Inflation is to cart as COLA is to horse

I suppose in some ways it might look like zero inflation is bad for you.  After all:

  • Social Security checks don’t go up.
  • Marginal tax bracket cutoffs don’t go up.
  • The standard federal income tax deduction doesn’t go up.
  • Interest rates on savings accounts are in the basement.
  • Etc., etc., etc.

These bad things are all distractions from what’s really happening. Let’s compare a couple of examples.  (Before getting in too deep here, inflation is not the same thing as rising prices. Inflation is an increase in the money supply, after which rising prices follow.  But will just treat them as kind of the same thing in this post to keep things simple.)

First, an inflation example.  Say I could buy everything I needed last year for $20,000.  This year, the exact same stuff costs me $21,000 because there was 5% inflation last year.  A social security check that was $1,000 last year is $1,050 this year, but so what?  It buys the same stuff.  My savings account was earning 6%, but that’s only 1% return after inflation.

Next, a no-inflation example.  Say, this year, I can still buy everything I need for $20,000.  A social security check is still $1,000, but that’s all right, because it still buys the same stuff.  My savings account earns 1% (“in the basement”) but at least it’s a real rate of return.

Inflation – an increase in the supply of money – has been going on for decades.  It’s so entrenched in our economy that it’s commonplace.  Prices go up, sure, but wages go up thanks to inflation-based cost-of-living adjustments (COLAs).  We see larger numbers in our paychecks, and we feel richer.

But why is that we feel poorer when the money supply is stable, there’s no inflation, and therefore no COLA?  It shouldn’t, but it does.  Having no COLA next year should be a good thing, yet we feel instead like we’re falling behind.  What’s more, if we never had the need for a COLA, we wouldn’t be having this discussion! The reason “no inflation is ‘bad’ for us” now is because so many things in our financial lives are tied to inflation.

If there were no inflation (well, none beyond what was necessary to support a growing economy) then there wouldn’t be the need to tie anything to inflation, would there?  It’s putting the cart before the horse.  The COLA is around because inflation is around.  Zero inflation doesn’t take your COLA away — the COLA goes away because of zero inflation.  In the end, anyway, a true COLA wouldn’t matter at all, since it would just rise (and perhaps fall) with the money supply.

What’s the bottom line? Zero inflation by itself is not a bad thing at all.  It’s actually a Very Good Thing that we’re unlikely to see in our lifetimes.  It would mean that the money supply is stable and not being diluted.  Zero inflation only appears bad because so many credits, checks, and other goodies are tied to inflation.

It’s important to have the cart behind the horse.

John Wedding

Husband. Father. Web publisher. Musician. John has blogged at Mighty Bargain Hunter since 2005, helping people to recognize life's good deals.

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Comments

  1. MBH,

    Great point! I always get so frustrated when I hear people complaining about this while they ignore the benefits of no inflation. Though I noticed for myself that a COLA often exceeds my own personal costs because I’m more frugal than the average person. So while general costs might go up, mine don’t – meaning I have even more left over to save or give.

  2. Good article, MB.

    The employed should benefit tremendously from the current lack of inflation. Those who are classified as high-income wage earners will benefit more than others because the taxable limit for Social Security will remain steady at just over $100 grand and change in 2010.

    The downside is our current zero inflation rate is largely attributable to the negative GDP of the past several quarters.

    All things being equal, I think I would prefer a stable inflation rate of roughly 3%.

    (But I’m not complaining.) :-)

    Best,

    Len
    Len Penzo dot Com

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