Inflation's Redistributive Effects

While debates about inequality typically focus on corporate greed or tax policy, inflation is an underevaluated mechanism that systematically advantages asset holders over wage earners and savers. This essay argues that inflation, properly understood as an increase in the money supply rather than a rise in prices, redistributes wealth from the poor to the rich through predictable channels that remain largely overlooked in mainstream discourse.

Inflation is commonly misunderstood as a consistent and sustained rise in prices; however, Hazlitt suggests that this is just one of the effects of inflation: ‘inflation is the increase in the supply of money and credit’ (Hazlitt, 1960). Making this distinction is crucial: seeing inflation as merely a rise in prices masks the mechanisms that fuel inequality. Understanding that inflation is a result of monetary expansion reveals a crucial mechanism at play. When the money supply increases, each pound, euro, or dollar becomes a smaller percentage of the total money supply; each unit claims a smaller share of the available goods and services in an economy. Savers and wage earners see their purchasing power evaporate just by trying to retain their wealth. This purchasing power doesn't disappear but is transferred elsewhere in the economy.

The Cantillon effect describes how ’the first ones to receive the newly created money see their incomes rise whereas the last ones to receive the newly created money see their purchasing power decline as consumer price inflation comes about’ (Rouanet, 2017). Markets cannot anticipate increases in money supply; they respond only after spending has occurred. Hence, the first recipients of new money (banks and financial institutions) benefit disproportionately as they gain access to scarce assets such as real estate before prices have adjusted to their spending. Markets respond to these signals, adjusting prices upward to account for the new money in circulation. Even though most are unaware of the causal mechanisms at play, holding currency is an obviously bad decision, which creates a demand for assets that increase in supply at a slower rate than the money does. 

Scarce assets like housing become an inflation hedge rather than shelter, with 955,437 unoccupied houses in New York (Hopkins, 2022). Prices are bid up beyond their value as a shelter and gain a monetary premium, which emerges as a result of their ability to store value more effectively than the currency. The supply of houses owned with the intent of being lived in decreases, pushing rents higher. Renters watch rent prices become a larger share of their wages, and currency holders experience devaluations of their savings. This creates a cycle of wealth concentration, as money fails to retain its value; everyone scrambles to acquire scarce assets, bidding prices up further and making wealth preservation an even harder goal to achieve. Asset holders receive stolen purchasing power from currency holders merely by owning assets, being rewarded for passive ownership. The incentives that are created in an inflationary environment encourage the repurposing of assets from satisfying consumer wants and needs to acting as passive inflation hedges.

The redistributive effects of inflation extend to debt dynamics by rewarding debtors whilst punishing savers. The wealthy can acquire far more debt than the lower-income earners. They already own assets and can therefore offer collateral to receive cheaper and larger loans, which depreciate in real value over time due to monetary debasement. Lower-income earners and young people, on the other hand, are perceived as risky borrowers and don't already own collateral, so they cannot benefit in the same way. As a result, the wealthy can acquire more assets whilst their debt burdens shrink. Still, lower-income earners are subject to a persistent devaluation of their savings, which perpetuates their economic situation and widens the wealth gap.

Keynesians might refute this claim by arguing that there is an inverse relationship between unemployment and inflation, citing the Phillips curve. Supposedly, without inflation, unemployment would rise, disproportionately harming the lower classes. Their argument suggests that injecting new money into the economy makes people feel wealthier as they receive this new money before prices have time to adjust. This encourages increased spending, which signals to firms to produce more, which requires hiring more workers. However, this ignores the Cantillon effect mentioned earlier. New money does not correspond to new goods; it only increases the number of claims on existing goods. There is a time lag, as suggested, between injecting new money and price increases, but only the first receivers of new money benefit from this time lag. Where demand increases in one part of an economy, it is decreased elsewhere as currency holders suffer from an adverse wealth effect. Total demand is not increased; it is only redistributed. This theory was empirically refuted in the 1970s when the United States experienced an increase in unemployment despite an increase in inflation (Bryan, 2013), directly contradicting the Keynesian claim. The Phillips curve ‘works’ only by redistributing wealth from currency holders to first receivers, perpetuating the very inequality it claims to address.

Monetary expansion systematically redistributes wealth from wage earners and savers to asset holders and the first receivers of new money, making inflation a primary, yet overlooked, driver of inequality. Until we recognize monetary policy as a redistributive mechanism, debates about inequality will continue to miss their true target.

Bibliography

Bryan, M. (2013). The Great Inflation. [Online] Federal Reserve History. Available at: https://www.federalreservehistory.org/essays/great-inflation [Accessed 18 November]

Hazlitt, H. (1960). What You Should Know about Inflation. New York: Funk & Wagnalls.

Hopkins. (2022). How Many Vacant Homes Are There across New York State? [Online] 101.5 WPDH - The Home of Rock ‘N’ Roll. Last updated: 31 March 2022. Available at: https://wpdh.com/housing-market-in-new-york/[Accessed 18 November]

Rouanet, L. (2017). How Central Banking Increased Inequality. [Online] Mises Institute. Last updated: 15 August 2017. Available at: https://mises.org/mises-wire/how-central-banking-increased-inequality [Accessed 18 November]