Part I · Chapter 1 · Ledger · lesson 6
Purchasing power, and why the balance lies
10 min
Part I · Chapter 1 · Ledger · lesson 6
10 min
An account paid 2% last year. Prices rose 5%. The statement shows a bigger number than it did twelve months ago, and the weekly shop that used to cost 100 now costs 105.
The balance went up. What it buys went down. Both of those are true at once, and the second one is the only one that has ever fed anybody.
Money is a claim on other people's work. Inflation is that claim shrinking.
The number in the account is the size of the claim. What matters is the size of the pile it can be exchanged for, and that depends on two things — the number, and what everything costs. Track only the number and you are watching one of the two variables.
Purchasing power is the name for the other one. It is what the balance would buy, and it is the only measure of a balance that means anything across time.
A statement is a perfectly accurate record of a claim. What it cannot show you is the denominator, because the denominator is out there in the shops and it moves.
This is what makes inflation such a strange kind of loss. Nothing is taken. No line appears anywhere saying what was lost. The account goes on being perfectly correct about a number that is quietly becoming a different amount of stuff.
Predict
Here is the part that gets left out of the complaint. Inflation does not destroy value so much as move it, and the direction it moves is fairly consistent.
Consider someone who owes 200,000 at a rate fixed years ago. Prices double. Their wages, eventually, roughly follow prices. The debt does not. It is still 200,000, now denominated in units that are worth half as much, and paying it off takes half as many hours of work as it used to.
Now consider whoever lent them that 200,000. They are owed the same number and will be repaid in the smaller units. The loss the borrower did not take is sitting with them.
Something people say
“Inflation is bad for everyone.”
Check
The word doing the work in that question is unexpected. A lender who correctly expects 8% inflation charges for it in advance, and comes out level. It is the surprises that move value, and by definition nobody prices those in.
Most central banks aim at a low positive number rather than at zero, and the usual reasons given are that a small buffer keeps an economy away from falling prices, that wages are much easier to adjust upwards slowly than to cut outright, and that measurement itself has a small upward bias.
These are arguments, not settled facts, and the people who make them disagree with each other about how large the buffer should be and what it costs. It is worth knowing that the target is a choice somebody made, and that reasonable economists have argued for numbers on both sides of the one in use.