care to rebuttal this?

[shanek]

Originally posted by lyghtningbyrd
I think the reason its such a hard concept for people ( like me) to grasp is because were talking about the entire country, which is a gigantic system that is all interrelated. For instance, like when I said a hamburger costs 3 dollars now, mcdonald's gets 2.95 more than it would have recieved in 1950 when it was 5 cents. so basically its like the entire economy just changes its scale, so to speak. Is that accurate?

Yes. It's the difference between nominal value and real value, and it gives a lot of first semester econ students headaches.

The price index is what you use to compare real value. The formula is:

Real Value = Nominal Value × Price Index (target year) ÷ Price Index (source year)

I guess it makes me wonder though, who benefits from inflation, and who suffers the most? Bond holders?

Hardly anyone benefits from inflation. Consumers suffer because tangible value isn't held over time, investors suffer because their return on their investment isn't as much, lenders lose out because the higher interest rates they have to charge to make money reduces demand for the loans, and pretty much everyone suffers because of the slowing economy.

BTW - I'm going to the library today cause its too hot here to do anything else. I'm going to look for some books on this subject. Someone recommend some books on Economics/ Inflation/ National debt... It's really interesting.

Good starter books on economics are "Essentials of Economics" by Faustino Ballve and "Uncle Eric's Whatever Happened to Penny Candy" by Richard J. Maybury (actually, all of his Uncle Eric books are good).

After you've gotten started, since we've primarily been talking about money here, I highly recommend "The Economics of a Pure Gold Standard" by Mark Skousen.

[shanek]

Originally posted by Zombified
My (layman's) understanding is that CPI is based on a "basket of goods," that is, the sum of all the stuff an "average American" buys in the course of a year, as determined by economic experts somewhere. This basket changes from time to time. The definition of CPI didn't include computers or VCRs in 1967, but I think it does today.

Right, and of course they can't get the figures for every single one of those goods sold and at what price. It's a moving target.

Also, the CPI does not change based on the quality of goods; as Shane points out the utility of a computer has gone up significantly even as the price has fallen (I say utility because in my head "value" is ambiguous). So even if, when all is said and done, the buying power of the dollar relative to the "basket of goods" is the same, there's more stuff and better stuff in the basket today.

However, with very few exceptions (none of which I can think of at the moment), these improvements end up making the economy more efficient. It's obvious that you can do more with a computer today than you could 20 years ago. That means more work can be done with less effort and in less time. The effect of this is to increase Long Term Aggregate Demand, thus growing the economy.

Someone who knows more about economics than I do can explain to me why we would even expect buying power to change at all over time, given the way CPI is defined.

Tons of reasons. Think about all the factors that can affect supply and demand in any given product. Now multiply that by the biggest number you can think of. :)

If we periodically adjust the CPI to reflect what people are actually buying, doesn't that tend to force Shane's graph to a nearly flat trend?

The problem is, CPI is a measure of nominal value, not real value. What you're talking about is converting the amounts of CPI to (say) 2002 dollars. But CPI is the measure of what makes 2002 dollars worth a certain amount compared to any other year! Ultimately, you would end up with a perfectly flat graph—but the information you would get from this is exactly as useful as knowing that any number divided by itself equals 1, because that's all you're really doing.

Notice in the graph I posted the figures are all in 1999 dollars. This is adjusting for inflation and why it's important to understand that the median household income ends up being pretty much flat.

I'm tempted to believe, then, that the actual economic growth is hidden under the basket.

Some of it does get hidden, and that that isn't hidden is hard to measure accurately. That's why, as I said earlier, economic indicators are chaotic and uncertain.

[Zombified]

Originally posted by shanek
However, with very few exceptions (none of which I can think of at the moment), these improvements end up making the economy more efficient. It's obvious that you can do more with a computer today than you could 20 years ago. That means more work can be done with less effort and in less time. The effect of this is to increase Long Term Aggregate Demand, thus growing the economy.I agree completely, I don't think there's any "however" about it. The point I attempted to make is that there is a lot of change "hidden" by the CPI.
Tons of reasons. Think about all the factors that can affect supply and demand in any given product. Now multiply that by the biggest number you can think of. :)I certainly appreciate all the things that can cause prices to change, and thus the CPI to move in the short term. What I can't figure out is how to make meaningful comparisons over the long term as the CPI is periodically changed. If the basket of goods is "all the stuff a household buys", then the buying power of a household is, on average for periods of time longer than the rate of changing the basket, 1 baskets-worth. I'm sure economists must have a way of addressing this problem, I just don't know what it is.
The problem is, CPI is a measure of nominal value, not real value.Alas, you have exceeded my knowledge of economics jargon.
What you're talking about is converting the amounts of CPI to (say) 2002 dollars. But CPI is the measure of what makes 2002 dollars worth a certain amount compared to any other year! Ultimately, you would end up with a perfectly flat graph—but the information you would get from this is exactly as useful as knowing that any number divided by itself equals 1, because that's all you're really doing.This is exactly my point: the long term buying power of a household, by definition of CPI, is one basket. Your graph would appear to exactly that, where the units are 1999 dollars instead of baskets. Either I have misunderstood this, or misunderstood your purpose for posting it.
That's why, as I said earlier, economic indicators are chaotic and uncertain. With that I wholeheartedly agree. Why can't economics be more like physics? ;)

[shanek]

Originally posted by Zombified
Alas, you have exceeded my knowledge of economics jargon.

Real value is the actual value of a product; why you would want it. A gallon of milk now has the same real value as a gallon of milk 50 years ago. You want it for pretty much the same reasons, and can do the same stuff with it. But its nominal value, in other words, the price of a gallon of milk in current dollars, has changed dramatically.

Of course, sometimes real value can change, as in the case of technology. As I said earlier, computers can do the more things today than they could do 20 years ago. Hence, they have a greater real value.

This is exactly my point: the long term buying power of a household, by definition of CPI, is one basket. Your graph would appear to exactly that, where the units are 1999 dollars instead of baskets.

If you're asking if the overall buying power of households is pretty much the same, then the answer is yes, with that slight rise you see in the graph.

Either I have misunderstood this, or misunderstood your purpose for posting it.

The purpose was to rebut the idea that the inflation rate was an indicator of economic growth. It clearly isn't.