Inflation

Eric Boehm | From the October 2024 issue

When Russian peasants set fire to hundreds of buildings in Moscow in 1648, the acute cause was a sharp rise in the price of salt. When they rioted again 12 years later, it was to protest a government policy that made copper money equal in value to coins made from silver—a policy that naturally caused widespread price inflation.

An increase in the price of bread, and an inept government response to it, helped set the French Revolution on its bloody course.

Periodic violence targeting Jews and other minority groups throughout European history has been linked to inflation and other sources of economic instability. The most infamous and horrific of those incidents, of course, began as an attempt to scapegoat Jews for the spike in inflation that plagued Germany in the wake of World War I. American history, too, is littered with panics, riots, and upheaval caused by sudden rises in prices and the public's perception that they are being ripped off. In the early days of the American experiment, indebted Massachusetts farmers took up arms against the new federal government's monetary policies. Two centuries later, dozens of farmers drove their tractors to the front door of the Federal Reserve in downtown D.C. to protest rising costs.

It may be tempting to dismiss the unsettling history that links high inflation with political unrest and aggressive xenophobia. Americans living today are the richest cohort of human beings ever to inhabit the planet. Surely we're not as susceptible to the psychological effects of inflation as our forebears, for whom a spike in the price of basic goods might be a matter of life and death?

And yet we may not be as far removed from Russian serfs or Weimar Germans as we'd like to think. Just look at the panicked runs on toilet paper in the early days of the COVID-19 pandemic, and the social media–fueled outrage over last year's sharp increase in the price of eggs. Or there's the bipartisan political impulse to reduce international trade and limit immigration—policies that will not reduce inflation but attempt to deflect blame for it onto foreigners.

Milton Friedman famously described inflation as being "always and everywhere a monetary phenomenon." That's still true when it comes to the causes of inflation—more money chasing the same number of goods is a surefirerecipe for higher prices. But it does not fully capture the effects of inflation, which academics are still studying.

Inflation, it turns out, is also a psychological phenomenon. It makes us angry. It makes us irrational. In any democratic system, that anger and irrationality can be quickly translated into poor policies—unless elected and unelected officials are prepared to withstand it, and to recognize that combating inflation often requires unpopular actions. Now is not the time to indulge the wisdom of the mob.

In short, inflation breaks our brains. It makes us poorer, and poorer citizens too.

Inflation has been a trigger for political and social unrest for as long as America has had its own paper money.

The country's first inflation incident occurred while the Revolutionary War was ongoing, according to Carola Binder, the chair of the Haverford College department of economics and the author of a new book, Shock Values: Prices and Inflation in American Democracy,which examines the interplay between rising prices and politics. The fledgling American government issued paper money, known as "continentals," to fund the war effort, but the bills were seen as being mostly worthless. As a result, inflation occurred.

"Inflation meant that debtors could pay off their debts in depreciated currency, which of course infuriated their creditors," says Binder. "The big problem was that creditors were forced to accept the Continentals in repayment for debts, even though the value of the Continentals had fallen."

John Witherspoon, one of the signers of the Declaration of Independence, dryly noted the humorous results. Rather than lenders pursuing borrowers to seek repayment, he wrote, creditors were "running away from their debtors, and the debtors pursuing them in triumph, and paying them without mercy."

A postwar period of deflation—in which prices actually fell—left some farmers unable to sell food at high enough prices to make payments on their mortgages. That triggered Shays' Rebellion, a violent Massachusetts uprising in 1786 and 1787. "The army eventually quashed the rebellion, but it sure made an impact," says Binder. "It showed the framers of the Constitution that price fluctuations affected not only the economic but also the political and social well-being of the states and the union."

Much of the first 100-plus years of U.S. history is marked by that same pattern of inflation and deflation, along with the corresponding panics, bankruptcies, booms, and busts. Each shift in the value of money triggered calls for political action, often in the form of protectionist schemes like tariffs or direct political intervention in the economy to set prices.

When the Federal Reserve system was created in response to the Panic of 1907, the new central bank was given a mandate to keep prices stable. In theory, that would remove the levers of monetary policy from American politicians, who had for decades used those powers to influence elections, reward friends, and punish enemies.

The Federal Reserve's main tool for combating inflation is the ability to raise interest rates. Higher interest rates make it marginally more attractive to save money rather than spend it, so dialing up interest rates can reduce the amount of money circulating in the economy and thus ease inflation.

Of course, people don't like higher interest rates either. When the Federal Reserve raised interest rates to combat inflation in 1980, homebuilders mailed lengths of lumber to Chairman Paul Volcker's office as a form of protest, since higher interest rates made it more difficult for Americans to afford homes (as is happening again today). Dozens of farmers staged a protest outside the Federal Reserve's headquarters in Washington. "They wanted a general lowering of interest rates. They also wanted the rates on loans to........

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