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A recent CNBC article highlights a common economic fallacy surrounding the concept of inflation. The author claims that inflation can be beneficial because, “as inflation takes hold, wages may increase, too.”
This statement, though misleading, holds a grain of truth. In order to understand where it goes horribly wrong, it’s important to understand the difference between nominal wages, simply the number on your paycheck, and real wages, what your paycheck can buy you relative to prices. Because, although it’s true that inflation is associated with higher nominal wages, this increase in nominal wages actually represents a period of lower real wages and lower wealth overall.
Inflation and Nominal Wage Increases
To understand why your wages going up due to inflation isn’t as good as it sounds, let’s consider a hardware store. As spending begins to pick up after the end of COVID lockdowns and restrictions, hardware store shelves that were full of building materials begin to empty out. In fact, as I’ve explained in a previous article, the new money created by the Federal Reserve spurs even more spending than usual as the economy returns to normal.
In order to deal with goods flying off the shelves, stores do a few things. First, they need to raise the prices of their building materials to avoid having a shortage of materials for sales. This contributes to inflation. Second, the stores need to hire (or re-hire) laborers to restock shelves and deal with selling the higher-priced goods.
But hiring may be tough. Let’s say the business already had a few job openings which offered $8 an hour. Now the store needs even more laborers to restock the recently depleted shelves. How can they entice workers to apply for their jobs? Easy—the store can raise wages to some higher rate, say, $10 dollars an hour. If you stop thinking there, this sounds like a great thing for workers. But in order to avoid CNBC’s fallacy, we need to keep thinking.
The Money Illusion and Real Wages
People don’t value the number on their paycheck in itself. To understand why, you just need to answer a simple question. Would you rather be paid $15 an hour or 16 pesos an hour? It’s clear that $15 is the better option. Why? Well even though 16 is a bigger number than 15, we know that $15 can buy us more real goods than 16 pesos. That’s why the peso is less valuable than the dollar.
This example illustrates that what people care about is what their paycheck buys them. This concept is called your real wage. If you offer someone a larger number on their paycheck, but then tell them the larger number comes with the caveat that they’ll be able to buy fewer goods and services in the present and future, they’d be a fool to take the deal.
Let’s return to our hardware store worker. Imagine you were working at the hardware store before lockdowns making $8 an hour, and you pay $200 per month for groceries. In order to pay for your groceries, you’ll need to work 25 hours.
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Now let’s say that the hardware store has given you a raise to $10/hour to keep you on to restock shelves. However, because inflation means higher prices, now your groceries cost you $250. How long does it take you to earn enough to pay for your groceries? That’s right, the exact same amount of time. In this example, your nominal wage has increased from $8 to $10, but your real wage is the same.
Anyone who thinks the worker is better off is suffering from the money illusion. They’re confusing dollars for well-being.
However, there’s good reason to believe that the story is even worse than that. Why? Well, as the CNBC article admits, wage increases tend to lag behind inflation. In other words, there was a period of time where the worker was still making $8 an hour, but the cost of groceries had already risen to $250. In that case, there was a period of time where the worker had to work over 31 hours in order to buy the exact same groceries. Higher nominal wages not only fail to make the worker better off than before the inflation, they indicate that the worker was worse off for some time!
It doesn’t end there, either. If our hardware store worker had some money put away, say $1,000, that money now has less value. Why? Well before inflation $1,000 could buy five trips ($1,000/$200) to the grocery store. After inflation, it can only buy four trips ($1000/$250).
And, while it’s possible wealthier people will have access to wealth-storing financial instruments which protect their savings from inflation, it seems likely that poorer individuals won’t have equally easy access to these instruments. So inflation not only leads to lower real wages for some period of time, but it also sucks real wealth away from those without ways to avoid inflation.
The Art of Economics
When considering public policy, it’s easy to point to one small result (like higher nominal wages) and consider it to be a silver lining if it’s isolated from the larger picture (like falling real wages). As such, it’s important to take the advice of economist Henry Hazlitt when examining policies and their economic results.
“The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy,” Hazlitt observed; “it consists in tracing the consequences of that policy not merely for one group but for all groups.”
So, when considering the result of inflationary policies, we should heed the words of Hazlitt—and be wary of false silver linings.
Peter Jacobsen is an Assistant Professor of Economics at Ottawa University and the Gwartney Professor of Economic Education and Research at the Gwartney Institute. He received his PhD in economics from George Mason University, and obtained his BS from Southeast Missouri State University. His research interest is at the intersection of political economy, development economics, and population economics.
This article was originally published on FEE.org. Read the original article.
New Conservative Network Seeks Crowdfunding Help
They say we have to go big or go home. We’re trying to go big and bring the patriotic truth the the nation, but we need help.
Readers may or may not realize that over the past year, we’ve been bringing more conservative news and opinion outlets under our wing. Don’t take our expansion as a sign of riches; all of the “acquisitions” have been through sweat and promises of greater things to come for all involved. As a result, we’ve been able to bring together several independent media sites under a unified vision of preventing America from succumbing to the progressive, “woke,” Neo-Marxist ideologies that are spreading like wildfire across America.
The slow and steady reopening of America is revealing there was a lot more economic hardship brought about from the Covd-19 lockdowns than most realize. While we continue to hope advertising dollars on the sites go up, it’s simply not enough to do things the right way. We are currently experiencing a gap between revenue and expenses that cannot be overcome by click-ads and MyPillow promos alone (promo code “NOQ” by the way).
To overcome our revenue gap and keep these sites running, our needs fluctuate between $3000-$7000 per month. In other words, we’re in the red and hemorrhaging.
The best way you can help us grow and continue to bring the truth to the people is by donating. We appreciate everything, whether a dollar or $10,000. Anything brings us closer to a point of stability when we can hire writers, editors, and support staff to make the America First message louder. Our Giving Fuel page makes it easy to donate one-time or monthly. Alternatively, you can donate through PayPal as well.
As the world spirals towards radical progressivism, the need for truthful journalism has never been greater. But in these times, we need as many conservative media voices as possible. Please help keep NOQ Report and the other sites in the network going.
Thank you and God Bless,
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They’re Trying to Shut Us Down
Over the last several months, I’ve lost count of how many times the powers-that-be have tried to shut us down. They’ve sent hackers at us, forcing us to take extreme measures on web security. They sent attorneys after us, but thankfully we’re not easily intimidated by baseless accusations or threats. They’ve even gone so far as to make physical threats. Those can actually be a bit worrisome but Remington has me covered.
For us to continue to deliver the truth that Americans need to read and hear, we ask you, our amazing audience, for financial assistance. We just launched a GiveSendGo page to help us pay the bills. It’s brand new so don’t be discouraged by the lack of donations there. It’s a funny reality that the fewer the donations that have been made, the less likely people are willing to donate to it. One would think this is counterintuitive, but sometimes people are skeptical because they think that perhaps there’s a reason others haven’t been donating. In our situation, we’re just getting started so please don’t be shy if you have the means to help.
Thank you and God bless!