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February 23, 2004 Defining Inflation My old friend, Billy Beck has taken me to task about a definition of inflation I used when talking about Kerry’s plan to index the minimum wage to inflation. Of course inflation wasn’t the primary topic, but then Billy and I usually don’t disagree about the broad topics, but more about the details. And we’re known to figuratively throw furniture at each other while doing it ... then go have a beer together. Anyway, to the case in question, I put my definition of inflation into the essay. I said: What is inflation? It’s a sustained rise in the general price level." To which Billy replied: “No, sir, it's not. That's wrong.”
OK ... fair enough. Again due to knowing Billy as long as I have, that’s all he had to say because I know which economic school’s definition he prefers. That would be the Austrian school. Of course, giving Billy's disagreement the full benefit it deserved, I ended up maintaining my definition was not wrong at all. In fact, I decided, if there is a ‘wrong’ definition here, it is that of the Austrian school of economics. My job, however, was to find the time to actually make my case. So here and there over the weekend I've been pecking away at it. The Austrian school’s economic doctrine insists that all inflation is tied to the money supply’s expansion. That’s essentially the nut of it. It all flows from there. Thus Billy’s “paper clip” analogy in the comments section of the above cited post But before I get to his thoughts, I was particularly interested by something Brian Griffiths said in his book “Inflation: The Price of Prosperity”, which helps put this disagreement in perspective: Inflation has been variously defined. In the inflationary period following the Second World War, The Economist coined the expression 'too much money chasing too few goods'. Jacques Rueff relates that for him in the Ecole Nationale in the 1920s it was typically thought of as 'an increase in the amount of currency in circulation'. Why is this interesting? Because it gives a litany of the evolution of the definition of inflation in economic terms. His point, of course, is that in the ‘20s, inflation was typically thought of as ‘an increase in the amount of currency in circulation' with a clear implication that the definition touted by the Austrians, while once accepted, is no more. That was economic doctrine at that time. But it appears it is now considered to be an old, or at least imprecise definition. Griffiths further implies that there is more too inflation than just expansions in the money supply. And you may also note that he gives as the “best” definition of inflation that definition which I gave in my article. As a peer with an economic background has suggested (Mr.” X” will lend his name to the discussion if he so desires, but he's been kind enough to allow me to use some of this thoughts here) when talking about the Austrian’s concept of inflation: The reason it was abandoned as the proper definition of inflation is because as markets became increasingly free, increases in the money supply, i.e. too much money chasing too few goods, turned out not to be the only cause of inflation. It was a fairly good definition at one time, mainly because it accurately described why prices increased. Serfs didn't, after all, provide much of a wage pull on inflation. In the absence of free markets in labor, inflation is entirely a monetary phenomena. If its true, then, that the definition preferred by the Austrians is no longer valid, the next question then has to be, well if that is so, why is it so? In most cases where something is declared as an absolute (i.e. inflation is always defined as exclusively an expansion of the money supply), any exception to that absolute will disprove it. Such is the case with an orthodoxy which declares that inflation, without exception, is strictly a monetary phenomenon. Obviously if we can find an exception, then it would seem that the definition which depends on such an absolute wouldn’t be valid, or at least wouldn’t be the best available.. Michael R. Smith; Aldine De Gruyter take on that task in their 1992 book, “Power, Norms, and Inflation: A Skeptical Treatment”. On page 41 they discuss the various ways inflation can be caused, such as a rise in taxes to fund growth in government: Growth in government funded through increased taxes -- whether as a result of the self-interested efforts of civil servants or the purchase of the votes of interest groups -- may under some circumstances, have an effect on inflation by reducing overall economic efficiency and in so doing reducing the capacity of the economy to provide the goods and services that people have come to expect. The thrust of public choice writings is, however, to argue that growth in government will be funded through