Look This is Germany in 1923 These people were pasting their wall using banknotes Light up fire with banknotes The Deustche Mark became worthless too small to even use as toilet paper prices doubled up every two days on average the annual inflation rate had reached This is Zimbabwe in 2008 They printed the infamous banknotes can’t even count the zeros in there this is 100 trillion Zimbabwean dollars the price doubled up every 24.7 hours the annual inflation rate had reached 7.3% multiplied by 10 to the power of 108 Can you imagine that? Well I can't This is Hungary in 1946 prices doubled up every 15.6 hours the annual inflation rate We may be joking aboout it now but at that time it was disastrous for the local economy In 2022, USA, EU and UK the inflation suddenly rises, The word, inflation has once again become the topic of global economy I’ve dugged up this hole multiple times Let me help you get through it We’ll talk about inflation in depth while making it fun and easy And we’ll talk about what is exactly in the mind of government and central bank Are you ready? Inflation means currency depreciation Inflation is actually the depreciation of currency The most common measuring indicator is called CPI Consumer Price Index It measures the trend of price of common goods and services This is USA’s CPI It was around 29 sixty years ago Now it’s 296 Although this absolute number doesn't show much significance From the comparison you can know that current’s price is about 10 times compared to 60 years ago It means that 60 years ago, 1$ is equivalent to $10 now It’s lower than what you imagine right The inflation in China is similar In 60 years Australia prices increase 16 times UK 25 times India 88 times Turkey 9.7 million times As prices go up, money is worth less and less It’s not hard to understand But if we were to get deep into understanding inflation first we have to look at a formula Look at this C Hey I’m joiking Lin would never talk about boring formulas Actually economists have tonnes of formulas to describe and explain inflation like Keynesian, Monetarism Neo Keynesian, blablabla They all sounded reasonable but non of them is proven useful long-term This is actually one of the amazing things about inflation Because the way it was formed is actually quite simple It's nothing more than the amount of money circulating in an economy exceeds the size of the economy Too much money with too few goods hence prices go up Simple as that but none can seem to grasp The primary goal of central banks in every countries Or even the sole goal of many central banks is to maintain the stability of price Print as much money as you want Adjust interest rates as how you like Just as long as the price is stable and maintain the inflation rate But it’s difficult to maintain Even the Federal Reserve and the European Central Bank where they’ve gathered world’s renowned economists they often disagree among themselves So this is actually not as simple as you may think Let’s dive deep If we stand in the perspective of an entire economy then money is nothing more than a mean of circulation Currency corresponds to purchasing power For example, it doesn’t really matter if this milk tea is $3 or $300 What we are after is more enjoyment, more happiness That's too deep for today For an economy we are chasing after higher output value To put it simply, higher GDP Meaning to say if everyone works hard every day do more works, more outputs produce more and better products and services Then, as consumer we get to enjoy these better products and services So the economy as a whole operates more efficiently This is what we are after From the perspective of currency how does it help us in achieving higher output Normally we’d think that currency is a just a medium in an economy so it just needs to be stable means that if you have $100 you can buy the same items with that amount forever Very stable It helps the economy run But slowly people discover that assuming the money in our hand is not completely constant and that the money is our hand is depreciating bit by bit So although it seems very safe to hide your money under the bed but due to inflation the purchasing power if your money is slowly diminishing This purchasing power is transferred to the newly created money It actually is constantly making fine adjustment to everyone’s wealth Can’t let you be too comfy Gotta let you hide less money under those beds and force you out to make more money To produce more, spend more Inflation is actually a constant redistribution of wealth Interesting right For example If this year a cup of milk tea cost $20 then next year the same cup of milk tea would cost you $21 So you see the money in hand if not spent this year then it’ll worth less next year Might as well spend more now That way people are more likely to make instant purchases which increases aggregate social demand and GDP will rise See, a pool of dead water rejuvenated by mixing in inflation This is why now it’s commonly believed that a healthy dose of inflation is better for the whole economy Of course as consumer we definitely don’t like the feeling of being forced to spend So a lot of people list inflation into something called Misery Index But overall economists doesn’t really care about misery index Economic growth is way more important Alright, so what if it’s deflation? For the same $100 the things you can buy next year will be more than this year I would have hidden it under my bed Your wealth would increase each year It doesn’t sound like a misery right sounds incredible But the problem is no one will want to work hard to earn more money just lay flat at home spend less After all if you don’t spend you’re actually making money Then everyone will not spend unless