Let's have a little chat about inflation...

Inflation is one of those things that almost nobody who isn't an economist seems to understand (though that doesn't mean all economists understand it either!). First of all, there is the fact that most people don't even seem to know what inflation is. Some people seem to equate the word "inflation" with "a decrease in [my] real wages" - if things seem harder to afford, then it must be "inflation". Others seem to think that if stock prices go up, then that is "inflation". Still others use the word "inflation" to describe specific price changes - for example, if oil gets more expensive, people call that "oil price inflation". And the other day, I had a friend tell me: "[It's] simple. Low [interest] rates mean the price of money is low. That's a form of deflation."

(Note that that last statement is the exact opposite of correct. Inflation is a decrease in the value of money. Deflation is an increase in the value of money.)

Or the other day, someone on Twitter asked me: "How is it possible for inflation to help debtors when wages are going down? If wages are going down, doesn't inflation just make it harder for people to pay off their debts?"

The answer is no. Here's why. Suppose you make $50,000 a year and you have $50,000 in debt. Your debt-to-income ratio is 1. Also, just for convenience, let's say the general price level starts out at "1".

Situation A: -50% real wage growth, 100% inflation.

In this case, the new price level is 2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 2 = $50,000. Your debt is still $50,000. Your debt/income ratio is still 1.

Situation B: -50% real wage growth, 0% inflation.

In this case, the new price level is 1. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1 = $25,000. Your debt is still $50,000. Your debt/income ratio is now 2.

Situation C: -50% real wage growth, 50% deflation.

In this case, the new price level is 1/2. Your new real wage is $25,000. Your new nominal wage is $25,000 x 1/2 = $12,500. Your debt is still $50,000. Your debt/income ratio is now 4.

So as you can see, even if your real wage is going down by 50%, it's better to have inflation than no inflation if you are a net debtor. Inflation erodes the value of your debt no matter what is happening to your real wages.

So what's going on here? Why do so many people misunderstand inflation? Maybe it's a form of "Stockholm Syndrome". Inflation-hawkish economists have been bellowing, so loudly and so vehemently, that inflation is Satan - this goes back at least a hundred years - that non-economists just can't help believing it. People end up trying to think up reasons why inflation must be bad after all. When you offer them freedom - when you tell them that sometimes inflation can erode debt, relieve balance sheet recessions, and help stimulate the economy - they don't want to take it. , and they come up with more brilliant ways to identify with their captors. Or something like that.

I don't know. I feel like that's kind of a weak theory. What's really going on here? Why don't most non-economists seem to get what inflation is or what it does?