The Concept of Inflation

By: Colin Combs

With recent data showing a sharp rise in consumer prices for the month of May, there has been a lot of discussion on price inflation over the past week, in spite of Janet Yellen’s attempt to dismiss this inflation as merely being “noisy.” Some talk about balancing “Good Inflation” against “Bad Inflation”, as if it were cholesterol, while others even praise inflation because “higher inflation comes from higher growth rates, and so when an economy expands robustly, then prices should also rise robustly.” But what is inflation? What should we know about it?

There could be an entire book could be spent answering these questions. In fact, there is. Unfortunately, though, while the word “inflation” is thrown around a lot, few seem to have a clear understanding of inflation. The classic definition of inflation is an increase in the supply of money in credit not backed by specie. It is the quantity of money being increased or “blown up” by government intervention. Every time the Federal Reserve prints another dollar, that isn’t simply causing inflation, it is inflation.

Today, however, the usual definition is the related but distinct idea of a “general rise in prices”. This might be distinguished as “price inflation” should anyone need to clarify between the classical and “modern” definition of inflation. Defining inflation as a general rise in prices is to confuse the cause of inflation with one of its effects. However, this definition is popular as it is much more convenient for politicians that want to deflect blame for inflation either from their own failed policies hurting the economy or from their expansion of the money supply, and instead want to blame hire prices on “greedy capitalists” or some other such nonsense.

Now, it is common knowledge and one of the few universally agreed upon areas of economics that prices are determined by supply and demand. If we are to have a general rise in prices though, this must be caused by either one of two things: either the supply of goods in general has gone down, meaning people have become poorer and what goods remain have become more expensive, or the quantity of money has increased faster than the supply of goods.

So we can see immediately that claims that price inflation is caused “when an economy expands robustly” is about as wrong as you can get, no matter which definition you use. In our world of paper currencies today any government can print more pieces of paper, regardless of the state of the economy, and prices rising because we’re becoming poorer is the opposite of the economy being “robust”.  Greater analysis is required to show in full why increasing the quantity of money can also be expected to do great harm, but the short answer is that one cannot print one’s way into prosperity. Riches are not a matter of more or less money, but of a great supply of goods and services. Modern writers would do well to heed the advice of the 19th century economist Frederic Bastiat, how long ago warned of the danger of confusing money with wealth.

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