the "monetization" of deficits, with direct inflationary consequences. Note that Smith and De Gruyter blame the inflation this sort of activity engenders on a reduction in “overall economic efficiency” which in turn “reduces the capacity of the economy to provide the goods and services people have come to expect”, which would in turn bid up the price of these goods and services. This example has nothing whatsoever to do with an expansion of the money supply, but instead, a redistribution of it. However, the net result is price inflation. The final sentence points to the inclination, however, for a certain groups of economists to STILL blame it on ‘monetization’, when in fact, it is clearly not. Mr. X points to another example - 1970s Oil Crisis - in which it isn’t clear at all that all the inflation was caused by monetary policy/expansion: And the oil crisis of the 1970s saw some wildly unwise fiscal policy measures as well, such as rationing, wage and price controls, etc., so policy was all over the map at that time. That makes it, I think, hard to break out monetary policy as the sole cause of inflation. So despite the Austian claim that all inflation is to be found in an expansion of the money supply, these exceptions seem to say otherwise. These exceptions alone are enough to throw considerable doubt on the claim that ALL inflation is a result of an expansion of the money supply. One would assume it was because of those sorts of exceptions that Milton Friedman too rejects that definition. In his 1975 book “Milton Friedman in Australia, 1975", (Milton Friedman; Constable & Bain, 1975), Friedman makes no bones about it: But the essence of an inflationary process is that both prices and costs go up. That is what inflation is. Inflation is a rise in the general level of prices, including cost prices and including final product prices. The fact that sometimes in the process one goes ahead and at other times others go ahead should not mislead you into confusing the results for the cause. (P 12) [emphasis added] Rather hard to argue nuance in that statement isn’t it? He comes right out and says it. And bigger advocate of the free market economics will never be found. So what is inflation? Well it appears to be a still evolving concept which is right now best described as “a sustained rise in the general price levels”. Will that always be the definition? I have no idea. But it appears to be a better description of the economic phenomenon than the one that insists it all lies solely in the expansion of the money supply. |
In houses, thermostats are programmed to turn on the heat when the house starts to get cold.
Indexing the minimum wage to the inflation rate is a dumb idea because it does something like the opposite: the thermostat is programmed to turn the heat UP whenever it starts getting warm. Your house is going to get really hot, really quickly and it will keep doing so until you turn the heat off.
A rising minimum wage contributes to inflation, and the inflation rate contributes to a rising minimum wage.
It's a loop, and only a stupid person would think it was a good idea.
Posted by: John Rogers at February 24, 2004 05:29 AM
Agreed, John ... but then no one has yet made the claim that Kerry is a "rocket scientist" either.
By the way, you did know he served in Viet Nam, didn't you?
Posted by: McQ at February 24, 2004 08:56 AM
"The reason it was abandoned as the proper definition of inflation is because as markets became increasingly free, increases in the money supply, i.e. too much money chasing too few goods, turned out not to be the only cause of inflation."
So...this person is telling us that "increases in the money supply" represent a free market.
I'm supposed to take that seriously? (laff)
The reference to Smith/De Gruyter is equally ridiculous. Look: if, due to "inefficiency", half the steel suppliers in the country went out of business, steel prices would probably increase due to demand, but that would not be "inflation". It would merely be a price increase due to demand. These people are assuming their conclusion. There is a reason why "this example has nothing whatsoever to do with an expansion of the money supply." It's because the effects of supply and demand on price are an entirely different phenomenon from inflation.
Friedman? (cackle) What the hell should I expect from a monetarist? I might expect a serious regard for free markets, but the guy's a monetarist, after all, so that's right out.
Bruce: you believe that inflation is "a still evolving concept" simply because the gibbering continues. And you can do that. It's your mind, and you tend it. But you're doing your readers a serious disservice.
Posted by: Billy Beck at February 24, 2004 09:10 AM
Lay it out Billy ... I did. If you disagree, saying "you're doing your readers a serious disservice" ain't gonna cut it.
