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A blog by Leon Oudejans

Inflation: cash flow versus home equity

Most articles about inflation focus on cash flow and argue that inflation is bad. Some articles on inflation (eg, my 2021 blog) focus on home equity and argue that inflation is good. Actually, both perspectives are (generally) correct. This article will elaborate on this apparent contradiction.

Inflation impact on cash flow:

  1. Cash flow IN (eg, salary):
    • Inflation adjustments (eg, pensions, salaries) are usually below inflation %;
  2. Cash flow OUT (eg, expenses):
    • Daily expenses increase (ie, CPI);
    • No increase in fixed mortgage payments.
  3. Hence, net wealth decreases (ie, bad).

Inflation impact on home equity:

  1. Assets (eg, house):
    • Houses increase in value like expenses (CPI).
  2. Liabilities (eg, mortgage):
    • Debts remain the same (ie, nominal).
    • Future redemption decreases (ie, relative; not absolute)
  3. Hence, net wealth increases (ie, good).

Our conclusion depends on the relative importance of cash flow versus home equity. Some examples:

  1. High salary and a nice house: inflation is a problem for others;
  2. High salary, no house: inflation does not hurt your cash flow too much;
  3. Low salary and/but (home) equity: inflation is not a big problem;
  4. Low salary, no (home) equity: inflation is a big problem.

I reached a similar conclusion in my 2021 blog about a misleading 2021 article by The Intercept, entitled: Inflation Is Good for You. That article mainly focuses on examples 1-3. Example 4 is often more relevant in our societies because increasing inequality causes civil unrest (eg, strikes).

The above is about the consequences of inflation.

The cause of inflation can either me an overheating of the economy (ie, demand exceeds supply), or an increase in production prices (ie, supply driven inflation). The 2022 Russian invasion of Ukraine shows that a supply driven inflation hardly reacts to anything (eg, interest rise, price caps, sanctions).

Its cause should / will determine the national Central Bank response. I have mixed feelings about the causality between inflation, Central Bank interest changes, and its economic impact. It’s a very blunt knife that takes too much time. Moreover, rising interest levels will (first) accelerate consumer prices.

Remarkably, I even noticed an example of inflation in quotes:

1974, Quote magazine: “It’s inflation when you have to pay $5 for the $2 haircut you used to get for $1 when you had hair.” A quote by Franklin P. Jones (1908-1980), a public relations executive and humorist

1997, Wall Street Journal: “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.” A quote by Sam Ewing (1920-2001), an American writer and humorist

Source: Barry Popik

Money’s Too Tight (To Mention) – 1982 – by Simply Red (1985)
1982 original by The Valentine Brothers
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[Verse 1]
I’ve been laid off from work, my rent is due
My kids all need brand new shoes
So I went to the bank to see what they could do
They said son looks like bad luck
Gotta hold on you

Note: all markings (bolditalicunderlining) by LO unless in quotes or stated otherwise.

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