U.S. Inflation: Causes, Cost Term Paper

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[. . .] This calculation neglects another result of monetary policy and that is the effect that monetary policy has on outstanding debt. This effect comes through the price levels of debt on future price level of the debt, and the future price level of the bonds. The effects are also through the reflected cost of interest for that debt, as this is affected by the interest costs that have to be paid.

It is also argued that inflation has no real influence on the demand of products from the consumers, and this should control the effect of inflation on the demand for goods. Yet fiscal shocks affect demand and these are the consequences of monetary policy on demand. The reason for this are the disturbances that are caused to private budgets through the change of prices, and these can be removed from affecting demand only if the government budget takes care of these disturbances which is not a practical solution. This can be affected only through fiscal policy, and thus the central bank has to determine the fiscal policy for the country to maintain a financial equilibrium. In simple textbook terms this can be stated as a process for countries with a strong fiscal position as fiscal exigencies determining the size of the real government budget deficit that must be financed; then this budget deficit is determined to the central bank as a part of the seigniorage revenue that it is created through the creation of money; and the increase in the growth of money will finally determine what the inflation will be and for this logic there are a number of theories.

Through these theories, it is clear that fiscal developments affect the rate of inflation in a country, and this happens only because they affect the monetary policy. This makes it clear that inflation still remains a 'purely monetary' phenomenon. This supports the view that when the government and the central bank are committed to an anti-inflationary policy then there has to be a suitable monetary policy to ensure price stability. At the same time, this is doubtful whether this theory will be applicable to a country as advanced as United States. It is said that these countries have an independent central bank and that does not have to accept the targets that are set by the Treasury.

Inflation also has a lot of good effects. An increase in inflation means an increase in wages and real estate prices. There will also be gains for individuals who have fixed rate loans which result in stable mortgage payments. This is a problem for lenders. They lend money in sums of hundreds of thousands of dollars, and due to inflation, the value of the repayments that are received by the lender decreases as the value of money itself goes down in terms of buying power. All bonds are also long-term loans and that is the reason why the bond markets are also hurt by inflation. Thus, when lenders feel that there is a likelihood of inflation, the lenders in the market start demanding higher rates of interest before inflation starts actually. These demands for higher rates ultimately bring the entire economy to a standstill as no development takes place due to the high cost of money in terms of interest rates.

Preventing inflation from taking place

Now let us look at the views of an expert, Alan Greenspan. He said in 1966 that "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. The abandonment of the gold standard made it possible for welfare sadists to use the banking system as a means to an unlimited expansion of credit (debt creation)."

He has said again before the Economic Club of New York City on December 19, 2002 that "It was the case that the price level in 1929 was not much different, on net, from what it had been in 1800. But, in the two decades following the abandonment of the gold standard in 1933, the consumer price index in the United States nearly doubled. And, in the four decades after that, prices quintupled. Monetary policy, unleashed from the constraint of domestic gold convertibility, has allowed a persistent over issuance of money. As recently as a decade ago, central bankers, having witnessed more than a half-century of chronic inflation, appeared to confirm that a fiat currency was inherently subject to excess"

The effects of his statements are quite clear -- he feels that the country has to go back to the level of backing up the value of dollars with gold. Certainly this cannot be viewed as a practical system in the present day world.

There have been also a lot of efforts from the different organizations, including the government. One of the important methods was to reduce the measurement methods for consumer price index in 1995. At that time itself, inflation was reduced from 3.1% to 2.8% due to the new method. Similarly for 1996, the figure was reduced from 3.4% to 3%. The statisticians in the Labor Department have quietly adopted this method and the results have been "Since the start of 1995, Labor Dept. statisticians have 'quietly' modified their treatment of rents, hospital prices, drugs, and altered other sampling methods. This has lowered the published rate of consumer inflation by 0.2 to 0.5 of a percentage point - and, a change of 0.63 points will be applied in 1998 and 0.75 in 1999 and forward. But, the govt. is not going back to fix historic data in the same way. Therefore, part of the apparent lower inflation rate numbers reported today compared to the past are from changing the yardstick of measurement."

This can certainly be viewed as a method of lowering the level of inflation as perceived by people, but not as the real effect on the levels of inflation.

Thus it is clear that inflation is happening and in the present situation, the individual has been left to himself. There is no great difficulty about the present situation for him as the salaries and job opportunities are likely to increase with inflation, but the greatest difficulties are in the area of investment. So far as an industrialist is concerned, he gains from the revaluation of his assets due to inflation, and the prices of his materials also increase due to inflation and there is no suffering that is caused through inflation. The difficulties due to the present inflation are with investors whose investments generally loose value with inflation. He has been given a new option in the inflation-adjusted Savings Bonds or I Bonds. These bonds yield 3.67% and they have a fixed 1% interest rate along with the inflation rate as measured by the consumer price index. Whatever adjustments have taken place to consumer price index cannot be reversed, but the new increases will be taken care of by these new bonds. The interest rates change every May and November for these bonds.

There are also the Treasury Inflation Protected Securities or TIPS. These also have been a fixed interest rate and the principal values change every six moths as per the inflation rate. The increases are taxed in the year that the Treasury credits the owner and for that reason it is better to hold them in tax deferred accounts like retirement accounts. These two accounts are able to take care of inflation and that is the reason why they have been launched. As in the case of other bond funds, the share prices of funds in TIPS rise when there is a drop in interest rates, but the prices will tumble if there is a big increase in interest rates without an increase in inflation. The only situation when this can happen is when the foreign buyers decide to buy less Treasury securities as those securities are used to finance the federal deficit. These bonds are also directly connected to CPI and when the oil prices increase, the returns from these investments will also increase.

These make it clear that the instruments are good for investment, and can be used by any person who is experienced in making money through funds of any type -- mutual or conservative bonds. They have been launched in January 1997. They generally have maturity dates of either five or ten years and the increases in inflation during this entire period are adjusted in them. Even when there is no inflation, and the prices of products are dropping, the principal values of these bonds will not decline below the par amount that is mentioned as was mentioned on the date when the bonds were issued. The interest that is payable on these bonds is guaranteed by the United States Government. This is the reason why… [END OF PREVIEW] . . . READ MORE

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