Take the symbol (word) for a cause and use for the cause's affect.
Then the populace over time won't think about the cause. Or
understand the cause. In this case it's government. Hey, good trick.
Bob
Subject:
Defining Inflation
Date:
Fri, 8 Mar 2002 10:54:14 -0500
From:
"R. A. Hettinga" <[EMAIL PROTECTED]>
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From: Mises Institute <[EMAIL PROTECTED]>
To: [EMAIL PROTECTED]
Subject: Defining Inflation
Date: Fri, 08 Mar 2002 08:04:03 CST
<http://www.mises.org/fullstory.asp?control=908>http://www.mises.org/fullstory.asp?control=908
Defining Inflation
by Frank Shostak
[Posted March 8, 2002]
On August 16, the U.S. government will debut of a new type of Consumer
Price Index (CPI), one which it says will better reflect true inflation.
Unlike the existing CPI, the new index will be subject to revisions as
more
detailed data become available. The regular CPI has long been criticized
for overstating the actual rate of inflation. The hope is that, once the
Fed is able to use more accurate information concerning general prices,
it
will be in a better position to use its tools to counter inflation.
Is inflation about price rises?
The fundamental problem here is a failure to define the problem
properly.
For example, the definition of human action is not that people are
engaged
in all sorts of activities, but that they are engaged in purposeful
activities--purpose gives rise to an action.
Similarly, the essence of inflation is not a general rise in prices but
an
increase in the supply of money, which in turns sets in motion a general
increase in the prices of goods and services.
Consider the case of a fixed money supply. Whenever people increase
their
demand for some goods and services, money will be allocated toward other
goods. Thus, the prices of some goods will increase--i.e., more money
will
be spent on them--while the prices of other goods will fall--i.e., less
money will be spent on them.
If the demand for money increases against goods and services, there will
be
a general fall in prices. In order for an economy to experience a
general
rise in prices, there must be an increase in the money stock. With more
money and no change in money demand, people can now allocate a greater
amount of money for all goods and services.
>From this we can conclude that inflation is a general increase in the money
supply.
As Mises explained in his essay
"<http://www.mises.org/efandi/ch20.asp>Inflation: An Unworkable Fiscal
Policy":
"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."
When inflation is seen as a general rise in prices, then anything that
contributes to price increases is called inflationary. It is no longer
the
central bank and fractional-reserve banking that are the sources of
inflation, but rather various other causes. In this framework, not only
does the central bank have nothing to do with inflation, but, on the
contrary, the bank is regarded, against all evidence, as an inflation
fighter.
Thus, a fall in unemployment or a rise in economic activity is seen as a
potential inflationary trigger which therefore must be restrained by
central-bank policies. Some other triggers, such as rises in commodity
prices or workers wages, are also regarded as potential threats and
therefore must always be under the watchful eye of the central bank.
The popular definition cannot explain why inflation is bad
If inflation is just a general rise in prices, then why is it regarded
as
bad news? What kind of damage does it do? Mainstream economists maintain
that inflation, which they label as general price increases, causes
speculative buying, which generates waste. Inflation, it is maintained,
also erodes the real incomes of pensioners and low-income earners and
causes a misallocation of resources.
Despite all these assertions regarding the side effects of inflation,
mainstream economics doesn’t tell us how all these bad effects are
caused.
Why should a general rise in prices hurt some groups of people and not
others? Why should a general rise in prices weaken real economic growth?
Or
how does inflation lead to the misallocation of resources? Moreover, if
inflation is just a rise in prices, surely it is possible to offset its
effects by adjusting everybody’s incomes in the economy in accordance
with
this general price increase.
However, if we accept that inflation is an increase in the money supply,
and not a rise in prices, all these assertions can be easily explained.
It
is not the symptoms of a disease but rather the disease itself that
causes
the physical damage. Likewise, it is not a general rise in prices but
increases in the money supply that inflict the physical damage on wealth
generators.
Increases in the money supply set in motion an exchange of nothing for
something. They divert real funding away from wealth generators toward
the
holders of the newly created money. This is what sets in motion the
misallocation of resources, not price rises as such. Moreover, the
beneficiaries of the newly created money--i.e., money "out of thin
air"--are always the first recipients of money, for they can divert a
greater portion of wealth to themselves. Obviously, those who either
don’t
receive any of the newly created money or get it last will find that
what
is left for them is a diminished portion of the real pool of funding.
Furthermore, real incomes fall, not because of general rises in prices,
but
because of increases in money supply; in other words, inflation depletes
the real pool of funding, thereby undermining the production of real
wealth-- i.e., lowering real incomes. General increases in prices, which
follow increases in money supply, only point to the erosion of money's
purchasing power--although general rises in prices by themselves do not
undermine the formation of real wealth as such.
As a result of an erroneous definition of inflation, some economists
argue
that low inflation is a precondition for healthy economic growth. For
them,
inflation is bad news only when it is reaches high figures (George
Akerlof,
William Dickens, George Perry,
"<http://www.brook.edu/dybdocroot/views/papers/dickens/20000602.htm>Near
Rational Wage and Price Setting and the Long Run Phillips Curve,"
Brooking
Institution study, 2000). If a general rise in prices is the outcome of
a
rising money stock, how can it benefit the economy if it is stabilized
at a
low level? Surely the rising money stock that will dilute the real pool
of
funding cannot be good for economic growth.
