Inflation is a word that’s commonly heard in financial reports and everyday economic news. But what does it really mean as it relates to your money? Inflation is generally regarded as negative, but did you know that the Federal Reserve and other central banks actually think inflation is good? Let’s talk about how inflation affects your wealth. Let’s also define MMT and explain how it relates to inflation.
How Inflation Steals Your Wealth
Inflation is defined as the reduction in the value of a currency, as evidenced by prices in that currency going up. This is due to the fact that the decreasing value of the currency requires more of the currency to transfer the same amount of wealth. Inflation is often measured using consumer indices like the Consumer Price Index (CPI) in the U.S. This metric takes a “basket” of goods and services and measures the price of them every quarter. This measure tells us what the rate of inflation is at any given time.
How Central Banks Work
The central banks around the world who manage fiat currencies manipulate the value of these currencies through various means. One of these methods is the interest rate at which banks can borrow money. This money is, in turn, lent to borrowers. Central banks and the economists who run them see themselves as referees for the economy. When they feel the economy is growing too fast, they reduce the growth of the money supply. This slows the flow of money and makes the currency deflate at a slower rate. If central bankers feel the economy is too slow, they cut interest rates. This encourages banks to lend more money because they can borrow it at a lower rate. Often some of these rate cuts are passed on to consumers. They, too, are more eager to borrow money at lower rates. This activity increases the money supply, increases the flow of money, and speeds up the economy. But in order to gain this increased flow of money, the value of the currency is decreased.
The U.S. Federal Reserve has set the interest rate at near zero. Several jurisdictions in Europe and Japan have even set negative interest rates in recent years. The practical result of this is that banks can get the money very cheaply. In the case of negative rates, those who deposit money in a savings account could actually have to pay for the pleasure to do so. Naturally, this does not make depositing or saving money very attractive. Lower interest rates stimulate lenders to offer more loans and the lower rates entice borrowers to take advantage of them. In the meantime, those saving their money are punished with less real value for their currency.
If you like this article, read and find out how Bitcoin protects you from Inflation: Is Bitcoin A Safe Haven in Times of Crisis? By Aaron Koenig.
What Does MMT Stand For?
MMT stands for Modern Monetary Theory. This school of thought is outside the mainstream of economics. The most notable argument of MMT is that a country should be able to print as much money as they need to be able to pay their bills. When politicians espouse massive spending for social programs or stimulus, they are usually influenced by the tenets of MMT. Under this theory, countries encountering budget deficits have no reason to worry because they can simply print more money. Of course, when a country is unfettered in its ability to print currency, that reduces the value of the national currency. Those who are holding large amounts of that currency suffer because the buying power of that money is reduced. People who work for a living soon find that their wages, which don’t magically adjust for inflation, amount to less and less in real value when it comes to buying goods and services.
Critics of MMT say that an unbounded increase in the money supply leads to a lack of faith in a country to pay its bills. When a country can print as many units of currency as they need in order to pay their bills, they can always actually pay their bills. But those who lend to that country know they are not getting the same value back that was lent to them. Imagine if you could rip a dollar in two pieces and claim that it was worth double what it was before. This is essentially what the government does with its monetary policies.
Crises and MMT
The ideas behind MMT are not widely held. But in crises like the Great Recession of 2008-2009 and the Coronavirus (COVID-19) pandemic, massive amounts of currency are printed under the justification of helping the public. The stimulus checks sent out to millions of Americans and similar programs throughout the world were funded through the creation of new currency. The new currency acts to dilute the value of each unit of currency and leading to inflation.
Inflation steals your wealth by making your currency hold less value. Economists justify this as part of their role as overseers of the economy—to keep the money flowing. The modern monetary theory argues that governments should be allowed to print as much money as they need to remain solvent. Belief in this concept is not widely held, but the notion of printing as much money a needed always makes its way on the table in a crisis, and the coronavirus pandemic is no exception.