- [Narrator] Recently, Vox released a video explaining
how inflation works,
and it was very wrong.
At Learn Liberty,
our mission is to educate people
about what makes a society free and prosperous,
and how we can improve the world we live in.
Once we saw the Vox video,
we had to do something.
So, let's dive in.
(upbeat music)
- [Vox] In a recession,
lots of fish lose their jobs and stop spending money.
And other fish gets scared that they might be next,
so they stop spending and start saving.
And with less money being spent in the economy,
the water level falls.
(water spilling)
- [Narrator] Uhmm, what?
That sounds odd.
We invited our good friend,
Professor Antony Davies,
to explain what inflation actually is.
- Inflation is the rise in the average price level.
And people sometimes confuse this
with rises in specific prices.
So you see the price of milk go up and you say,
"Well, that's inflation."
It's not.
During a periods of inflation,
some prices may go up,
some prices may go down.
What's important is that the average price level rises.
That's what we call inflation.
- [Narrator] But why is it important
to properly understand this concept?
Well, Professor Davies gives us
some clear practical examples.
- Inflation erodes the purchasing power of dollars.
So when we think about dollars,
what really matters here is what the dollars will buy.
And I can give you a very simple example,
if I give you the option of,
I'm going to drop you on a desert island
that has sand, a Palm tree, and that's all,
and you get a suitcase full of a million dollars;
or I can drop you on a desert island,
I'm not going to give you any money,
but there's a house there,
it has electricity, and there's food, and there's water,
and there's heat, there's cooling,
and there's medical equipment, all of that.
And if I ask you,
which of these two islands would you like to be on?
Clearly the answer is the second one.
But then I stop and say,
"But wait a minute.
On the first island, I'll give you a million dollars."
But the point is, there's nothing to buy.
It's the value of the goods and services
that gives money value.
And so, when you have inflation and prices start to rise,
your money buys fewer goods and services.
- [Narrator] Okay, Now that we have a clear picture
of what inflation is,
let's look at what's wrong with Vox's fish tank analogy.
- The point is that the analogy ends up invoking a fallacy.
And the fallacy is what we call money illusion.
And money illusion is the idea
that numbers of dollar bills matter,
as opposed to the purchasing power of those dollar bills.
So someone who succumbs
to money illusion would say something like,
"I would rather live in New York City
"earning $100,000 than to live in Alabama earning $80,000."
And you say, "Well, why?"
Then he says, "Well, because in New York City,
"I get $100,000."
Well that person is suffering for money illusion.
He's only looking at the number of dollars,
completely ignoring the purchasing power.
And the fact is,
$80,000 in Alabama will go far, far further
than $100,000 will in New York City.
And this is what Vox gets wrong with it's analogy.
As it talks about the water and the fishbowl, it says,
"Well look, the water gets too low,
"and what can happen is, to help the economy along,
"the government can come along,
"and pump more water into the aquarium."
Okay, but that looks a lot like money illusion.
That what matters is the number of dollars.
The analogy completely ignores the real important thing,
which is the purchasing power of those dollars.
- [Narrator] We have seen this in the US very recently,
money illusion affects everyone;
but in the US, it affects lower income people the most.
- And who does this inflation principally hurt?
Well, it hurts people who, for example,
are locked into their wages.
If I have $100 sitting in my dresser drawer,
and the $100 will buy a certain amount
of goods and services;
over time if there's inflation,
that $100 in my dresser drawer will now buy less
than it did before.
The inflation erodes the purchasing power of that money.
When the economy goes into recession,
people are out of work,
because they're out of work,
they're not buying things,
and because they're not buying things,
businesses start to cut back on hiring,
which just exacerbates the problem.
And the idea of stimulus checks is
to get the economic ball rolling,
inject some money into the system
so that people feel comfortable going out and buying things.
And if they feel comfortable going out and buying things,
businesses will feel comfortable hiring more workers,
which generates income for the people,
and then the economy starts to pick up.
There are some problems associated with that.
The political problem is in timing.
Is that politicians aren't aware that we're in recession
until after the recession has already began.
And then what did they do?
They have to come up with some decision,
"What are we going to do about this?"
"Well, we should increase spending.
"We should spend this way or that way."
And so that also takes time.
And so what can happen, doesn't happen in every case,
but what can happen is
that the government ends up pressing the accelerator,
stimulating the economy at the exact wrong time,
at the time when the economy is already coming out
of recession.
And we have a good example of that here,
Joe Biden when he took office in January,
immediately started pushing for stimulus spending.
And by the time all of that came to fruition,
the economy was already coming out of recession.
And so right now, as we're moving out of the recession,
that $2 trillion is now hitting the economy,
which can push us into inflation.
And all of that falls under the heading
of the knowledge problem,
that is that politicians
simply don't have enough information
to be able to make decisions for people that are,
on average, better than the people could make
for themselves.
So a politician might say he wants to help me,
and he's going to help me by spending money.
Well, the politician doesn't know my particular situation,
he doesn't know what I need, what I want,
what I'm capable of doing.
And so when he makes the decision
of how to spend the stimulus money,
he ends up making choices
that likely are choices I would not have made.
- [Narrator] Explaining inflation in the correct way
is very important
because it makes a huge difference in our lives.
Politicians might suggest that they know
what is best for us, but they do not.
If they make bad decisions for us,
eventually it is us who suffer from it.
Vox is suggesting that when we don't have enough money,
we can turn to politicians and ask for more money.
We needed to set the record straight
and explain why we cannot do that.
Comment below your opinion about this video
and let us know what your saving strategies are
during a recession.
(upbeat music)