I'll be glad to link to your answer. But what I laid out can't be just dismissed with a hand wave and a cackle just because it is inconvenient to your theory. A little more substance would be appreciated.
Posted by: McQ at February 24, 2004 09:28 AM
So...this person is telling us that "increases in the money supply" represent a free market.
Uh, no, that's NOT what I said. I didn't even imply it. In fact, you have managed, somehow, to divine a meaning that almost precisely the opposite of what I have written. Try reading for comprehension.
What I said, and what I think is fairly obvious from even a casual reading, is that A) an increase in the money supply is NOT the only cause for inflation, and B) this became obvious as other markets, such as the market for labor, were released from coercion that led to artifically low prices.
I realize that you are of an Austrian bent, but I defy you to explain logically to the average person why an increase in the price level due to movement on the demand curve is in any way substantively different to his pocketbook from an increase in the price level due to an accomodative monetary stance.
For extra credit, do so while at the same time not sounding like a crank.
Posted by: Dale Franks at February 24, 2004 09:11 PM
"I defy you to explain logically to the average person why an increase in the price level due to movement on the demand curve is in any way substantively different to his pocketbook from an increase in the price level due to an accomodative monetary stance."
I can do that. I've done it many, many times.
Are you this "average person"?
Posted by: Billy Beck at February 24, 2004 10:40 PM
For your purposes, assume so.
Posted by: Dale Franks at February 24, 2004 10:50 PM
Did you see the paper-clip example? That much is so easy that even children can understand it.
The "substantive differen[ce]" is in the fact that a genuine inflation relieves people of value in their medium of exchange surreptitiously, while an increase in price due to demand does not. In the latter case, one can simply avoid losing value by refusing a purchase. In the former case, there is no way to avoid losing value as long as it's mediated in the currency that's being inflated: if you're merely holding it, you're losing.
That's the crucial difference. In one case, property owners (those holding their values in money) can't lose. In the other case, there is no way that they can't lose.
Posted by: Billy Beck at February 25, 2004 12:10 AM
Ah. I see. So let's address the following:
Let us assume the money supply remains constant. Due to war in the Mideast, our regular supply of oil is substantially reduced.
This price shock causes a more or less permanent rise in the price level. The cost of going back and forth to work rises. The cost of heating my house rises. The cost of food and clothing rises due to increases in the cost of production.
I am now less able to buy as much food, clothing, heating and cooling. At the same time, my demand for not starving to death while I freeze in the dark is relatively inflexible.
How is this materially different from reduced purchasing power through monetary means, since in both cases, the purchasing power of my available money is reduced? In what way does the end result for me from a rise in general price levels differ between these two causes?
My demand for goods and services has precisely the same elasticity in either case. I am, therefore, similarly hindered in my ability to refuse a purchase when the general price level rises.
Your statement that I can avoid losing value by not making a purchase implies that you are not talking about a rise in the general price level, but rather a rise in the price level of particular goods and services for which demand is elastic, and which I can either forego, or substitute other products. Either that, or you are arguing that, apart from monetary processes, a rise in the general price level is not possible, although rises in particular goods and services are, for which substitutions may be found. Neither of those arguments is illegitimate, but they are entirely different arguments than the one we're having now.
Moreover, your example of housing is a bit difficult to understand.
Let us assume I own an extra house which I desire to sell for $400,000, before inflation. In the case of monetary inflation, Selling the house for that amount results in lost value. In the case of a general rise in the price level, selling the hosue for that amount similarly results in lost value. In both cases, my $400,000 buys less than it otherwise would.
So, since I'm not the sharpest knife in the drawer, I fail to see how my financial situatiuon is subtsantially different in either case. The only difference is the cause of the rise in general price levels. The end result is precisely the same reduced purchasing poower in either case.
Posted by: Dale Franks at February 25, 2004 03:42 PM
My example of housing?
Hey, Dale? Try reading it again, without reading like a crank. I never said a single word about housing, and I don't bother with people who can't pay attention.
