If inflation/deflation is actually caused by a variation in the size of the money supply, how can we counter the claim that dropping oil prices is driving deflation?
This depends on how inflation and deflation are defined. If they are defined as changes in the CPI, then the fact that the gasoline index fell by 17.2% and accounted for almost 90% of the December decline in the CPI indicates that this is the source of “deflation.” The question, then, is what caused the decline in the price of gasoline?
The price of oil spiked upward in the second half of 2007 and the first half of 2008. This was driven largely by increases in the U.S. money supply. Investors, seeing that the money supply increases would cause a drop in the value of the dollar, moved their investments to tangible assets, such as oil. This pushed the price of oil to $147 per barrel and gasoline prices to over $4.00 per gallon. This was much higher than the prices indicated by the underlying fundamentals.
As 2008 drew to a close, the Fed had reached the end of its perceived ability to inflate the money supply. The Fed fund and discount rates were effectively 0%. The price of gasoline dropped in response to this, so the decline in gasoline prices is actually, in large part, a result in changes in the money supply.
This isn’t always the case. Price indexes indicate changes in the relationship of the value of a good and the value of money. There are many factors that influence the prices of individual goods other than changes in the value of money. But changes in the value of money are predominately caused by changes in the money supply because it varies much more than the demand for money. Therefore, if inflation and deflation are defined as changes in the value of money, the money supply is the cause. If they are defined as changes in the money supply, then it becomes a tautology.
Almost what he said.
You are confusing what Austrians say, and what the news says.
The paper might tell you that we are “in danger” of “deflation” due to falling oil prices, but that’s just because oil plays a large part in the arbitrary measure they like to use to measure “consumer prices”. An accurate measure of prices is the money supply, as that is a measure of “total inflation” (i.e. for everyone rather than the “average joe” they calculate the basket on).
I actually haven’t. MY question was how does the news have it wrong. My question is what’s happening to the money supply that oil prices are falling (and coming back up a bit now)