Monetary inflation caused by a central bank or government (and not by the free market) is harmful to the overall economy and is harmful to the average person’s standard of living. While inflation could be harmful in a free market too (let’s say a gold miner discovers a huge quantity of gold that was previously unknown), the market can also adjust and even switch to another form of money if necessary.
Monetary inflation is harmful in many ways. It misallocates resources and causes artificial business cycles (booms and busts). Inflation allows the government to spend more and accumulate more debt than it could have without a monopoly over money. Inflation also redistributes wealth. While it is a net loss overall to society, it does benefit debtors at the expense of savers.
So while our standard of living would be much higher if there were no government monopoly over money (and granted to the central bank), I want to look on the positive side and offer at least a little good news about monetary inflation.
First, inflation itself is limited, even if it doesn’t seem so. If the Fed allows things to get out of control and we actually see hyperinflation, then the Fed would destroy its own power. Hyperinflation means that the money would no longer serve its proper function as money. The market would be forced to switch to something else. For this reason, I actually don’t think we will see hyperinflation.
Second, inflation can actually counteract and correct some other bad government policies. One example is the minimum wage and unemployment. The minimum wage laws do not allow the labor market to clear. There are unemployed people who do not have the skills and productivity to make it worth it for employers to hire them, even at the minimum wage. However, if we see enough inflation and the minimum wage does not rise in unison, this could actually help the unemployment situation. Real wages could actually go down, even if the nominal numbers do not.
This actually happened in America during World War 2. The government was trying to keep wages up. But the inflation that came with World War 2 actually helped in this particular area. It allowed a decrease in the real (inflation adjusted) wages, which actually helped unemployment. Of course, sending millions of young men off to war also caused unemployment to drop, even if it wasn’t “productive” labor.
Another example of inflation counteracting bad government policies (that phrase may be somewhat repetitive) is in dealing with the budget. It is commonly discussed that devaluing the currency allows the government to pay back its debts with money that is worth less. But this also can work against the government with its annual budgets. I recently discussed the Obama and Bush budgets, and the annual spending over the last 3 years has actually gone up very little (although it started at a very high point). If the budget goes up at say 2% and inflation is at 3%, then the inflation-adjusted government spending is actually decreasing. While this may not seem like much, and it isn’t, I am at least trying to look on the bright side with something.
I will throw in one final last “benefit” of inflation. While it devalues the money being collected by savers and those on a fixed income, this also includes all of the government employees with pensions. This means that Ben Bernanke’s pension becomes worth a little less each time he inflates. This is another reason that I believe the Fed will not go to hyperinflation.