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  • Ever wondered how your grandparents bought a house with what would barely be enough to

  • buy a used car today?

  • Yes, the prices for things are constantly going up, and the main reason is inflation.

  • Here's a fun fact for you.

  • If you had bought a pint of milk in the UK, in 1960, it would have cost you three pence.

  • Today that will cost you 50 Pence.

  • Can we even buy anything with three pence today?

  • Probably not.

  • So why does this economic phenomenon happen? And is it a good or a bad thing?

  • Inflation is the rate of increase in the price of goods and services over a period of time.

  • Hello Joumanna.

  • Hey Timo.

  • This is Joumanna Bercetche, a CNBC anchor, and our resident monetary policy and economics whiz.

  • Let's talk about inflation.

  • Why don't we go back to the basics.

  • Let's do it.

  • Traditional economics would dictate that there are two main causes for inflation.

  • There is demand-pull inflation and cost-push inflation.

  • Cost-push inflation happens when business expenses increase, and these extra costs are

  • passed on to their customers.

  • So with cost push inflation, what happens is that the price of your inputs or your raw

  • materials goes up over time, and that could be because of anticipated events or unanticipated

  • events, like say a natural disaster.

  • A good example of that would be say what has happened to many of the world's economies

  • coming out of lockdown.

  • On the back of that, we've seen a lot of supply chain bottlenecks, we've seen a rise in shipping

  • costs, we've seen in certain areas a labor shortage, and because of those, the most of

  • those inputs will go into the price of manufacturing, inevitably that has led to higher costs.

  • Then there is demand-pull inflation, which is when the demand for goods and services

  • outpaces supply.

  • This tends to happen when the economy is strong.

  • Demand-pull is probably a better reflection of what happens when the economy is very close

  • to full capacity.

  • In the case of a very well-functioning economy, people may feel that they have more disposable

  • income to spend, and therefore demand for goods and services may go up.

  • And if companies are operating at full capacity, they won't be able to increase their production

  • to keep up with that demand.

  • So that could also be inflationary.

  • Some economists also see increasing money supply as another major cause of inflation.

  • Around the 70s, a new type of view came to the forefront.

  • And that was posited by famous economist Milton Friedman, and his view, and he actually said

  • this, is that inflation, primarily, and everywhere is a monetary phenomenon.

  • So, is Milton Friedman's theory always right, that increasing money supply causes prices to increase?

  • You're putting me on the spot, Timo. I mean, try to get a couple of economists agree on anything.

  • It's really difficult.

  • Keynesian economics is all about what governments do.

  • Milton Friedman is saying, well, this is actually the domain of central banks, and if you look

  • at the response to the great financial crisis, to the pandemic, what central banks have done

  • globally, at least advanced economies, has contributed to an increase in the amount of

  • money supply that's available.

  • And so many of the people who believe in the Milton Friedman monetary theory of inflation,

  • suspect that because there has been such an expansion of money supply, eventually

  • that is going to be extremely inflationary.

  • But Timo we're not seeing it.

  • And so the question is why?

  • So let me give you an example.

  • If I walked in to this room, let's say with a bag of cash, and I just put it on the floor,

  • but no one picks it up, and no one did anything with it, its impact on inflation would be nil, right?

  • Because it's just sitting there.

  • What if we told everyone at CNBC that there's a bag of cash sitting on the floor, waiting

  • to be picked up, you'd probably get a stampede of people taking the bills out,

  • going down to Costa buying coffees, buying croissants and spending on goods and services.

  • That situation, the pile of cash that I brought into the room actually is inflationary, because

  • it's leading to more transactions.

  • So the missing link right now is the number, what we call the velocity of transactions, has actually dropped quite a lot.

  • In order for this money supply to be inflationary, you need to see the transaction levels or

  • that velocity of money go up again.

  • Got it! Wow, that was like a lightbulb moment. I feel like I really get it now.

  • I don't have a bag of cash though.

  • Oh really? I'm leaving. (Both laugh)

  • The most widely used measure of inflation is an economic indicator called the Consumer Price Index.

  • It's calculated by measuring the percentage change in the price of a basket of selected

  • goods and services a typical household uses over a period of time.

  • This so-called basket can include the price of goods such as food, cars, furniture, and

  • apparel, as well as the price of services such as rent, medical costs and recreational spending.

  • So let's talk about CPI, the consumer price index.

  • During my research, I found that this is the way inflation is measured across many countries.

  • Let me just caveat that by saying each country constructs their own CPI basket,

  • so what is in it is a function of that country's policymakers.

  • Essentially, what you want to have is a basket that just reflects people's spending habits,

  • monthly spending habits.

  • And so what you put in it is supposed to be a reflection of what a consumer would typically

  • spend on a month-to-month basis.

  • Economists then take the cost of this basket, divide it by the cost of basket from the year

  • or quarter they're comparing it to, then multiply it by 100.

