A lot of people who support raising the minimum wage will sight inflation as a reason to do so. When I see this come up I always ask- what is the reason for the inflation and suggest that we would be better off with out inflation and bring up the reason for inflation.
Inflation is a monetary phenomena caused by an expansion of the money supply from a mixture of fractional reserve banking, government over spending and money printing.
First fractional reserve banking- the way our banks operate is the following. 100 people deposit $1000 in the bank-on the 15th then they turn around and lend $50,000 on the 16th. They still tell the first group of people they all of $1000 available to them but they have only $50,000 in the bank. So the money supply has grown and as it does prices start to rise.
Rising prices tell companies to produce more while consumers buy less which results in this inflationary trend reversing until people feel things are cheap enough they want to buy and companies cut back on production.
When prices are increasing across the board due to monetary inflation- it is hard to tell where consumer demand lies. So if it were completely up to the banks they would start raising interest rates which sends the signal to people who have debt to pay it down and for those who don't to save their money. Eventually the money supply will shrink and prices will start to drop.
Fractional reserve banking is still dangerous as a bank that makes the wrong call they won't be able to cover their depositor's money.
There have been two extreme ways to deal with the risks of fractional reserve banking-the newest is a central bank and the older has been to ban fractional reserve banking.
The argument for a central bank is that you need a lender of last resort backed up with tax dollars the problem with this answer is that it basically ends up centralizing interest rates. Now if the central bank has interest rates set to low and refuses to increase the rate- now the market gets confused. The low interest rates send the signal to borrow money but because the average person has little to no money in the bank they are not in a position to buy big ticket items or to fund the long term investments and thanks to the inflation it becomes hard to tell what prices are increasing because of consumer demand.
The reason that a lot of people like Ben Bernanke object to the idea of falling prices is on the notion that they will inevitably ruin the ecconomy- as people will stop buying things and stop paying on their debts and will start hoarding money and some will bring try to sell the fact it lower real wages.
The alternative view simply calls stuffing your cash is a mason jar a form of savings- and expect to see the consumer base for a particular product to expand as prices fall.
In the next part I will talk more about where fear of falling prices will lead some people.
