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Why does a more productive economy lead to inflation?

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September 24, 2012 – Comments (5)

I am sure the answer is obvious, but I am running on no sleep, and also am stupid.

 

More productive economy = more goods produced per dollar in existence.  More goods produced per dollar should mean there is DEFLATION, as a given dollar can buy more goods now.

 

Also, I know we don't have a stable money base, so this is not exact.  But why is it that a productive economy bumps up inflation while a recession brings along deflation?  Is it because credit shrinks? 

5 Comments – Post Your Own

#1) On September 24, 2012 at 11:26 AM, Schmacko (55.22) wrote:

Productive economy = more jobs = more people getting paid = more consumers buying stuff = increase in demand = inflation

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#2) On September 24, 2012 at 11:41 AM, Valyooo (99.37) wrote:

Right but more jobs = more production = more stuff = more supply

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#3) On September 24, 2012 at 1:06 PM, Schmacko (55.22) wrote:

I think the amount of money sloshing around is the primary driver.  If the economy is up more people are working and spending money, so prices rise and soak up the extra cash.

When people aren't working, they aren't spending money, so prices fall to try and lure consumers back out.

I think in a lot of markets demand tends to be more of the driver than supply.  Or maybe better put would be supply tends to play catch up with demand.

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#4) On September 24, 2012 at 6:56 PM, Melaschasm (55.96) wrote:

An increase in productivity is considered deflationary.  When production increases without an increase in labor, supply increases, causing prices to fall.

An increase in production without an increase in productivity, generates inflation because it costs more for the additional labor needed.  Generally this is considered true when we have full employment.  On a more specific level, it can be true when we have full employment in the specific field.

Full employment from an economics perspective is a tricky and changing thing, because many factors impact what is considered full employment.  Because of changing job skills and pay incentives, it is possible to be at 'full employment' while having a higher unemployment rate than usual. 

From what I have read, most of the people concerned about inflation refer to the increased levels of money printing which has occurred in recent years.  The theory is that the increased supply of money will show up as inflation when the economy starts growing.  There is a general expectation of falling prices during a recession, which has been mostly prevented by the Fed.  Once economic growth resumes, the Fed would need to reverse its policies to prevent higher than usual inflation.  Such a sudden and drastic tightening of the money supply would likely send us back into a short term recession.  Since that is believed to be politically unacceptable, people expect the Fed to slowly tighten the money supply, resulting in a higher rate of inflation than normal.  How bad the inflation will be is a question without a certain answer, and the opinions differ greatly.

IMO higher inflation seems certain as soon as economic growth becomes consistently strong, but I am only predicting 4 to 6% core inflation (official numbers), while many people expect us to exceed double digits.

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#5) On September 25, 2012 at 4:55 PM, SockMarket (41.96) wrote:

A couple thoughts from an Econ major:

1) Schmacko - that is a  more efficient labor market, not economy. Those arent the same thing

2) Valy - True but D will increase more than S because MPL is decreasing so each extra worker adds less and less output while taking home the same amount of money.

Also assuming MPC isn't 1 then there will be more demand in saving, which means interest rates will fall. Lower interest rates leads to lower interest rates. That plus better credit/income means more borrowing, which I belive boosts money supply. Higher money supply = more inflation.

 

3) Melashasm - totally agree. Awesome post. 

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