A Lesson in Inflation

 

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A Lesson in Inflation

Imagine you’re at the grocery store or filling up your gas tank, and you notice prices creeping up. That’s inflation at work, and the government freely printing money plays a big role in it. So, grab a snack, and let’s see if I can simplify this very complex economic measure. You’ve probably felt it before: things like bread, coffee, or even your favorite lunch spot just don’t cost what they used to. That’s inflation when prices rise over time, and your money doesn’t stretch as far. A little inflation is expected, like the economy’s way of stretching its legs. But when prices climb too fast, it’s like your wallet’s shrinking while you’re trying to keep up. When someone says the government’s “printing money,” they don’t mean workers in a basement churning out dollar bills (though that’d be a wild scene!). It’s really about the central bank, like the Federal Reserve in the U.S., adding more money to the economy. They might do this to pay for big stuff, like helping out during a crisis (think COVID relief) or giving the economy a jumpstart when it’s sluggish. It’s like tossing extra logs on a campfire to keep it going, but too many logs, and you’ve got a problem. Here’s the simple version: if there’s suddenly a lot more money out there but the same amount of stuff to buy, like pizzas, cars, or concert tickets, people start competing for it. Imagine you and your buddies all get a cash bonus and race to buy the last slice of pizza. That slice is going to cost a lot more! Economists call it “too much money chasing too few goods.” So, prices tend to rise if the government pumps out cash faster than the economy can grow. The US government is the single biggest consumer of goods, bought and paid for on IOU’s.

If printing money always caused inflation, we’d see prices soar every time the Fed added a few bucks. But it’s not that simple. Here’s why: If everyone gets extra cash and just saves it, like stuffing it in a piggy bank, prices might not jump much. No spending, no bidding war. So, the question becomes, is the economy growing? If businesses are making more stuff (more pizzas, more cars), the economy can handle extra money without prices going crazy. It’s like having enough slices for everyone, no need to fight over them. So, how does this affect the supply and demand measure? If you think prices are about to shoot up, you might charge more for your product or ask for a raise. That can kickstart inflation all on its own. There are also outside forces at work. Ever notice gas prices spike when oil gets pricey or when supply chains snag (like during the pandemic)? That can push inflation up, even if the money supply stays put. After the financial crisis of 2008 and during the pandemic, the Fed “printed” trillions of dollars to keep things afloat. Inflation didn’t explode right away—why? The economy was slow, and people weren’t spending like wild. It was like adding fuel to a dying fire. But in 2021-2022, with supply shortages and big demand, and the excessive dumping of money into the global supply by the Biden Administration, boom; prices took off. That extra money finally found fewer goods to chase. Recall what happened in Venezuela and Zimbabwe. Their governments printed money like it was Monopoly cash to cover huge debts. Result? Hyperinflation, prices doubling every few days. Imagine a soda costing $5 today and $10 tomorrow. Total chaos.

The U.S. Treasury doesn’t run the printing press per se. Instead, it borrows money by selling bonds. Think of them as government IOUs. If the Fed buys those bonds (a fancy move called quantitative easing), that’s when more money enters the system. So, the Treasury’s not printing, but its borrowing can nudge the Fed to crank up the cash flow. Here’s the deal: printing money can spark inflation if it happens too fast and the economy can’t keep pace. But it’s not a straight line from printing press to price hikes. How much people spend, how fast the economy’s growing, and what’s happening globally all mix into the equation. The Fed tries to keep inflation chill—around 2% a year is their sweet spot. Too much money is too quick, like dumping gasoline on a campfire; things can flare up quickly. So, think of it this way: a little money printing is like adding a log to keep the fire cozy. But if you throw a whole tree in there, you’re stuck with a blaze that’s tough to tame. And trust me, nobody’s roasting marshmallows over that mess!