  • This formula calculates the inflation rate we see in headlines.

  • This is known as headline inflation, but many argue that something called core inflation

  • is the more valuable metric to follow.

  • What economists try to do is try to smooth out and remove any of the subcomponents that

  • would be extremely volatile on a month-to-month basis or have no ultimate reflection on the

  • strength of the economy.

  • Oil, for example, on any given month, you can have oil moving up and down because of

  • factors that are exogenous to how an economy is operating.

  • So what economists will do is say, "Well, we'll look at the headline number to get a feel

  • for how at an aggregate level price levels are doing."

  • But then if we want to get an idea for the overall trend of prices, then we're gonna

  • strip out some of those volatile components and that will give us a better measure of

  • how these Inflation numbers are panning out.

  • Now that we understand what inflation is and why it happens, let's explore whether it's

  • something we should worry about.

  • Ultimately, is it a good thing or a bad thing?

  • Well, economists have come around to the view that a little bit of inflation is good.

  • It's like Goldilocks, you don't want it to be too hot and too cold.

  • You want it somewhere in the middle.

  • Usually inflation is a sign of a well-functioning, productive and growing economy.

  • But when you talk about hyperinflation, then we're entering into a completely different stratosphere.

  • Hyperinflation is when prices spiral out of control, with an inflation rate typically

  • increasing by more than 50% per month.

  • Though many things can trigger hyperinflation, it's most commonly caused by excessive money

  • supply and a loss of confidence in the economy or monetary system.

  • Take Brazil for example.

  • From 1980 to 1995, the price level increased by a factor of one trillion, meaning you would

  • have to pay one trillion Reais for something that cost you just one 15 years ago.

  • In the case of the Weimar Republic, in Germany, for example, post-World War One, they were

  • experiencing inflation, average inflation of about 300 percentage points per month.

  • These are numbers that are actually so high, it is difficult to comprehend.

  • At one point, the Riggs bank, the German central bank at the time, actually issued a 100 trillion mark note.

  • Are you kidding me?

  • No.

  • I mean, it was extremely, extremely painful for many of the people who witnessed and lived

  • through that time.

  • There are loads of these images from the 20s of little kids using stockpiles of cash as

  • Lego, because cash was worthless.

  • But inflation doesn't need to spill over into hyperinflation territory to cause trouble.

  • In the 1970s, many of the world's developed economies witnessed double digit inflation.

  • But it was how the chair of the U.S.'s central bank handled it that made the history books.

  • Essentially, what happened is you had a couple of supply shocks.

  • So we talked about cost push, you know, one of them was an energy supply shock, you had

  • that around 1973 1974 with the oil embargo, and then the Iranian Revolution in 1979.

  • So that led to skyrocketing oil prices.

  • At the same time, you had a couple of other things going on, back in the U.S.

  • President Nixon had pulled the us out of Bretton Woods.

  • He had removed some price controls on certain goods and in the food space.

  • So, all of these things contributed to a slow and steady rise in inflation.

  • Until, we talk about secondary effects, it led to a wage spiral.

  • So workers started demanding an increase in pay.

  • And at one point, we had inflation reach about 14%.

  • And this was around 1980.

  • And the then Fed chair Paul Volcker came in and said, "Okay, well, inflation is the enemy,

  • we've got to cure this."

  • And the only way you can cure this is by hiking interest rates.

  • So he kept hiking and hiking hiking, the Fed started this interest rate hiking cycle,

  • at which interest rates in the US reached 20 percentage points.

  • Eventually, they managed to start taming inflation and inflation went down to three percentage

  • points by the mid 80s.

  • But, Timo, it came in a very heavy cost, because you had more than 4 million Americans unemployed

  • at the time.

  • And it was it basically led to an economic recession in the U.S.

  • So that was the trade-off that they had to make, in order to keep inflation team or to

  • bring it back to tame levels, the economy had to go through a very painful adjustment period.

  • And that is a reason why, in this day and age, nobody wants to go back to what happened in the 70s

  • and then the painful tradeoffs that ensued afterwards.

  • What are the changes we've seen countries make to ensure we don't see a repeat of what we saw in the 70s?

  • Well, I think one of the most important developments is that you have institutions now,

  • you have central banks whose primary, or one of the main mandates, is to keep an eye on overall

  • price levels in the system.

  • So many developed market, or many central banks out there, their number one goal is to ensure

  • that inflation doesn't get above a certain level.

  • The magic number is around 2% for advanced economies' central banks, they'll say somewhere around there

  • because it's not too high so that it will start causing secondary effects, but not too low or close to zero

  • or even negative, that we may be dangerously close to that deflation or disinflationary dynamics also,

  • which central banks want to avoid.

Ever wondered how your grandparents bought a house with what would barely be enough to

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