Inflation Calculator: The Danger of Inflation

Inflation Calculator: The Danger of Inflation


     The danger represented by an uncontrolled evolution of prices: inflation, a scourge of certain times that is now very controlled.

     Inflation: the process of cumulative and self-sustaining increases in the general price level.

     Inflation involves a multiplier mechanism that passes on the rise in the prices of certain goods and services to the majority of prices.

     Inflation occurs when the flow of money flows increases relative to the flow of real flows (consisting of goods and services).

     In terms of income, inflation is the repeated loss of AP (purchasing power).

     Purchasing power remains stable only when it is translated into wages indexed to inflation, i.e. when the price index increases by n%, wages increase by the same amount.

     Currently, when inflation exceeds 2%, the SMIC adapts by increasing by the same amount. But this is far from being the case for all wages since entrepreneurs keep a close eye on their production costs to remain competitive.

There are four main reasons for inflation:

     Demand Inflation: If the demand for a good is too high relative to its supply on the market, the price of that good goes up…

     Cost inflation: increase in the price of raw materials, various goods entering the production cycle, production factors (e.g. increase in the wage bill).

     Structural inflation: protected prices not subject to the law of the market

     Incentive inflation: the incentive to consume more and more creates needs and pushes economic agents to demand more and more income.

     The origins of inflation analyzed by different schools of thought:

     Keynesian analysis: inflation occurs when the productive apparatus is no longer able to meet the increase in demand.

     For KEYNES, it is necessary to determine the threshold beyond which the rigidity of Supply (the productive capacities of entrepreneurs are used at 100%) will provoke the inflationary phenomenon and contain the money supply below this threshold.

     However, for KEYNES, encouraging demand remains the driving force behind economic activity.

     The neo-classical analysis: inflation is due to non-compliance with the principles of the CPP. Several factors hinder the free functioning of the market and are responsible for inflation: prices set by the State, trade union action, tax charges.

     The recommended policy is therefore simple. It is necessary to reduce State intervention, the power of trade unions, and to put in place a policy favoring genuine competition.

     Milton FRIEDMAN‘s monetarist explanation: “The immediate cause of inflation is always and everywhere the same: an abnormally rapid increase in the quantity of money in relation to the volume of production“.

     FRIEDMAN explains inflation by the phenomenon of “rational anticipation by economic agents“: Faced with an increase in the money supply (increase in income, i.e. the wage bill) due to a so-called “stimulus” policy, the entrepreneur is wary of this incentive to invest (to match Supply with the new Demand) on the part of the government; he is in fact only encouraged to invest on the basis of new outlets for HIS product, yet this new Demand is not necessarily going to be oriented towards the national products sold by the entrepreneur in question.

     The entrepreneur will, therefore, wait to invest until he is certain of new markets for his personal product, but at the same time, he risks increasing his prices in line with the increase in his production costs (increase in the wage bill due to the increase in the minimum wage).

     The inflationary phenomenon, i.e. an increase in the money supply > to that of the production carried out.

     Thus, according to the “monetarist” FRIEDMAN, an objective must be set for the growth of the money supply with a view to the stability of the general price level.

Imported inflation:

     Through rising costs (seen above): Rising raw material prices. The need to import certain raw materials makes it necessary to take into account the evolution of the prices of these products.

     By the variation of currency rates: when the prices of imported products are denominated in a foreign currency, the evolution of the rate of this currency on the foreign exchange market has a direct impact on the prices of these products on the national territory.

     Thus, when international tensions make the dollar a safe haven currency and contribute to its rise in the foreign exchange market, the prices of M (imports) expressed in dollars increase, yet a very high proportion of international contracts are denominated in dollars.

     The market’s self-regulating mechanism is thus called into question, on the one hand, because of the reduced autonomy of the consumer (the role played by the firm in guiding its decisions), but also because the price mechanism is hampered in several ways :

– certain prices are not subject to competition

– the prices of products are taxed in different ways by the state

– the price evolution itself is due to factors other than (as seen above) the rational decisions of the various economic agents.