Friday, April 08, 2011

GUEST POST: What is inflation—and why Matt Nolan should care. [Updated]

Guest post by Phil Scott of NZ’s Foundation for Economic Growth. (If you’re not a subscriber to their regular newsletters, then kindly remedy that now!)

Last weekend I read an article in the Saturday's DomPost entitled, "What is inflation and why should people care?" by Matt Nolan from Infometrics and the Visible Hand blog.
    After a couple of introductory paragraphs Matt states, "By definition, inflation is an increase in the general level of prices, independent of economic fundamentals."
    At no stage did he mention the money supply which I thought might be an "economic fundamental". It is quite obvious that prices cannot rise across the board unless the money supply is rising. If the money supply is static then when people pay more for some items they are automatically forced to buy less of other items which will cause the sellers of those items to reduce the price to meet the reduced demand. So changes in the money available effect changes in the price of goods. So prices will change up and down if the money supply is static but there can be no general increase in all goods unless the money supply increases.
    Therefore increased money supply must come first followed by a general price rise.
    Increasing the money supply CAUSES price inflation in goods and services.
    Sounds fundamental to me.
    But never mind, Matt is in good company. In Thursday's DomPost Ben Bernanke is quoted on page 2 as saying, "an increase in US inflation had been driven primarily by rising commodity prices globally, and was unlikely to persist."
    So Ben Bernanke tells us that rising commodity prices causes inflation. Perhaps he didn't notice the 2 or 3 Trillion dollars he produced from thin air recently.
    I wonder if Matt and Ben are using the same definition of inflation? It is difficult to construct a logical line of thought when one defines effects rather than the cause of those effects. But, then Keynes was not known for his logic either.
    Saying that inflation causes inflation doesn't seem particularly helpful in educating the public.
    My very good friend Hugh Templeton who was recently honoured by the Australian government for his work in starting up Closer Economic Relations (CER) recently borrowed my book, Human Action  by Ludwig von Mises. He informed me that this book is the best book on economics he has ever read. [He’s right you know – Ed.]
    Ludwig thinks that changing the money supply causes changes in prices of goods. In fact he starts at the logical place - the cause - and defines inflation as an increase in the money supply.
    This allows him to construct a logical and true framework for economics which clearly demonstrates cause and effect and explains economics so there are none of the current logical inconsistencies which so plague current "Keynesian" thinking.
    I have tried to describe how Austrian economic thinking describes reality in the section of our web site called REAL Economics. Perhaps Ben should have a look!

Phil Scott is the Chief Executive of NZ’s Foundation for Economic Growth. Send him mail at phil@feg.org.nz

UPDATEKeith Weiner points out, correctly, that

_Quote It's not an increase in money supply per se. For example, in a gold standard gold miners do not create inflation (or rising prices).
It is an increase in
counterfeit credit.

But that might be going one concept too far for most mainstreamers to get their heads around!

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4 Comments:

Anonymous V said...

Here is a must read, I think it joins a lot of dots (IMO) on the subject!

http://www.ritholtz.com/blog/2011/04/must-read-apropos-of-everything/

4/08/2011 04:12:00 pm  
Anonymous Julian said...

Mises captured this semantic confusion beautifully in the below quote. I ensure that all my students have read and understand this:

"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. It follows that nobody cares about inflation in the traditional sense of the term. 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 technological confusion is not entirely wiped out, there cannot be any question of stopping inflation."

4/08/2011 05:22:00 pm  
Anonymous Mark said...

Actually I think it's easier to explain to people that way.

If you double the amount of money with no corresponding increase in goods and services what are you going to see.

Inflation. People do understand this.

4/10/2011 02:47:00 pm  
Anonymous Kimble said...

Why not ask Matt why he didnt mention money supply?

You can ask him why money supply didnt come under the heading "economic fundamental"?

I would guess it means supply and demand of all goods.

4/12/2011 12:37:00 am  

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