when it’s necessary In long term it’ll enter into a very scary vicious deflation cycle Japan is a very classic example of this Japan is a very classic example Japan entered deflation and after that they were facing credit crisis. For 30 years no matter how the central bank tries to stimulate the economy no matter how the government borrow money the demand just couldn’t be stimulated Of course there are other problems like culture and aging population But from here you can see how terrible deflation is Cheaper price is not the actual problem It’s when everyone is not working not earning money, no output just layflat and doesn't spend Enter low desire society That's the deeper problem We care so much about inflation not because we care about the changes in price It’s that the changes in price will bring changes in demand and GDP Of course inflation and the redistribution of wealth cannot go overboard For example If this year the money under the bed can buy me 100 cups of milk tea next year 99 cups and the year after 98 cups Then it’s still quite okay right Just need to keep hustling But if it’s like in Zimbabwe where if today I could buy 100 cups of milk tea tomorrow 50 cups and by next week none Then what’s the point of working to earn money Every two three days Everyone's wealth get reshuffled Working so hard to earn money but gone just like that I’ll definitely just lay flat I’ll just earn enough to get by Having money is like holding hot potatoes spend it away as soon as you got it because it’ll be gone soon even if you try to save it This situation is being called as Hyperinflation It's really devastating to the economy Like Germany after WW1 A piece of bread cost 100 billion Mark day after tomorrow it became 200 billion Mark Under such circumstances The financial and credit system of this economy is completely paralysed social productivity plummet At that time in Germany 6 million people became unemployed in just 6 months This led to military control of currency political turmoil and the rise of Hitler Any country in history that had experienced hyperinflation had to go through painstaking full reformation and reignition to slowly recover We mentioned deflation earlier it’s a bit like the economy is being frozen Growth and development stop Hyperinflation is overheated economy which ended up in combustion that got worse These are all bad We talked about how terrible deflation and hyperinflation are so now we are going to go even deeper to understand why most economists are going after that right amount of inflation It's just a matter of right degree For example, central bank of USA, EU, Japan Canada, Australia have set the inflation target to around 2% - 3% Central banks of other economy bodies although didn't announce a specific inflation target but similarly they wish to control inflation between 2% to 5% No matter what monetary policy they decided on their main target is to control the inflation to stay in a reasonable range Even at the cost of sacrificing short-term economy growth or even enter a short-term recession Maintaining inflation is the bottom line for all the developed economies right now Just a quick talk Some people are curious about the effect of inflation towards price of assets What’s the effect on stock price and housing price In theory it’s quite hard to say Because there are many interfering factors But if you were to guess on a direction you might think it’s positively related Because due to inflation, prices increase in order to hedge against inflation people would invest in real estate or stock market However in reality it’s quite interesting Let's look at the IMF's regression of the past relationship between share prices and inflation in 71 countries I’m not going to explain on this diagram The conclusion is that no matter it’s a developed or developing country There is a negative correlation between stock price performance and inflation Meaning to say, during high inflation stock price would fall This is because policy is the main reason for the fall of stock price During high inflation period in order to curb inflation government and central bank would tighten up on financial and monetary policies And this tightening policy caused the stock price to fall However Turkey is an exception They didn’t tighten up policy during inflation that’s why their stock price increase 3 times in a year Another exception is the stock price of energy companies Historical data suggest that generally during periods of high inflation Energy stocks have done very well This is also very much in line with global inflation in 2022 Didn’t we awarded best performance company to Exxon Mobil So why do you think inflation happens? The most direct would be because central bank prints money they printed too much money which causes inflation Well it’s correct but also not entirely correct Sometimes even when the government doesn't print money, it can lead to inflation Sometimes the government could print as much money but won’t cause inflation For example, for the past 20 years, Japan’s central bank has been printing money endlessly, but still couldn’t end deflation Let’s look at 3 factors that could cause inflation First is demand-pull inflation For example imagine in a functioning economy and then one day for some reason everyone wanted to drink milk tea In this economy where everything runs as usual but suddenly have an extra demand Everyone go and buy milk tea At this time all the milk tea shop owners in the country they get very excited which would lead to two consequences One is producing more milk tea another is higher milk tea price Regardless of which the milk tea shop owners get the profit The boss who made money can now afford to buy more food, bags and whatnot If the boss is