The Myths surrounding the phenomenon of inflation...

Economics Economics Questions
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1

Hey everyone, figured I’d contibute a little something to the forum here with my first post… I was just wondering as to what every one else thinks about the fallacious reasons typically given for inflation and why it is that everyone buys into those concepts rather than accepting the logically sound Austrian view?

Perhaps there is more to the Austrian perspective than I am aware, but if I am correct, Austrian’s believe simply that inflation is caused by an increase in the money supply. [It really is so simple!]

Why is it that we still have the idea that inflation is a natural phenomena? That with growth comes inflation, inevitably? Why do we hear that the Fed has “inflation concerns”–they cause the inflation! Not exclusively, of course, but as the “banker’s bank” they have some controls over the lower levels of inflation too, those not directly in their hands.

On Saturday, I went to a Ron Paul rally in Chicago (anyone else there?). It was pretty good, and the portion that he spoke on the need for a gold standard and a halt to inflationary taxes by the Fed was fantastic. Lots of people were clapping and whooping for every third sentence he said… I was surprised, however, that when he said, straightforwardly, “Inflation is an increase in the money supply,” I was the only one who yelped my praise.

I know that the MSM and the government (and all politicians therein) have plenty to gain from inflation (or at least, approving of current policies). Why is it though that the simplest definition and, indeed, the only correct one, has failed to make it into the mainstream? How can we fix it.

Thanks! Cris

2

In Economics 101 we were discussing inflation, and our professor asked us what we thought caused inflation. I raised my hand, and asked about the monetary policy and the blatant increasing of the money supply!

She shrugged the point off and asked others for ideas that she wrote on the board, but left mine out.

Yesterday. I brought up the interview with Greenspan on the Daily Show, and then said “and then John Stewart asked a really good question…” to which she cut me off and said “no it wasn’t a good question. Greenspan was right that he should read the book again.”

So our econ students are, from the beginning fed this line, and that might well be why they come out of college with NO idea why inflation happens.

3

Good call, Joe. I was very blessed by an open-minded monetarist for Econ 101 and 102. While he supported the Monetarist view, he introduced us to Hayek and, to a lesser degree, Mises. In subsequent conversations, he’s admitted that there is ‘something to’ the Austrian perspective, but since he made a few hundred thousand while he worked at the Seattle Fed bank, I think he’d have to explode if he admitted that those 20 years of his life were evil… :slight_smile:

4

This is one regard in which I am fortunate. My professor of economics is a staunch Hayekian, and constantly “injects” Austrian themes into his teachings.

5

Hey Inquisitor, I’ll give you a pound sterling if you record a lecture for me :slight_smile: What school are you at?

6

that’s truly amazing. I don’t see how you can be an economics teacher or economist and totally disregard something so obvious. It’s not voodoo.

7

Lancaster. The professor in question is Gerry Steele. As much as I’d like to take you up on that offer, he has some lectures and articles available here as it is.

8

I would say rather that inflation IS DEFINED AS an increase in the money supply. (As Ron Paul said at the rally you attended). This definition used to be the only defintion, before somehow the central bankers / Keynesians got us to buy into the clever lilttle newspeak dodge of redefining it as a general rise in prices.

Inflation can cause an general rise in the level of prices, but when you redefine it AS a rise in the level of prices, then you can go off looking for other causes of “inflation” besides the obvious one: aggressive credit expansion by the central banking system.

Cheers!

9

The problem in defining what causes inflation is that the two parties generally do not agree what the definition of inflation is.

Austrians, such as most of us, believe that the definition of inflation is “the increase in money supply,” therefore the cause of inflation is “increasing the money supply.” Non-Austrian Economists tend to believe that the definition of inflation is “the increase in prices in a market,” and is caused by an increased demand for a market, or a decreased supply of that market (services or product). For them, inflation has more to do with increased demand/decreased supply than a change in the money supply.

Many of us Austrians can agree that inflation (the increase of money supply) usually causes some or many markets to move up in price as new money floods towards a fixed or previous supply of a market’s product or service, but inflation doesn’t necessarily cause ALL prices to go up. Over the past 2 decades, the money-supply-adjusted price of computers has tended to go down, which non-Austrians would call “deflation,” but we would call “price drops.” Even in an inflationary economy (i.e., the rising of the money supply), prices don’t always tend to go up. It is possible that new money is hoarded outside of the banking system (mattress, vault, wallets and purses locally and foreign lands, etc). It is possible that new money is deposited into accounts that have high reserve requirements and isn’t loaned out.

Whatever the basic premise is for the cause of inflation, it is important to understand that more often than not, we are looking at two different subjects: money supply inflation (which can and usually does cause some price increases), and price increases (which can and usually is caused by either money supply inflation or by new demand or reduced supply for a given market product or service).

10

Please correct me if I’m wrong: it seems to me that the Austrians agree that an “inflation” of money supply necessarily makes monetary prices of goods higher than they would be without the “extra” money, which doesn’t mean that prices will increase or decrease as of in a causal relation.

11

Danilo is correct. When the government inflates the money supply it dilutes the purchasing power your dollar, causing prices to rise.

