The real meaning of inflation
A distinctive feature of the economists of the so-called “Austrian School of Economics” is that they advocate a theory of money considerably different from that of their colleagues in other schools of economic thought. The differences between the aforementioned approaches already begin in the very definition of the word inflation and this will be the main topic of this article.
First let’s see what the mainstream definition of inflation is. According to Mankiw (2013) inflation is:
An increase in the overall level of prices in the economy (MANKIW, 2013, p. 15).
Other mainstream economic economists who also define inflation similarly are, for example, Olivier Blanchard (2020) and Thomas Sowell (2011).
According to the most accepted view within academia, high monetary expansion is actually just one of several possible causes of inflation.
On the other hand, most Austrian School economists choose to use the original definition of the word inflation and, therefore, claim that inflation is not the increase in the general ‘level’ of prices, but the monetary expansion itself. This is made clear in the article entitled ‘Inflation in One Page’, by the American economist and journalist Henry Hazlitt, who defines it as follows:
Inflation is an increase in the quantity of money and credit. Its chief consequence is soaring prices. Therefore inflation—if we misuse the term to mean the rising prices themselves—is caused solely by printing more money.
As we can observe, Hazlitt says that the rise in prices is just one of the consequences of inflation and what causes price inflation (which the mainstream just calls inflation) is the monetary expansion.
The Nobel Prize in Economics in the year 1974, Friedrich August von Hayek (1899-1992), also uses the original definition of inflation:
Much confusion is caused in current discussion by a constant misuse of the term “inflation.” Its original and proper meaning is an excessive increase in the quantity of money, leading in turn to an increase in prices. But a general rise in prices, for instance one brought about by a shortage of food caused by bad harvests, is not inflation. Nor could we properly call “inflation” a general rise in prices caused by a shortage of oil and other sources of energy that led to an absolute reduction of consumption, unless this shortage had been the pretext for a further increase in the quantity of money. (HAYEK, 1980, p. 44-45).
Ludwig von Mises (2008) believes that one of the main problems with this change in the meaning of the word inflation is that this semantic revolution generates a dangerous confusion between cause and effect. The Austrian still argues that this revolution is one of the main features of our days and that because of it many today have abandoned the original meaning of inflation. It is certain that the aforementioned revolution was very successful, since the vast majority of the lay public and even several economists (even some who say they are Austrians) started to define inflation or deflation not as a large increase or decrease in the money supply, but as its most visible consequence: the general trend of price increase or decrease (MISES, 2008).
Mises goes on to argue that this revolution plays an important role in popularizing inflationism. A significant drawback of the mainstream definition is the fact that many inflationists go on to say that they fight inflation, when in fact they are promoting it (MISES, 2008).
Note that if inflation is defined as the general rise in prices, then it is entirely possible for a layman to be convinced that this is the fault of the greed and opportunism of businessmen who want ever greater profits. However, if inflation is recognized in its correct definition, that is, as an enormous expansion of the money supply, then the blame lies with governments and their respective central banks for abusing their monopoly over currency. Note that it is not uncommon to see politicians and even economists arguing that there is no relationship between monetary expansion and the general increase in prices.
Another problem that Austrians School Economists point out in the mainstream definition of inflation is that it talks about a supposed ‘level’ of prices (something that does not exist in the real world), and as Professor Mises (2007) had already observed, when talking about the level the picture most people have is:
‘that of a liquid which goes up or down according to the increase or decrease in its quantity, but which, like a liquid in a tank, always rises evenly.’ (MISES, 2007, p. 73).
However, nothing could be more false, as prices do not change to the same extent, much less all at the same time. What happens is that people who receive the new money first will have a temporary increase in purchasing power, at the expense of those who receive it last. Prices will also not rise equally, as many believe, as people who receive the money first will spend on specific goods, which causes the prices of some goods and services to rise more than others.
This Austrian view can be summarized in the following passage by Professor Ubiratan Jorge Iorio (2011):
The central idea is that new money enters at a specific point in the economic system and, therefore, it is spent on certain specific goods and services, until, gradually, it spreads throughout the system, just like any other object. , when thrown on the surface of a lake, it forms concentric circles with progressively larger diameters, or as when honey is poured in the center of a saucer and it spreads from the mound that forms at the point where it is being poured (analogies, respectively, of Mises and Hayek). Therefore, some expenses and prices change before and others change after and, as long as the monetary change – let’s say, an expansion of credit – is maintained, its irradiation to expenses and prices persists in movement (IORIO, 2011, p. 134).
In addition, it is important to note that, because of its mistaken definition of inflation, the mainstream acts as if the price index is the main problem in issuing large additional amounts of money. However, as shown by F. A. Hayek, Murray Rothbard, Jesús Huerta de Soto (2009) and Ludwig von Mises (2008), these indices are not the only points we should note. There are several other problems caused by monetary expansion.
The Austrian economist F. A. Hayek argues that most economists focus too much on the general level of prices and do not pay attention to relative prices, that is, how the price of good A can impact good B considering both within the same chain. productive. For Hayek, the distortions in relative prices will cause a disarticulation in the capital formation process. As a result, we will have misallocation of scarce resources.
Therefore, in order for us to really understand the real problems caused by inflation, it is necessary that we master the subject, knowing especially what inflation is and what is not. This is the only way that we will we be able to follow a logical coherence and thus be able to abandon once and for all the shallow and confusing definition that the mainstream uses to define inflation.
Sources:
BLANCHARD, Olivier. Macroeconomics. 8th ed. Pearson, 2020.
DE SOTO, Jesús Huerta. Money, Bank Credit and Economic Cycles. 2nd ed. Ludwig von Mises Institute, 2009.
HAYEK, F. A. von: Unemployment and Monetary Policy: Government as Generator of the “Business Cycle”. 3rd ed. San Fracisco: Cato Institute, 1980.
IORIO, Ubiratan Jorge. Ação, tempo e conhecimento. A Escola Austríaca de economia. 2nd ed. São Paulo: Instituto Ludwig von Mises. Brasil, 2011.
MANKIW, N. Gregory. Principles of Economics.
MISES, L. H. E. von: Human Action: A Treatise on Economics. 4th Rev ed. San Francisco: Fox & Wilkes, 2008.
______Economic Policy: Thoughts for Today and Tomorrow. 3rd ed. Auburn, Alabamo: Ludwig von Mises Institute, 2007.
SOWELL, T. Basic Economics: A Common Sense Guide to the Economy. 4th ed. Basic Books, 2011.