generous they would issue bonus, raise salary the employees would be able to buy more food, bags and whatnot So you see now the businesses for selling food and bags are thriving and then enter another cycle of buying more goods In conclusion In conclusion, increase in aggregate demand would cause a rise in production and price The company's profit will increase which will lead to an increase in consumption causing a new wave of demand growth A virtuous circle thus begin That’s why we said that aggregate demand will lead to economic growth But did you notice that there’s a side effect, that’s increase in price of goods or so called inflation So the entire logic is actually demand-pull inflation Demand really is the productive force that drives social progress For example if there’s a demand to get into stock market various trading platforms would arise and demand for one-stop trading platform would arise One 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talked about demand pull inflation it bring about economic growth right So if the government wishes to stimulate economy, they will start from stimulating aggregate demand just that the side effect is inflation What does it mean by stimulating economy Simply put, it's to motivate people to spend money buy milk tea, buy bags It's either government spend money themselves like developing infrastructure or giving out subsidy or the simpler and easier way like recently the Western government is willing to hand out money to their people Let them buy it themselves In the beginning of pandemic everyone is staying at home So who would be buying milk tea, the demand dropped So the governments are starting to print money This is the balance sheet of central bank of US, Europe, Japan, UK While stimulating demand they had to inject large amount of money into the economy that brought the risk of inflation This means that inflation and economic growth goes hand in hand Buy one free one Although they come hand in hand but if you choose the right time to stimulate you can achieve economic growth with lower inflation For example, now the government is handing out $1 trillion to motivate people to buy milk tea Assuming if the milk tea shop is idle the ingredients are sufficient So when the customers come, I can just make it Very easy to fulfill the demand doesn't really need to increase price of milk tea only increase in GDP Now this is nice Conversely, if this milk tea shop is already crowded and busy and the government go ahead to stimulate demand then it'll only force the price of milk tea to increase The production didn't actually increase The situation is worse in this case Can you see that the main difference in the two examples is that whether the milk tea shop still has production leftover Assuming that if the economy possess huge production capacity potential You'll see economic growth if you throw money in You'll even feel that no matter how much money you throw in all you can see is economic growth and not increase of price of goods The economy keeps going upwards very prosperous So how do we look at the production capability in an economy? Actually you just need to look at unemployment rate If the unemployment rate is high that means many people are not working so there's a lot of production capability Conversely, if the unemployment rate is low only 2% or 3% that means most of the labour force has already been put to work In such case, the production is already quite tense This is why in normal circumstances before high inflation there'll be a stage of low unemployment rate Actualy in Keynesian there's Philip's curve It means that between inflation and unemployment rate is negatively related If you look at current US few years ago the unemployment rate was going down Job vacancies filled increased to more than 10 million At the same time, companies' profitability is at historical high in 60 years What does it mean? It means the company is constantly making money at the same time it wanted to expand production to earn more money employ more people However, the labour force in society has basically become saturated. Isn’t this similar to the one we mentioned earlier the overcrowded milk tea shop What to do now? Increase price There you go, inflation So in such circumstances the feds is still continuing on quantitative easing it’s no wonder that inflation is getting so high Let’s diverge a little We said that printing money can stimulate demand and will enter the cycle of stimulated economy and inflation However central banks for all countries are now facing a problem their money that they printed are not issuable if the central bank wanted to control currency the policy they can make is either adjust the interest rate or buy and sell some financial products Actually with these methods the money is still circling in the financial system What does it mean For example central bank buys in a lot of government bond and company bond but the financial institutions that obtained money from the sale of these bonds They wouldn’t take out the money no matter what nor are they lending it to real economy they invest in stock market instead no matter how low the interest rate is if the commercial banks wouldn’t give out loans then there won’t be any money flowing out to real economy so the money would only be circling within the financial system It’ll never reach the hand of consumers like you and I to buy milk tea The central banks put lots of effort lowering interest rates and printing money but the actual money didn’t flow in to the cycle of economic growth This to some extent explain why prior to 2020 for about 10 years countries like Japan, Europe, USA despite having quantitative easing lowering interest rates for long-term but still couldn’t get