Why new technology (e.g. AI) does not necessarily result in lower inflation

New technology lowers average/marginal cost of production. Lower average/marginal cost leads to either higher productivity or lower inflation, or both. And I believe technology has a larger role to play in raising productivity than in reducing inflation. Here are a few examples to illustrate the point.

  • The cost of producing a loaf of bread has gone down substantially from the Victoria era to now, with the benefit of machines. That has certainly led to a higher productivity in the bakery industry,. The price of a loaf of bread has also gone down, helping drive down inflation, but its contribution may not be as large as one may think, because the weight of bread in the CPI basket has also gone down substantially.
  • The cost of computer memory halves almost every year, which in theory should make IT equipment cheaper and cheaper. However, at the same time we demand higher and higher computer memory to run in our laptops, desktops and mobile phones. iPhone 1 is substantially cheaper than 5 years ago, but many people have already upgraded to iPhone 6/7 which still costs quite a bit. Again, technology leads to better goods, but not necessarily lower expenditure on certain goods (e.g. IT equipment).
  • There is new demand that was not foreseen 100 years ago or even 10 years that helps push up inflation. For instance, the CPI basket 100 years ago wouldn’t include computers. 50 years from now, the CPI basket may not include any desktops, but rather new products – which deserves a premium in its price – built on new technology.

Another (monetarist) angle to explain why new technology does not necessarily lead to lower inflation (or by the same argument lower government bond yield): inflation is probably a monetary phenomenon. Why broad money supply – driven by growing narrow money or higher monetary/credit multipliers – increases beyond people’s estimate, unexpected inflation occurs and leads to inflation overshoot.

At the end of the day, it is much easier to generate hyperinflation than moderate inflation (with decent growth in the background).

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