Sneak peek of part one of my talk tomorrow

These are some points I’ve prepared for my talk tomorrow on inflation and business cycles in the Sound Money seminar at the Mises Institute. I decided to explain the topic of inflation by comparing the two main conceptions of inflation: rising prices and an increased money supply. The latter turns out to be more tractable and appropriate.


The word “inflation” means different things to different people. One popular conception of inflation focuses on prices—all prices, actually. For these people, including some economists, “inflation” means a rise in the general price level. The goods and services we buy have higher price tags. The other conception of inflation focuses on the money supply. Economists with this focus think of inflation as an increase in the amount of money in the economy.

We’ll see that viewing inflation as a rise in prices can be misleading and ambiguous especially compared to viewing inflation as an increase in the money supply.

First of all, prices can rise for many reasons: If the demand for something increases relative to its supply, or if the supply of something decreases relative to the demand for it, the price will increase. The fundamental reason for this is called diminishing marginal utility—increasing our stock of some good means that it will go toward the satisfaction of a lower-ranked end.

If the next “marginal unit” goes toward a lower-ranked end, then the most we are willing to pay for the next unit must be less than the previous unit. You might be willing to pay $600 for one Apple Watch, but the most you would be willing to pay for another might be $100, maybe as gift for somebody else or so that you could have one on both of your wrists!

Even though this sounds pretty limiting in terms of the reasons prices can rise, these two concepts—supply and demand—can and do channel all sorts of changes in the market. Preferences can change, goods can go in and out of fashion, accidents can happen that reduce our supply of a certain good, we can think of new and more efficient ways of producing goods, services that at one time could only be done with human labor can be replaced or complemented with new tools and machines, and so on.

The list of things that affect supply and demand is infinite, depending on how specific you get, but the important thing to remember is that all of these sorts of changes are integrated into and channeled through our preferences and ideas and therefore supply and demand.

Secondly, there is really no good way to measure a general rise in the price level. You maybe familiar with indexes like the Consumer Price Index, which are calculated and compiled based on survey data and technical mathematical methods, but by their very nature they cannot appropriately capture the price level. They cannot do so because these sorts of indexes are one number. They try to boil the trillions of pieces of data on the prices of all goods and services in the economy down to just one piece of data. Market prices, which are a complicated phenomenon on their own, fluctuate not only year to year, but month to month, day by day, and even second to second. Also, there is no central repository of price information.

Even in one country, prices emerge in a very scattered, decentralized way, from the halls of Washington D.C. to the dark, back alleys of downtown Chicago; from the lots of car dealers with neon paint to hand-to-hand-to-pocket tips for bellhops and restaurant servers; from fleeting ones and zeroes soaring at light speed across the internet to long-term contracts for land use or film production. One number couldn’t even begin to describe the magnitude and dynamic nature of something like the “price level”.

It would be like driving out West for a camping trip and going to the remotest location at night to view the stars and a meteor shower and then the next month, when you return to civilization and cell service you text your parents what the view was like and say, “Cool.”

Price index information is delayed, incomplete, and by its very nature incapable of describing the astronomical picture of market prices. And we haven’t even mentioned the well-cited issues with surveys, government data, and the more specific issues with the particular measurements.

A third issue with viewing inflation only as a rise in the price level is that it stops short of explaining the full consequences of monetary inflation. Many people correctly understand the relationship between the price level and the money supply—more money means higher prices—and they also understand that this relationship is bad for the average Joe. Now, Dr. Salerno is not average by any measure, but we can say that if he is one of the later receivers of new money, he has to pay higher prices before his own salary increases due to inflation, however you define it. In this way, inflation is not harmless—it represents a wealth transfer to the first users of the new money from the later users of new money as it ripples through the economy.

Even though most people know and understand this consequence of increasing the money supply, it stops short of explaining the full consequences of monetary inflation, which will be developed in the second part of my talk on the business cycle.

But to summarize, viewing inflation as a rise in the price level has at least three main problems: it is ambiguous because almost anything can change prices, it is impractical because it can’t be appropriately measured, and it is incomplete because it doesn’t tell the whole story of increases in the money supply. Inflation is more appropriately viewed as an increase in the money supply, and this conception of inflation does not suffer the same problems as the other. Monetary inflation has a simple, well-defined cause, unlike price inflation. Monetary inflation is measureable because money is its own unit of account and can be counted up, unlike price inflation, which is not directly measureable. Monetary inflation is also the starting point for the business cycle story, instead of a stopping point for many, like price inflation.

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