Unexpected Inflation

It’s what makes prices go up, your raise worthless, and the money in your bank account degrade in value: inflation. Ugh.

Unexpected inflation is one of the worst kinds of inflation, since nobody was anticipating it. Nobody, as in: economists, regulators...the people we pay to know what’s up with the economy and inflation and stuff.

When inflation goes up, prices go up. Paychecks follow, albeit at a slower pace. That’s why a raise can be worth nothing: if prices went up and you have the same buying power as a few years ago, then your real income didn’t rise, even if your nominal income did. And if your savings account is only paying you 1% interest, and inflation is 2.5%, then your money is eroding 1.5% in real value every year. With unexpected inflation, your buying power will erode at an even greater rate. As a borrower, inflation is good though, since the real amount you have to pay back is shrinking as prices and incomes rise.

Unexpected inflation happens when economists’ models are wrong, which is...well, we don’t know how often. That’s why there’s so many major schools of economic thought. Even if an economic model might appear to be true to reality...it might not be. We only know when things go wrong that our model is for sure wrong, like when there’s unexpected inflation.

Most modern economies function on Keynesian principles, which means the central bank intervenes when the economy is down, and the policy is to promote spending to keep the economy’s energy up. Yet part of Keynesianism stated that inflation wouldn’t happen with GDP growth was slow...which makes sense, right? Why would prices rise when growth is slow? Usually, if growth is slow, things go on sale, because firms try to attract buyers.

In the 1970s, that part of Keynesianism was shown to be false, as unexpected inflation occurred during a period of slow economic growth, puzzling economists. Hrrmmmmfff.