the Wealthy Canadian

I previously posted about what inflation and the consumer price index are. Today I thought that I’d discuss how inflation affects us.

Quite simply, the cost of inflation is that things cost more today than they did yesterday. For an extreme case look at Zimbabwe’s trouble with hyper inflation, last time I looked it was sitting around 6500%. So if a loaf of bread a year ago cost one dollar, today it costs $66. Obviously, in the case of an average Zimbabwean it makes no sense to save any money as it would quickly become worthless, they must buy whatever they can as soon as they get some money.

Even in Canada during the mid 70’s and early 80’s where inflation rose as high as 12% it would have been difficult to save anything. Imagine obtaining a mortgage at prime, all of your income would go towards servicing your debts.

Negative inflation, or deflation, sounds great by comparison. Prices fall and our income seems to go further. Unfortunately, if prices remain low for too long then companies will also see their profits begin to diminish. After watching profits fall (or losses accumulate) for some time the corporations will begin to cut costs such as on the workforce.

In fact, there has been considerable research into the relationship between inflation and unemployment that suggests they have an inverse relationship. As unemployment drops, inflation tends to increase. However, the relationship, called the Philips curve, (shown in the figure) is not always accurate but for simplicity it is a good consideration.

Which would you rather have:

• No inflation, where few people have jobs, or
• Everybody has jobs, but there is high inflation.