12

I still disagree completely. Price increases are not always caused by inflation of the money supply. Inflation of the money supply CAN dilute your dollar, but it isn’t required to, because your dollar’s purchasing power is market-specific, not overall economy-specific.

What money supply inflation does do is create malinvestment potential. Picture this: new easy money is created. People want the best return on their money as possible, so they look for recent historical returns in a given market, say housing. Since the recent history of housing showed a price boom, they mal-invested their new money into housing in hopes of a better return. Because the housing market had a flood of new and old money move into it, the increase of money in that market caused prices to go up. Why didn’t the price of computers and cell phones and car tires go up equally? Because they did not have the return on investment that housing seemed to show. In computers, prices went DOWN even in an inflationary (money created) economy.

You can’t just say that newly created money makes prices go up – it doesn’t. If the central bank doubled the money supply overnight, but everyone socked that new money in their mattress, prices wouldn’t change. You also can’t say that inflation automatically makes prices go up if that money disappears outside of our economy.

I’m against central banks, and against fiat money, but I am also aware that inflation does not create generic price increases right away. It is once that new money actually cycles into the economy overall that we see price increases – but not always, as we see with some consumer goods. New money is not as bad as easy credit, I’d say, because money can be exported easily (and out of our market) whereas credit can not be exported so simply. Imagine if immigration was legal and unlimited – immigrants might flood into the country, send their dollars out of the country “back home” and we might see price decreases overall as money left the country and the demand for money increased due to this fleeing of cash from the local economies.

13

I totally agree with you. Inflation as price increase and inflation as money supply increase are different things. I also agree on malinvestment potential. I once read something like this: “If a person gets more money than he/she can spend wisely, he/she tends to spend unwisely.”

14

I have argued both sides before. Back when I was still a slave to keynesian economics (sophmore year of college), I made a passionate argument (that I did not even understand) that inflation was somehow caused by “demand pull” and not the amount of printed fiat dollars.

Many on this forum, including myself, disagree with this generalization. However, I think that the manner in which “inflation” is measured should also be brought under scrutiny. In my student managed fund class, I did a special project which blasted the feds for how they measure CPI, and why it is in their interest to overstate it.

CPI apologists

Claim:

An accurate if not overstated measure of inflation is attained by selecting a “basket of goods” which reflects changes in the price of goods that a sampling of consumers bought.

Assumptions:

· Economists need a clearer picture of the economy and volatile goods distort this picture

· Changing to three decimals will make the published percent changes more precise.

· The value of quality change in a good is important to know—it could have inflationary or deflationary applications

· Substitution of goods may lead to an overstatement of the CPI and thus this quantity must be measured to reflect an accurate picture

While us crazy, Austrian conspiracy theorists

Claim:

It is silly to think the BLS can accurately measure inflation. Adjustments the feds makes to the “basket of goods” causes an overstatement in the CPI.

Assumptions

· Volatile products cannot be ignored for long and will eventually begin to take toll on other markets

· Economic data is already imprecise. Three decimals gives a false impression that these numbers can be made even more precise

· Government cannot accurately measure quality improvements in goods and this improvement is not a voluntary improvement

· Substituting may imply a declining standard of living and thus equating this with lower inflation is wrong

So what say you, forum lurkers? Who is right? The CPI Apologists or the Feds?

15

I tend to argue against the accuracy of the CPI. Among other things, the value of an item must be measured in utility, rather than in production cost, so it is next to impossible to accurately chain a CPI. Additionally, politicians gain power when inflation is high because that makes it appear as if wages are stagnating, thus creating demand for the government to interfere in the economy, thus biasing the statistic.

16

The usual scapegoat for inflation is oil and energy prices. Oil and energy are seen as comprising part of every good, because every good uses oil somewhere along the line. So can rising energy prices cause inflation?

17

No, inflation is, strictly speaking, the debasement of the monetary unit. Prices are indicators of relative scarcity. If supply falls or demand rises, prices rise because the good is now more scarce than before. My professor actually cuts marks on papers which treat inflation as a rise in prices.

18

Inflation arises from a discrepancy between the amount of money that can be spent and what it can buy at present prices. If the present amount of money being used to purchase goods is greater than the monetary value of goods available, then inflation will correct the imbalance. One good becoming more expensive with no underlying increase in purchasing power or decrease in availability of goods would merely shift prices around, leaving the average intact.

19

I think you made some good points here!

Some of the confusion about inlation has its origin in the unclear definition of the term. Sometimes it is used for increasing the money supply, and sometimes it is used for pointing to an increase in prices. I don’t doubt that printing or creating book money can leads to an increase in the money supply and can lead to an increase in prices for goods. I think people have already pointed this out well. There are however two other issues that concern me:

  • decrease in the quality and properties of goods (i.e. cars that don’t last that long any more), while prices remain the same - hidden inflation
  • Prices for certain items (i.e. property and company share price ) increase out of proportion - sector inflation
20

We should also keep in mind that in a healthy economy the normal trend ought to be for prices to fall. New technologies, improved efficiencies, and deepening of the division of labor all tend to cause prices to decline, as they did throughout the 19th century. There was low nominal price inflation during the 1990’s, even though the PC and internet revoloutions took place in that decade. But we didn’t see prices falling dramatically either and I think we would have had it not been for monetary inflation.