Using Cartoons to Teach About

By Mike Fladlien

What is Inflation?

• Inflation can be defined as the overall general upward price movement of goods and services in an economy. (BLS.gov)

• The best measure of prices is the Consumer Price Index or CPI. The Consumer Price Index (CPI) program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services.

• The Producer Price Index, PPI, measures the prices paid for intermediate goods.

All of Inflation’s Little Parts

• Each month, the Bureau of Labor Statistics gathers 84,000 prices in about 200 categories — like gasoline, bananas, dresses and garbage collection — to form the Consumer Price Index, one measure of inflation.

• This graphic shows the components of the CPI broken down into categories for 2007-2008.

Historical Inflation RateFRED data series (CPIAUCSL)

1960 1970 1980 1990 2000 2010 2020

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

Inflation Rate

Inflation Rate

The DroughtA nation-wide drought will reduce the amount of corn for consumption, Ethanol production, feed for cattle, and all products in which corn is used. The supply curve for corn will shift to the left which will increase prices. When the resources used in a good increases in price, economists call this cost-push inflation.

Cost-push inflation refers to a general rise in prices as aggregate supply shifts to the left. In a study conducted by Hope Jahren, the University of Hawaii researcher found that over 500 fast food items used corn.

According to Soyatech, corn is the most used food staple

An increase in the price of corn could lead to inflation as measured by the CPI.

Gas PricesHigher gas prices can hinder an economic recovery . As of this writing, gas prices have climbed 30 cents over the last five weeks according to this CNN Money report.

Arguably gas is an input into every product. Gas moves goods along the supply chain.

Gas allows consumers to consume goods and voluntary exchanges can be made. These voluntary exchanges allow prices to be driven down to their marginal cost.

When gas prices are high, the economy doesn’t work efficiently.

OilThis cartoon uses a play on words to suggest that gasoline prices would be lower if there were more domestic drilling for oil. The toon also makes the point that higher prices are depleting personal savings.

These experts believe that drilling will not lower domestic gas prices.

The supply of oil on the world market is so enormous that domestic drilling in the United States would do little to lower gas prices. (The Washington Times).

Gas prices constitute only 5% of a consumers budget. The smaller amount of a budget that than item consumes the more inelastic the demand. This elasticity suggests that changes in gas prices will result in higher prices.

In the Bag?This cartoon suggests that the prices of basic food items has increased drastically because of the 2012 drought.

This inflation rate calculator shows that the inflation rate is below historical monthly averages since 2002.

Remember that inflation is rise in the general price level. Some goods might be increasing in price while others are decreasing. The net effect of the increases and decreases is the overall inflation rate. There is also the possibility of CPI bias.

The CPI doesn’t reflect the quality improvement s, substitution effects, or new innovations. A Federal Reserve Paper explores the bias here.

Higher prices have an income effect and a substitution effect. As food prices increase in price relative to other goods, consumers have to make other consumption choices such as how much to spend on housing, education, and health care. This cartoon implies that food prices are high. Since people have got to eat, other goods that satisfy a consumers wants and needs go without fulfillment. In the end, inflation changes consumption expenditures on many other goods. This change in demand may result in unemployment in industries that consumers substitute away from.

Higher prices also rob consumers of buying power. Higher prices act like a wage cut.

Monetary Policy

Natural DisastersThe economy isn’t free from exogenous forces. In this cartoon, the drought of 2012 has hurt charitable contributions. This suggests that inflation hurts lower income earners harder than higher income earners.

Fiscal PolicyWhen the government cuts taxes, consumers have more disposable income to spend. This cartoon suggests that tax cuts will help the economy out of a deep recession. During a recovery, prices rise. Many economists believe that there should be a 2% inflation rate if the economy is healthy.

A small amount of inflation shows that consumer demand is strong and presents profit opportunities that encourage employment and investment.

HyperinflationWhen a country experiences rapidly accelerating inflation, the country is in a period of hyperinflation.

The most notorious case was Germany from 1919 to 1923.

More recently, Zimbabwe.

Monetary PolicyThe Federal Reserve Bank can indirectly control inflation through the discount rate or the Fed Funds Rate.

The discount rate is the interest rate that an eligible depository institution is charged to borrow short-term funds directly from a Federal Reserve Bank.

The federal funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve.

Raising either the discount or Fed funds rate contracts the money supply and brings the average price level down.

Debtors Debtors gain from inflation since they pay back the principal with less opportunity cost.

Real Money BalancesMoney buys less; the cost of inflation hurts children ; how come the income earners wages haven’t kept up?

One way to show the effects of inflation is to divide the nominal wage by the price level. So if the nominal wage rate is $10 and the price level is 5, then only $2 of real goods can be purchased. When prices rise faster than income, a families real buying power decreases.

Creditors and DebtorsInflation enriches debtors and the expense of creditors as explained in this article.

