Inflation - Obson/MicroSim-GUI GitHub Wiki
Price Inflation can be defined as a decrease in the purchasing power of money, or conversely as an increase in the aggregate cost of goods and services. It is conventionally given as an additive percentage, so for example 5% inflation is taken to mean that any given quantity of goods and services (often referred to as a basket) would cost 105% of their pre-inflation price.
Price Deflation is the inverse of inflation—i.e. an increase in the purchasing power of money. In practice (and for our purposes) it may be more convenient to talk in terms of negative inflation rather than deflation. Adopting this convention we can say that 5% deflation is the same as -5% inflation and accordingly a basket would cost 95% of its original price.
Inflation may be easy to define, but in the real world it is difficult to measure, principally because goods and services do not all increase or decrease in price at the same rate. Much attention therefore is given to the contents of the 'basket', which are generally chosen to represent the basic requirements of a 'typical' person's life. Since these also change as a result of both technological and socio-political changes, an acceptable, if somewhat arbitrary standard has to be agreed by economists, politicians, and statisticians. In the UK the official standard is defined and updated by the Office for National Statistics.
Obson has, with one important exception, no concept of prices. It is assumed that when someone makes a purchase (in Obson's terms, when a worker pays a firm) they get what they pay for—the value of the goods is assumed to equal their cost. The question of inflation doesn't arise, because we are not concerned with what the money is spent on, or its price.
The crucial exception to this is the cost of labour. Obson uses a standard (but user-modifiable) unit labour cost. This represents a rather subtle concept, the intrinsic value of a standard unit of labour over a unit period of time.
Now, labour isn't always easy to come by. To take the (theoretical) extreme case, if 100% of the population is already employed the only way a business can recruit more staff is by persuading the employees of other businesses to change employers. Unless an employee is unhappy in his present position (and Obson doesn't model unhappiness) he will only change employers if the new employer offers more money.
But we are assuming the reason for this change is simply that there are no other potential employees available, not that the employee's labour is inherently worth more than the standard unit labour cost. Let's suppose the employee requires a 20% increase to change jobs; then the employer is paying 120% of the standard unit labour cost for 100% of the standard unit of labour. If this were to happen generally it would mean that, as far as labour is concerned anyway, the level of inflation was 20%.
In Obson's terms then we can treat inflation as an increase in the cost of labour, given by actual unit labour cost divided by standard unit labour cost (generally converted to a percentage increase or decrease for discussion or commentary purposes).
An implication of this is that it makes sense to set the 'unit labour cost' to something convenient. Accordingly the default value in Obson is 100, so that an increase (or decrease) can be read off directly as a percentage.
Of course, if it were to happen generally it wouldn't stop there. Employment would still be at 100% and whatever an employer had gained by acquiring the employees of other companies would almost immediately be lost again as other companies acquired their employees. The increased costs of labour would have to be passed on to customers, who are, of course, those self-same employees, and the process would repeat but with an ever-rising baseline.
This scenario has led many economists to regard full employment as inherently inflationary and try to devise an acceptable level of unemployment that would avoid the problem. However, this is seriously problematic since (quite apart from ethical considerations) there is no direct wage to target the level of employment. On the other hand if it is targeted indirectly we will need to investigate the chain of causality that results in the change in unemployment and assure ourselves that it is not some link in this chain that is actually responsible for achieving the result we want.
At significantly less than full employment the level of taxation can be used, along with government spending level, to determine the growth (or otherwise) of the economy. The lower the taxation level and the higher the level of government spending, the larger the economy becomes. After a certain amount of time (longer if the taxation level is lower) the deficit will always tend to zero.
However, when there is full employment this is no longer the case. Here we find that the level of taxation required to reduce the deficit to zero is equal to the size of the government-supported sector of the economy relative to that of the economy as a whole. So if the size of the NHS, armed forces, state education, etc. is, say, 20% of tat of the whole economy the effective rate of taxation needs to be 20%. More, and the government will have a surplus; less, and it will sustain a deficit.
Low levels of inflation seem to be acceptable—even beneficial—perhaps because not every aspect of an economy inflates at the same rate and so inflation in some areas may be compensated for by deflation in others. But high levels of inflation tend to be viewed with concern. As long as the rate is stable it can be factored into most transactions, but the appearance of inflation where there was none previously clearly indicates a discontinuity, or at least an acceleration, and so carries with it the threat of even higher inflation in the future.
For this reason, among others, governments and economists usually have a marked preference for very low levels of inflation, and as we have seen at full employment this mandates a taxation level similar to* the ratio of the size of the government's part of the economy to that of the whole economy. By withdrawing from the economy funds equal to those it has put in, this prevents businesses from amassing spare funds that cannot be spent as the economy is already fully utilised. A higher level of taxation could be used to depress the economy (or as they say, "to cool it down").
* The correspondence isn't exact, owing to the effect of savings.