Class 5: Inflation Indicator

Inflation is Largely Driven by Demographics, Not Monetary Policy

Economists think that inflation is largely a monetary phenomenon – more money chasing fewer goods. But this doesn’t really make sense intuitively. If we doubled the money supply, then apples would cost twice as much, but we would have twice the dollars and we wouldn’t feel poorer. Inflation only causes real pain when prices rise faster than incomes and reduce our standard of living.

In reality, inflation is the economy’s means of financing not only the new, young generations that will become highly productive in the future, but also the new technologies these new generations bring.

Hence, due to the effects of young people, innovation and inflation go hand in hand. This occurred in the late 1960s and 1970s as the massive baby boom transitioned from schools into the workforce. At first these young people are inefficient and unproductive, causing inflation. As they become seasoned in the workforce, their productivity rises. Many of the technologies that are driving our economy today were largely born during that time.

Young people are expensive to raise — from parental investment to education by governments to initial incorporation into the workforce by businesses. Young people aren’t productive – they cost everything and produce almost nothing! But they do bring new innovations in technologies and thinking, and when they finally enter the workforce they become the next highly productive workers and spenders that drive the economy and adopt those new technologies and new business models. Young people are an investment in the future, just as are their new technologies.

The obvious exception to this simple demographic logic is major wars, where inflation has been most obvious in history. But, like young people, wars create a similar high need for short-term investment at the expense of consumer goods – but they pay off long term with new leading countries and technologies supplanting older, less efficient ones, and greater markets for trade and commerce developing. The difference in the new economy is that the massive baby boom has exaggerated the demographic trends since the 1970s and made their impacts both more obvious and more measurable.

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