Finance: What is Inflation and How Does It Work?

What is inflation and how does it work? Inflation is the gradual increase in prices over time. You might today pay 100x for the commodity coffee what you would have in 1905. Fortunately, you probably make 100x the salary you would have made then, too, so... it all works out. Now you can have your coffee and, uh... drink it, too.

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Transcript

00:21

that prices that have stayed steady well feel cheaper All

00:25

right now what the f*** does that mean Well when

00:27

economies are good and everyone is working getting paid able

00:32

to save money and buy themselves luxuries like ah waffle

00:36

maker that injects maple syrup directly into the waffle While

00:39

people tend to be willing to pay more to get

00:42

stuff they'll pay two hundred dollars a person for a

00:44

one day pass to disneyland They'll buy a second car

00:47

a flashy one that gets terrible mileage but will impress

00:52

the neighbors They'll buy this thing whatever it is because

00:55

it is heart Why not there's more money to go

00:57

around Products want to increase in price Ah home in

01:00

eighteen eighty and central california might have cost a thousand

01:03

bucks that same home today Well it's been remodeled a

01:05

couple times but it might cost a quarter million dollars

01:08

Or more but annual wage or salary in eighteen eighty

01:12

Might have been two hundred dollars So that house cost

01:14

five years Wages gruel forward to today in an average

01:18

wage is fifty grand And voila Well that home also

01:21

costs about five years Wages was their inflation Oh yeah

01:25

Big time Was there really cost increase in the house

01:29

will know you had to work the same amount in

01:31

eighteen Eighty is he do today to buy the same

01:34

house All right So why do people want inflation Like

01:37

why did money have to go up so much When

01:39

five yearswork buys the same today as it did one

01:42

hundred fifty years ago Psychology mohr is more which means

01:45

better So people simply like having a bigger number Over

01:49

time it comforts them to think that they're actually gaining

01:52

traction in the financial creek in which they are paddling

01:56

Perhaps more importantly governments want inflation Why Because they borrowed

02:00

tons and tons and tons of money But most of

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the money the governments have borrowed is in fixed terms

02:06

or steady interest rate numbers That is the government agrees

02:09

to sell fifty billion dollars worth of debt at two

02:12

And a half percent interest We exist in a given

02:14

time period at a rate of two point five percent

02:17

inflation calculated as the existing costs of a basket of

02:20

stuff that people buy You know like milk paper towels

02:24

a six pack of bundy's dog treats heartburn medication that

02:27

waffle thing And so on Those and many other prices

02:30

air checked in dozens of stores averaged and totaled And

02:33

a gross number comes out each year In this case

02:36

the total basket of goods assessing inflation last year might

02:39

have been well let's say a hundred grand for simplicity's

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sake This year that same total is one hundred two

02:44

thousand five hundred dollars that's How we got that two

02:46

point five percent annual inflation rate Okay so now there's

02:50

a shock to the system A bomb goes off in

02:52

a mini war start The economy booms his government's by

02:55

all kinds of us products In an effort to you

02:58

know kill one another The bomb making factories pay a

03:01

lot of overtime Toe workers who spend more save more

03:03

and inflation starts to happen all of a sudden that

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carton of milk which used to be three boxes now

03:09

four bucks and everything else moves the same direction So

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we go from a steady hundred year average rate of

03:15

about two and a half percent a year to now

03:17

suddenly a seven percent inflationary environment and that last for

03:21

five years before regressing to the mean of two and

03:23

a half percent So we have five years come Found

03:25

it at a four and a half percent increase in

03:27

inflation It quote made money cheaper unquote As for that

03:31

fifty billion bucks the government borrowed it still has to

03:33

pay the two and a half percent of your interest

03:35

on lee now it's relatively way cheaper to pay back

03:39

that loan You can imagine the case that brazil had

03:42

in desperately trying to pay back its loans many times

03:45

in the asked by inflating its currency i eat making

03:48

the federal borrowing rate from its treasury super cheap like

03:52

one percent or less It made borrowing easy for businesses

03:56

and individuals and in the process drove very high inflation

04:00

rate it's almost twenty percent a year on average for

04:02

a sustained period of time This means that the real

04:04

cost of debt drops by about fifty percent every three

04:08

And a half years or so and that the people

04:10

who loaned the brazilians money were very very p oed

04:14

might seem like inflation then it's just a dandy thing

04:16

to have It makes loans cheaper It lets everyone pay

04:19

off their bills quicker easier better The problem is that

04:23

what happens next time A government wants to borrow money

04:26

and they have a track record of letting inflation spiral

04:29

out of control Lenders just go away How deflating hey