By Jonny Lupsha, Wondrium Staff Writer
Inflation has ramped up to levels not seen since 2008. The obvious concern with inflation is that as prices outpace wage increases, consumers’ buying power is weakened. Inflation presents many dangers and can destroy an economy.
Compared to April 2020, the Consumer Price Index has risen an average of 4.2%. Officials from the Federal Reserve have stated that they believe the inflation is temporary and won’t sustain such levels. Additionally, part of the reason that April 2021 is such a contrast from last year is that the world had just been hit with the novel coronavirus pandemic in 2020 and essentially had closed down.
Regardless, it’s no wonder people worry about inflation in general. In his video series The Economics of Uncertainty, Dr. Connel Fullenkamp, Professor of the Practice and Director of Undergraduate Studies in the Department of Economics at Duke University, said inflation comes with a whole host of dangers for an economy.
Hyperinflation and Inflation Management
“When inflation gets out of control, it can wreck an entire economy,” Dr. Fullenkamp said. “An example of this occurred in the southern African nation of Zimbabwe between the years of 2005 and 2009. During this time, the rate of inflation rose from more than 500% a year to more than 79 billion percent a month.”
Dr. Fullenkamp said that this phenomenon—when inflation reaches incredibly high rates—is known as hyperinflation. Germany fell prey to hyperinflation after World War I. It’s widely believed that the damage it did to the German economy led to the rise of extremists like the Nazi Party, who blamed the hyperinflation on those they sought to oppress.
“When inflation starts to get above, let’s say, 5% a year, then people pay more attention, and it begins to affect their behavior,” Dr. Fullenkamp said. “We spend more time searching for good prices on the things we want to buy. Even though we pretend that a 5% inflation rate makes all prices go up by 5% a year, the reality is that the prices of some goods go up by less than 5% and some go up by a lot more than 5%. Its effect is uneven.”
What’s more, he said, some businesses raise their prices before others, and those prices aren’t raised across the store—they go per item. So we’re more likely to spend more time searching for the best price on each item at different stores, then shopping at multiple stores.
The Fisher Effect
“The other way that high inflation hurts the economy is by driving up interest rates,” Dr. Fullenkamp said. “This is a phenomenon known as the Fisher Effect, in honor of the early 20th-century U.S. economist Irving Fisher.
“Fisher realized that high inflation could potentially benefit borrowers and hurt lenders, because inflation reduces the value of money, and money is what borrowers use to pay back their loans.”
So even though borrowers may be paying back loans with more money, they’re ultimately paying them back with money that is worth less and less, in terms of what that money will buy. According to Dr. Fullenkamp, Fisher theorized that lenders try to protect themselves against the falling value of the money borrowers will be paying back. Lenders would do so by estimating the average inflation rate over the life of the loan and working it into the interest rate that they charge borrowers.
There are many reasons economists and consumers are wary of inflation, which is difficult to predict. Even economists interviewed about the recent 4.2% inflation rate had only assumed it would go up by 3.6%.