Inflation BullyInflation is a bully. Inflation is personified here as shaking down the consumer. At an annual inflation rate of 8.3 percent, this would be equivalent to a gallon of gasoline that cost $3.45 costing $3.74. With an inflation rate that high many home owners with a variable rate would be “upside down.”

MV = PQWhen a nation’s money supply rises, it’s price level rises too. In fact, Milton Friedman called for a monetary rule in which the money supply increased by 3% each year so that prices would increase equally.

In the cartoon, the dollar buys less foreign goods so the US dollar must be rapidly depreciating.

If you want to measure the change in prices, you will need to analyze the Consumer Price Index, CPI.

Shoeleather CostsWhen inflation is expected, the nominal interest rate raises through what economists call the Fisher Effect. When the nominal interest rate is relatively high, people hold less money for transactions. As a result, they make frequent trips to the bank to withdraw money and in making the trips, they wear out the leather on their shoes.

Distributional EffectsThis cartoon suggests that inflation hurts everyone but the poor are hurt the most.

Earners who are living on a fixed income are also hurt. Perhaps these earners live on a pension or income from bonds.

Chopping Block?This father can’t afford two of his children so he’s letting them go.

Fortunately, families don’t mirror businesses. But the cartoon raises a question. How does an income earner earn enough to provide for his family?

In periods of inflation, especially when wages don’t keep up with prices, the family has to make tough choices. This Christian Science Monitor article suggest that wages do not.

Economics is defined as how to satisfy unlimited wants with limited resources. Economics is often called the dismal science for this reason.

StagflationStagflation is an economic malady in which there is simultaneous unemployment and inflation.

In the United States the most notable period of stagflation occurred the 1970s due to an adverse supply shock when the price oil escalated.

The best policy response to a supply shock is Laissez-Faire since most supply shocks don’t last long.

Stagflation

Inflation TaxWhen price rise, buying power falls. Inflation acts like a tax on goods. The tax isn’t collected at the cash register but is a hidden tax as the purchasing power of the dollar is reduced.

When the money supply is increased, perhaps to monetarize the deficit, prices increase. As prices increase, the buying power of a fixed assets such as a bond falls. So do people on fixed incomes.

Inflation “taxes” those on fixed incomes. Several links can be found here, here, and here.

Inflation Tax

SeigniorageThe government can earn revenue when it prints money to finance the debt. This is called seigniorage.

A well written blog post can be found here.

To monetarize the debt, the treasury issues bonds and the central bank uses open-market operations to buy the bonds. If the government is running a large deficit, it might resort to seigniorage if it can’t obtain loans from foreign investors. This might result in hyperinflation.

Why is it cheaper the ride the bus than ride the train during hyperinflation? Because you pay at the beginning of the ride when use ride a bus.

Business Cycles?This cartoon suggests that policy makers have to balance monetary policy to stabilize the economy.

Fiscal policy suffers from lags so that when spending kicks the economy has already recovered and the effects are inflationary. If contractionary policy is enacted, fiscal policy can send the economy into a recession.

But, does inflation usually follow a recession? Evidence that some inflation is necessary to boost employment can be found in the WSJ article.

DataThe empirical data shows that since 1980 a run up on prices is followed by a recession.

Some questions to ask are:

Did policy induce the recessions?

What social forces contributed to the price declines such as housing bubbles.

This graph is taken from SeekingAlpha.

Bracket Creep or Tax Distortion

• Two other problems associated with inflation are an arbitrary redistribution of wealth and uncertainty about the future.

When an asset is sold, the seller pays capital gains on the amount of the sale over the purchase price. What if the asset rises in nominal value but the real value, adjusted for inflation, remains the same?

Say you are taxed on capital gains and there is no inflation. If you sell your home for no capital gain then there’s no tax. But what if inflation makes the value of the capital gain $10,000, but the real value remains constant. If the tax rate is 30%, then the seller pays $300 in taxes simply because the nominal value of the asset increased.

Inflationary FearsIn the late 70’s, inflationary fears motivated a raise in the FED funds rate . The FED funds rate is the rate that banks loan excess reserves to each other. When this rate raises, there’s less money for loans and the economy contracts.

This cartoon implies that the reaction to any inflationary news roils markets.

Real MoneyInflation makes the nominal value of money worth less. The real value of money is equal to M/P where M is the money supply and P is the price level.

Since people make contract decisions on real income and real buying power of money, knowing about inflation helps to make informed decisions.

Inflationary ExpectationsEveryone forms inflationary expectations. If inflation has been running at 2% in the past, consumers and investors think that the future inflation will run about the same.

How you view the future determines how you act today. I believe a self-fulfilling prophecy forms. The expectation of higher prices fuels higher prices.

In the late 1970s wage setters began to form inflationary expectations which resulted in the inflation augmented Phillips Curve.