Saturday, March 12, 2005

Some common features of inflations

Some common features of inflations:

• It takes a long time for people to catch on to what is happening, even during the more dramatic episodes of inflation. At first, firms believe that what they are witnessing is genuine pricing power. That is, that they have oligopolistic positions.

• Inflations tend to happen in the context of adverse balance of payments and aversion to taxation. The extreme of adverse balance of payments, of course, was Germany right after WWI. They were hit with massive reparations payments which clearly could not be made.

• Different prices rise at different rates, and there are often great changes in relative prices. To give an example of an extreme case, in the early 1920’s in Germany it was sometimes the case that it was more expensive to travel to the center of town than it was to travel to another city, as the prices of trams were adjusted more often than the prices of trains.

• Producers of producer goods benefit at the expense of producers of consumer goods. Manufacturers and traders make out like bandits. The closer you are to the ground, the better. Buy miners.

• Savings are wiped out; debtors benefit at the expense of creditors. In the case of the current inflation, the losers will be pensioners, and the winners will be debtors. That said, debtors will not feel like they are winning in the beginning, unless they are producers of inputs into production (commodities, industrial goods, consumer durables, etc). This is because wages do not rise as fast as prices in the beginning of an inflation. It is only after some time and considerable erosion of purchasing power that workers actually start demanding compensation for the debasement of the currency.

• There is considerable real depreciation of the currency at first. That is, the prices of domestic goods and especially services do not rise as quickly as the price of foreign exchange. This is because currencies are traded in very liquid, competitive markets and often even overshoot beyond the required adjustment.

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