Sunday, 3 February 2013

What Inflation Is

With the Federal Reserve, the European Central Bank and other central banks around the world having increased the size of their balance sheets dramatically in the aftermath of the "financial crisis" of 2008, it's worth recalling what the original meaning of "inflation" actually is.

Henry Hazlitt, the late American economist and journalist, explained what inflation is in his second edition of the book "What You Should Know About Inflation" published in 1964 (p. 1-2):
No subject is so much discussed today—or so little understood— as inflation. The politicians in Washington talk of it as if it were some horrible visitation from without, over which they had no control—like a flood, a foreign invasion, or a plague. It is something they are always promising to "fight"—if Congress or the people will only give them the "weapons" or "a strong law" to do the job.
Yet the plain truth is that our political leaders have brought on inflation by their own money and fiscal policies. They are promising to fight with their right hand the conditions brought on with their left. 
Inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit. In fact, inflation is the increase in the supply of money and credit. If you turn to the American College Dictionary, for example, you will find the first definition of inflation given as follows: "Undue expansion or increase of the currency of a country, esp. by the issuing of paper money not redeemable in specie." 
In recent years, however, the term has come to be used in a radically different sense. This is recognized in the second definition given by the American College Dictionary: "A substantial rise of prices caused by an undue expansion in paper money or bank credit." Now obviously a rise of prices caused by an expansion of the money supply is not the same thing as the expansion of the money supply itself. A cause or condition is clearly not identical with one of its consequences. The use of the word "inflation" with these two quite different meanings leads to endless confusion. 
The word "inflation" originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean "a rise in prices" is to deflect attention away from the real cause of inflation and the real cure for it.
Worth while remembering if you ever enter a discussion about what "inflation" actually is. You can access the book here.

1 comment:

  1. Any discussion of inflation should identify the three major kinds: Wage, Price and Currency. In my new book RULE OF MONEY I point out all these types of inflation are best controlled by competition. A large unemployed workforce will keep Wage Inflation under control. A large competitive marketplace will keep prices under control. Likewise, numerous stable currencies should dampen the desire for speculative trading.

    The causes of inflation are many and varied. It seems like an almost meaningless effort to try and categorize the causes. A meteor could cause inflation. The root cause is human choice and willingness to accept higher costs. Does that seem like the right arena for government participation? It doesn't to me. All government should do is to make the conditions of competition as free and open as possible.