inflation in real economy You could only see a rise in stock market After pandemic Biden’s government finally understand that printing money no longer works The government has to take action by giving out money to consumers literally handing out money In 2020 almost everyone received $1200 if you have kids +$500 if you become unemployed, another $600 per month and various loan relief measures In 2021 those with annual income less than $75,000 received another $1400 Anyway, during these two years a total of $5 trillion has been given out Can you imagine that It’s an average of $15,000 per person Normally the government would print money without restraint during war or due to political issue I mean if the government is not desperate they wouldn’t resort to printing and spending its own money We all know the consequences it’s impossible that they didn’t know We mentioned in the beginning Germany from 1920 - 1923 Hungary from 1945 - 1946 lost in WW1 and WW2 and signed a lot of reparation treaty and had to start printing their own money When the government prints money, the quantity of money increases so it will push demand Then came demand-push inflation. But because the government prints so much money it causes inflation to rise too fast and when it come to a certain height the redistribution of wealth in the society will become faster People would only think about earning enough to get by and not think about saving money Attention At this point, hyperinflation hasn’t occurred yet it’s only about 40% - 50% even if the government realised the danger of inflation and stop printing money but everyone has alredy reduced their work Then the productivity of society begins to decline supply of goods will start to decline What will happen because of this? Price increase this tells us that because supply is insufficient leading to cost-push inflation which eventually leads to even higher inflation No one is willing to work and supplies will get more scarce again lead to higher inflation That gives you an inflation rate of 7.5 times 10 to the power of 170 Inflation has one very important nature I've been keeping it and that is, expected inflation will cause inflation Meaning to say Everyone think that inflation is coming and it really is here When I first heard of this theory Most explain it this way Because everyone expect the price will increase then businesses will continue to raise price Slowly when all the goods price increased the bosses will start to raise your salary then everyone will have more money on hand and here comes the inflation This explanation is correct in long-term But there's a point I couldn't understand In an economy body there's only so much money for so many products It happened solely when people expect an inflation there's no policy stimulation or printing money The total amount of money has not changed then why would the price go up? Let me explain it to you it's a bit theoretical but I find it quite interesting When everyone is expecting inflation The money on hand becomes hot potato You will increase consumption on your own or even over consume by hoarding some goods because the price of goods will become more expensive later If everyone think the same in an economy Then the amount of time money stays on hand becomes shorter This actually increase the speed of money circulation This is to say when the market expect an inflation the speed of money circulation increases Even though the total amount of money is constant but the money in circulation increases Once the cycle starts Even if the central bank doesn't print money the inflation will still occur Can you see that, expected inflation will really cause inflation Lin call it as "Scare what come what" theorum It's the same as Murphy's law Take note that this theorum is a very important nature of inflation This is why when we look at central bank trying to control inflation not just about interest rate, quantitative easing There is another very important point and that is to control people's expectation You can see from Powell, chair of Federal Reserve whenever he makes a speech, he always seems calm Even in 2021 when the inflation was already at 5% He was still saying it was "transitory" But later the inflation data goes higher and higher he still appeared to be very calm we are confident, we are determined to push down the inflation He is basically telling the market to not panic Don't panic, I'm here, the inflation will go down, dont worry See, once you understand the inflation theorum you'll know that his confidence is part of his job Due to this nature, no matter at which level the inflation is Once the expectation is formed it's very difficult to shake it Once it goes up, it's hard to come down and it's easy to go higher Once people is stuck with that expectation then deflation will sink deeper Once you understand this you can understand why the central banks perceive inflation like it's a monster Because it panics See here, last year US increase interest rate at 75 points interval This is definitely a huge blow for local demand It presses down on the demand that the government stimulated by handing out money not only that it causes the US stock market to fall Whether it's investor or consumer their confidence is very low Everyone is worried that the interest rate hike will cause recession in US But the Fed doesn't care They continue to hike up the interest rate After listening to the long remarkable explanation are you finally enlightened once and for all getting better understanding on inflation, policy of central banks as well as understanding on global trend This entire logic is the underlying logic used by central banks when making policy So if you plan to work in central bank in the future watch this video again