When you hear that interest rates are going up, your first thought might be about how it’ll affect your car loan or mortgage payment, and fair enough, it’s not always welcome news. But have you ever wondered why the government or, more specifically, the central banks that set these rates sometimes push for higher interest rates? It’s not just about making borrowing more expensive. There’s a bigger picture at play, and one surprising piece of it involves tax revenue, especially from the higher prices you pay for goods and services. Allow me to explain how this works in simplistic terms. First, let’s get on the same page about interest rates. They’re essentially the cost of borrowing money, set by a central bank (like the Federal Reserve in the U.S.). When rates go up, loans get pricier, and people tend to borrow less. That might mean fewer new homes, cars, or big-screen TVs in your life. But it also means people save more, because stashing money in a savings account or government bond suddenly looks more appealing with a better return. So why would the government want this? It’s not because they enjoy seeing you pay more for your loans. It’s about managing the economy—and yes, bringing in more tax dollars in some clever ways. One of the less obvious reasons the government likes higher interest rates is how they can lead to more tax revenue from the stuff you buy. Here’s how it works: When interest rates rise, borrowing gets expensive, so people spend less. You’d think that would make prices drop and demand less, right? Sometimes it does, but not always. Businesses might actually raise prices to cover their own higher borrowing costs or to keep profits steady in a slower economy. Plus, if the economy’s already dealing with inflation (rising prices across the board), higher interest rates are often brought in to cool things down, but prices might stay elevated for a while. Now, here’s the tax twist: many taxes, like sales tax or value-added tax (VAT), are a percentage of what you pay. So, when prices go up, the government collects more per purchase, even if you’re buying less overall.

Imagine you’re buying a new phone: For example, if the phone cost is $1,000, with a 10% sales tax = that means $100 goes to the government. Conversely, if the same phone jumps to $1,200 (maybe due to inflation or supply chain costs tied to borrowing). Now, that 10% tax nets the government $120. That’s an extra $20 from one sale, adding up fast across millions of transactions. So, higher interest rates can quietly boost the government’s tax revenue by making goods and services cost more. There’s another tax angle: What happens when you save more? Higher interest rates make savings accounts and government bonds more attractive. Why risk your money in the stock market when a bond pays you a solid 5% instead of 2%? This is great for the government because when you buy a bond, you’re lending them money they can use for roads, schools, or whatever else is on the agenda. But here’s the kicker: the interest you earn on that bond is taxable. So, the government not only gets your loan but also takes a cut of the interest they pay you back. Let’s look at the following example: You buy a $10,000 government bond at a 5% interest rate. You earn $500 in interest each year. If you’re in a 20% tax bracket, you pay $100 of that to the government. Compare that to a 2% rate: you’d earn $200, and the tax would be just $40. Higher rates mean more interest income and more tax revenue from it. It’s a win-win for the government: they borrow your money and then tax you for the privilege of lending it to them!

Okay, tax revenue isn’t the only reason the government likes higher rates. They also use them to tame inflation when prices are rising too fast. Think of inflation like a runaway train: if it goes unchecked, your money’s worth less every day, and the economy can get chaotic. Higher interest rates slow that train by making borrowing costlier, which cuts spending and cools price hikes. Why does this matter for taxes? In a stable economy, tax revenue stays reliable. If inflation spirals out of control, prices (and nominal tax dollars) might go up, but the actual value of that money shrinks. Plus, wild inflation can lead to recessions, fewer jobs, less spending, and a big hit to tax revenue. By keeping inflation in check, higher rates help ensure the government’s coffers don’t take a long-term beating. Now, don’t get the idea that the government wants interest rates sky-high all the time. If they go too far, borrowing grinds to a halt, businesses struggle, and unemployment spikes, meaning less income tax and fewer sales to tax. It’s all about balance. The goal is a “just right” economy: not too hot with crazy inflation, not too cold with a recession, but steady and humming along. Tax revenue flows consistently when that happens, and the government can keep the lights on without drastic measures.

What does this mean for the taxpayer, and why should you care? Higher interest rates hit your wallet in a few ways: More tax on purchases: If prices creep up, you’re handing over more sales tax. Better savings, but taxed: You might earn more on your savings or bonds, but Uncle Sam takes a bigger bite. There will be broader challenges in borrowing: Loans cost more, so that dream house or car might have to wait. On the flip side, a stable economy benefits you, too. Your money keeps its value, businesses stick around, and the government can fund things like parks, schools, and healthcare without printing cash or hiking your taxes elsewhere. How did we get to where we are with the current economy? Economists point to the prior presidential administration; they dumped trillions of dollars into the economy to support immigration, pet projects, Non-Governmental Organizations, the war in Ukraine, and propping up the global economy. This is why the current administration needs to weed out governmental fraud and abuse. If not, the deficit will soon consume a large portion of tax revenue. At that rate, the government will indeed default on governmental bonds, and a complete global financial meltdown will ensue.