Everyday Economics

“This is why old-timers complain when they start talking about the good ol’ days when they could purchase a loaf of bread and a starter home for a nickel.”

A few nights ago I went on a first-date at a bar in downtown Philadelphia. We may or may not have ‘met’ through an online platform of some sort, and for anybody that is unfamiliar with how online dating works, you often have no real clue what you’re walking into the first time you meet someone.

The woman I met up with was probably quite surprised when the majority of our evening turned into a discussion on economics. In my defense, she seemed quite engaged with the topic- but, perhaps it is no surprise that I continue to find myself single.

One topic that we eventually worked our way into was inflation. When I asked her if she knew what it meant, she said ‘not really’. To me, this was surprising, and quite unfortunate. Not even as an economist, but just as a person that needs to manage their finances. People should be aware of the basic laws that govern their microverse, even if they have no interest in becoming an expert- Not everybody needs to be a surgeon, but everybody should probably know how to put on a bandaid.

There are plenty of topics in economics that I think are applicable and generalizable enough that they should be part of a general ‘life curriculum’- It’s why I write this blog. But inflation is a piece of understanding that I simply think we can’t afford to do without.

Inflation is simply an increase in prices. Typically, we talk about it as a general increase in prices – it’s not that pickles have specifically gotten more expensive, it’s that everything in your shopping cart has.

This is why old-timers complain when they start talking about the good ol’ days when they could purchase a loaf of bread and a starter home for a nickel.

To be fair, income usually increases along with prices (at least to some extent, ask the old-timers what the minimum wage was back in the day), but in general, prices always seem to crawl up, little-by-little, year by year. In fact, if you look at a graph, they seem to increase by a somewhat consistent 2-3%, each year. It’s almost as if there was some entity purposely designing it as such (spoiler alert, there is such an entity, and it’s called the Federal Reserve).

So, if the Federal reserve is managing this inflation, why keep it at 2-3%? Isn’t it better to keep prices consistent?

Imagine that at this very moment you have a dollar in your pocket, and there is a pack of gum that costs exactly $1. You could purchase the gum and happily chew on it. But, if you waited a year, prices would increase by ~2%. The pack of gum will now cost $1.02, and your one dollar will no longer be sufficient to purchase it. Your purchasing power has gone down. This is what consistent inflation does: it encourages people to spend money now, rather than hold onto it for the future.

People may find this irritating and feel that undue pressure is being placed on their purchasing habits. But the reason we keep a low level of inflation is that the alternative is far more concerning. Imagine that instead of everything becoming 2% more expensive every year, prices would decrease by 2%. The pack of gum would now cost only 98 cents next year. As such, you may decide to hold onto the dollar, buy the gum next year, and pocket the 2 extra cents. Sounds great, right? Getting more for your money is always appealing.

Except, if everybody behaved like this, the economy would grind to a halt. Nobody would purchase anything beyond the bare minimum and businesses wouldn’t invest- Everyone would rather wait, and do it for cheaper next year, or the year after that. The economy would stumble into a recession- Suddenly the dropping prices won’t be nearly as attractive when paired with major layoffs and loan defaults.

Low-level, consistent inflation acts as a buffer- it keeps people spending just enough to keep the economic wheels turning, and allows for some fluctuations in economic activity without sending us off the cliff and into a deflationary spiral and recession.

So – why is this important enough for me to bring up on a first-date? Simply put, it’s because as time passes, everybody naturally gets poorer.

Any dollar which you hold onto that isn’t tied up in some kind of asset which is going up in value (it could be stocks, bonds, real estate, artwork, etc.), is losing value.

Those accounts that people have, where they proudly point to the thousands of dollars that they’ve painstakingly saved from their incomes? Maybe they have an account with a high rate of return, but otherwise, money that isn’t out working and doing something, is only going to decay. Low-return accounts are being drained, day-after-day, year-after year. Even if no spending is taking place.

We’ll have other blog articles that focus more on how to think about investments and returns – tradeoffs between liquidity and rates, etc. But, for now, it’s just important to realize that keeping cash is not some terrific end-all-be-all. And that at the very least, everyone should be aware that there is a constant force, maybe not quite as consistent as gravity, but certainly as real, that is actively devaluing their money.

Try talking about that on your next date – And if it works, let me know.