Inflation After The Recession? Super Internet Man To The Rescue

Thursday, April 15, 2010 posted by mattadmin

There  is concern among many that inflation will skyrocket post recession after the financial system meltdown of 2008. A high inflation rate can be detrimental to the growth of the economy. Instead the ideal situation would be an inflation flat that is stable at about 2%. Those who are concerned inflation may have not realized how this time in history is very different from times past. What’s so different you ask? Technology and primarily the Internet.

“Inflation is a general rise in prices across the economy. The inflation rate is a measure of the average change over a period, usually 12 months. There are two main measures. The consumer prices index (CPI) was adopted as the Government’s preferred measure in 2003 and is used by the Bank of England for the purpose of inflation targeting. The target is 2%, which would mean that prices overall are 2% higher than in the same month last year.” [Source]

Econ 101 tells us that the FED tries to balance unemployment and inflation by influencing interest rates; lower interest rates to decrease employment and raise interest rates to combat inflation. But what if the Internet and transparency of information actually helps the FED on the inflation side of the equation? That might mean it could become easier for economies to maintain low unemployment while keeping inflation under control. Only time will tell, but economies all over the world are becoming much more diverse and the Internet might have more benefits than first anticipated.

Well let’s not speculate any longer because this topic has actually been studied. In 2005, Myung Hoon Yi and Changkyu Choi released an article titled, The effect of the Internet on inflation: Panel data evidence, via the Journal of Policy Modeling. Their hypothesis says, “the Internet improves productivity and thus will reduce inflation is tested by pooled OLS and random effects model using cross-country panel data from 1991 to 2000.”

Here’s what they found: “After controlling for money growth rate, unemployment rate and oil price, we found that the Internet significantly reduces the inflation rate. We found that when the ratio of the Internet users to total population increases by 1%, the inflation drops by 0.04264% point to 0.13193% point.” How could this be? Simple, just look at the airline industry where you could easily make an argument that ticket prices are cheaper today in many cases than they were 20 or 25 years ago. The Internet makes it easy to compare prices all over the world putting a constant pressure on companies to keep prices low through efficiencies. So maybe we ought to be more worried about deflation. Maybe we ought to put more healthcare prices on the Internet.

Really just about any product or service can be surveyed for price on the Internet. Amazon, the world’s dominant online retailer by far, allows merchants to compete on price and compete directly against them. You can literally compare bird cage prices instantly and just about anything else you can imagine.

What’s the bottom line to all of this? Well, don’t listen to the Bear’s when they try to spread the fear of inflation. As we recover from this recession, economists need to re-think founding principles and formulas to account for technology and the tremendous power of the Internet.

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