Friedman's misleading view of inflation
Some economists, such as Milton Friedman, maintain that if inflation is
"expected" by producers and consumers, then it produces very little
damage
(see Friedman's Dollars and Deficits, Prentice Hall, 1968, pp. 47-48).
The
problem, according to Friedman, is with unexpected inflation, which
causes
a misallocation of resources and weakens the economy. According to
Friedman, if a general rise in prices can be stabilized by means of a
fixed
rate of monetary injections, people will then adjust their conduct
accordingly. Consequently, Friedman says, expected general price
increases,
which he calls expected inflation, will be harmless, with no real
effect.
Observe that, for Friedman, bad side effects are not caused by increases
in
the money supply but by the outcome of that: increases in prices.
Friedman
regards money supply as a tool that can stabilize general rises in
prices
and thereby promote real economic growth. According to this way of
thinking, all that is required is fixing the rate of money growth, and
the
rest will follow suit.
However, it is overlooked by the distinguished professor that fixing the
money supply's rate of growth does not alter the fact that money supply
continues to expand. This, in turn, means that it will continue the
diversion of resources from wealth producers to non-wealth producers
even
if prices of goods will stay stable. In short, the policy of stabilizing
prices is likely to generate more instability.
While increases in money supply ( i.e., inflation) are likely to be
revealed in general price increases, this need not always be the case.
Prices are determined by real and monetary factors. Consequently, it can
occur that if the real factors are pulling things in an opposite
direction
to monetary factors, no visible change in prices might take place. In
other
words, while money growth is buoyant--i.e., inflation is high--prices
might
display low increases. Clearly, if we were to regard inflation as a
general
rise in prices, we would reach misleading conclusions regarding the
state
of the economy.
On this, Rothbard wrote, "The fact that general prices were more or less
stable during the 1920s told most economists that there was no
inflationary
threat, and therefore the events of the great depression caught them
completely unaware" (America’s Great Depression, Mises Institute, 2001
[1963], p. 153).
Why price indices cannot establish the status of inflation
Because inflation is not a general increase in prices but rather
increases
in the money supply, it is an exercise in futility to devise a more
accurate Consumer Price Index. Moreover, despite its popularity, the
whole
idea of a CPI is flawed. It is based on a view that it is possible to
establish an average of prices of goods and services.
Suppose two transactions are conducted. In the first transaction, one
loaf
of bread is exchanged for $2. In the second transaction, one liter of
milk
is exchanged for $1. The price, or the rate of exchange, in the first
transaction is $2/one loaf of bread. The price in the second transaction
is
$1/one liter of milk. In order to calculate the average price, we must
add
these two ratios and divide them by two; however, it is conceptually
meaningless to add $2/one loaf of bread to $1/one liter of milk.
It is interesting to note that in the commodity markets, prices are
quoted
as dollars/barrel of oil, dollars/ounce of gold, dollars/tonne of
copper,
etc. Obviously it wouldn't make much sense to establish an average of
these
prices. Likewise, it doesn't make much sense to establish an average of
the
exchange rates dollar/sterling, dollar/yen, etc.
On this Rothbard wrote, "Thus, any concept of average price level
involves
adding or multiplying quantities of completely different units of goods,
such as butter, hats, sugar, etc., and is therefore meaningless and
illegitimate. Even pounds of sugar and pounds of butter cannot be added
together, because they are two different goods and their valuation is
completely different" (Man, Economy, and State, p. 734).
If changes in price indices cannot provide us with the status of
inflation,
what can? All that is required in establishing the status of inflation
is
to pay attention to the money supply's rate of growth. The higher the
rate
of growth, the higher the rate of inflation.
Using the money supply definition of the Austrian School of economics,
we
can suggest that the rate of inflation in the U.S. is accelerating. The
yearly rate of inflation jumped to 9.5 percent in February, from 0.1
percent in January last year. Moreover, between 1980 and 2001, the
average
rate of inflation stood at around 14 percent. Clearly, this shows that,
rather than fighting inflation, the Fed has been the biggest promoter of
inflation.
Conclusions
The U.S. government’s plan to introduce an improved Consumer Price Index
in
order to more accurately measure inflation is an exercise in futility.
Inflation is not about a general increase in prices; it is about
increases
in the money supply. Hence, whatever the improved index would measure
has
nothing to do with true inflation, which is always increases in the
money
supply. Consequently, to find out the status of inflation, there is no
need
for various sophisticated price indices; all that is required is to pay
attention to the money supply's rate of growth.
Frank Shostak, Ph.D., is an adjunct scholar of the Mises Institute and
a frequent contributor to Mises.org. Send him
<mailto:[EMAIL PROTECTED]>MAIL and see his outstanding
Mises.org
<http://www.mises.org/articles.asp?mode=a&author=Shostak>Articles
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