When I read different articles and debates online or listen to conversations, there have probably been dozens of different definitions of these two words. This being said, it also is the reason and usually the root of many economic debates and discussion. I find that a lot of the debates that I have are not even worth having, due to the fact that the definition of these two words can not be agreed upon.
The definition I use is what I believe to be the Mises definition, which is increase in money supply (inflation) or decreased in money supply (deflation). Many tend to believe we are in a deflationary stage because asset prices, such as homes, are declining. Many also try and make the case that because lending is contracting, again, money supply is contracting. I disagree because money isn’t being destroyed when either of these two things happen. So when a loan is made 10 years ago for someone to purchase a home and the loan was for $500k, let’s say and the borrower only pays $300k back, many will argue that there is deflation because the remaining $200k was never paid back. I disagree because the $500k made its way into the economy the day the seller of the property was paid; it was never destroyed because the borrower failed to pay the entire loan back at a later date. Others will also argue that money is destroyed, once again, if the loan is paid back in full. Again, I fail to see how this is so because of the same reasons I explained when the loan wasn’t paid back.
Am I missing something? Is money supply really shrinking and there is something I am missing? Shadowstats shows M3 in a decline but none of the things that accounted for in M3 are being destroyed as far as I can tell. These pieces of paper aren’t being lit on fire and being completed removed from the economy. So what gives?
1] Increasing [i.e “inflating”] the money supply does not necessarily cause the economic condition generally known as"inflation" [i.e. a decrease in per unit purchasing power of the $] . It may, it may not.
2] Decreasing [i.e. "deflating] the money supply does not necessarily cause the economic condition known as “deflation”[ i.e. an increase in per unit purchasing power of the $].
3] as far as I am aware LVM and other Austrian economists do not define inflation as an increase in the money supply, but as an economic effect - the end result, at any point in time, of the constant interplay of two factors, the supply of money and the demand for it, an effect which may or may not be caused by an increase in the money supply, and which, as a matter of fact, can occur even when the money supply has been steadily decreasing.
“Inflation” and “deflation” are terms usually used by Austrians and other economists to describe prevailing economic conditions.
However, the terms “inflation” or “inflating”, and “deflation” or “deflating” are also often substituted for the words “increasing” ,or “decreasing”, to describe actions taken by the central bank .
Ideally, to avoid confusion, the terms “increase” or “decrease” and their common derivatives would be used in place of “inflating” or deflating" when describing actions taken by the central bank to control the money supply [in my dreams-right?].
However, neither action is the same as either condition, and furthermore, either action [inflating or deflating the money supply] does not necessarily cause either condition [inflation or deflation], as LVM proves, using simple logic, in “The Theory of Money and Credit” .
In other words, “inflating”[i.e. increasing] the money supply does not necessarily cause the economic condition known as “inflation”, nor does “deflating” [i.e. decreasing] the money supply necessarily cause the economic condition known as “deflation”.
“… we must never forget that changes
in the quantity of money affect prices in an uneven way. It depends
on the data of each particular case at what moment and to what ex-
tent the prices of the various commodities and services are affected.
In the course of a monetary expansion (inflation) the first reaction
is not only that the prices of some of them rise more quickly and more
steeply than others. It may also occur that some fall at first as they are
for the most part demanded by those groups whose interests are hurt.”
I know for sure that Peter Schiff and Hazlitt use the old school definition of inflation as well.
Onebornfree, I think you’re talking about the purchasing power of money, which is indeed caused by supply of, and demand for, money. And inflation, printing money, increases the supply of money, becoming a factor that will tend to reduce its purchasing power. But an increase in the purchasing power of money is not deflation, and a decrease in its purchasign power is not inflation, but a common consequence of inflation.
Here are two Rothbard quotes from What has Govt Done to Our Money:
" Like all commodities, its
“price”—in terms of other goods—is determined by the interaction of its total supply,
or stock, and the total demand by people to buy and hold it. (People “buy” money by
selling their goods and services for it, just as they “sell” money when they buy goods
and services.) "
" Inflation may be defined as any increase in the
economy’s supply of money not consisting of an increase in the stock of the money
metal."
Mises’ definition of inflation, though he finds the term practically untenable, is an expansion of the supply of money, in the broader sense, beyond the demand for money. This may or may not lead to general price inflation, but it must necessarily cause relative price distortions (expanding the supply of money is not always inflationary). Through 2008-2009 we had a deflationary period because velocity collapsed, which brought down the monetary aggregates. But the federal reserve, and other central banks around the world, have expanded their balance sheets (monetary base) to historical levels, and this must inevitably lead to massive inflation once velocity picks up again. The FED has no way to suck out excess reserves from the system, which is why they’re paying interest on reserves (they’re trying to prevent bank lending).
Furthermore, the monetary aggregates are kind of weird. They include assets which shouldn’t be considered as money. There is no way to accurately measure inflation.
"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. "
This is what Ludwig Von Mises says concerning the modern definition.
“But people today use the term `inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise.”
And from this…
“…they try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar.”
Here is the entire quote
“Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation’ to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation. . . . As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.”
von Mises, Ludwig (1951-4-6). “Economic Freedom and Interventionism”. Economics of Mobilization. Sulphur Springs, West Virginia: The Commercial and Financial Chronicle. Retrieved 2008-09-20.