Posted by: Billy Beck at February 25, 2004 05:52 PM
OK, you said property. Housing is a form of property. Lighten up, Francis.
Posted by: Dale Franks at February 25, 2004 07:24 PM
Good excuse for not answering the question I posed in my post, though.
Posted by: Dale Franks at February 25, 2004 07:26 PM
"Inflation is best defined, however, as a sustained rise in the general level of prices."
By what standard ought one judge definitions? What makes one definition better than another?
"In most cases where something is declared as an absolute (i.e. inflation is always defined as exclusively an expansion of the money supply), any exception to that absolute will disprove it."
How could you possibly find an exception to that definition of inflation without redefining inflation?
"And bigger advocate of the free market economics will never be found."
Milton Friedman? You can find bigger advocates of the free market in his immediate family.
Posted by: John T. Kennedy at March 1, 2004 01:44 PM
You're running a bit late, Kennedy. I'd hoped for an interesting discussion - one in which I could see both views advocated by intellects I respect - but Billy seems to have cut and run.
Petulance and snark just don't make for very convincing arguments - even if the author is right. And if you're going to take the time to argue, why use such poor arguments?
Note: I've done the same thing. I'm guilty, as well. That doesn't mean I like seeing it in the people I admire, though.
Posted by: Jon Henke at March 1, 2004 01:56 PM
"I defy you to explain logically to the average person why an increase in the price level due to movement on the demand curve is in any way substantively different to his pocketbook from an increase in the price level due to an accomodative monetary stance."
Wouldn't you say that the extent to which one's property rights are secure substantially affects the disposition of one's pocketbook? When demand changes in a market everyone is still disposing of their own property as they see fit. When a perfect counterfieter increases the money supply he's simply stealing out of everyone else's pocket.
You don't see why the former situation ought to be preferred to the latter?
Posted by: John T. Kennedy at March 1, 2004 03:15 PM
Henke,
"You're running a bit late, Kennedy."
I just found the thread.
"Petulance and snark just don't make for very convincing arguments."
I wasn't petulant or snarky.
1. I asked a question which goes to the heart of the matter: By what standard ought one judge definitions?
McQ holds that the definition he offered for inflation is best and I'm asking by what standard it is best.
2. McQ seems to think that empirical observations can reveal exceptions to the Austrian definition of inflation. They can't. How can he imagine they could?
3. Perhaps McQ was only saying that Milton Friedman is the most famous living advocate of free markets. That might be true. I took him to be saying that MF was the purest of free market advocates which is hardly the case, even in his immediate family.
Throughout though, McQ argues from authority instead of from principle.
Posted by: John T. Kennedy at March 1, 2004 04:13 PM
John, you need to review appeal to authority. It very clearly points to citing authority which isn't relevant to the field being discussed. So on its face, your critcism concerning authority isn't justified or correct.
We're both arguing from a premise. Your premise says all inflation flows from an increase in the money supply. Mine says it flows from that and other factors.
Based on what I've provided, I'd have to say I've, to this point, provided better evidence to support my premise than you have yours. The Austrian definition is by no means THE accepted definition of inflation, and, since it is absolute in its definition, exceptions disprove it. Logic 101.
Unless you have a way to prove your absolute, or refute the exceptions, I'd have to say
"game over".
Posted by: McQ at March 1, 2004 05:08 PM
"I just found the thread."
- - -I didn't intend to criticize your late entry...just point out that the interesting debate seems to have died. I doubt Dale is still reading this thread, so....
"I wasn't petulant or snarky."
- - -My apologies. I was unclear. I was referring to *parts* of the previous debate, not yours. I was just disappointed that we didn't take a good debate as far as we could have.
Posted by: Jon Henke at March 1, 2004 05:33 PM
McQ,
"The Austrian definition is by no means THE accepted definition of inflation, and, since it is absolute in its definition, exceptions disprove it. "
Again, how could you possibly find an exception to the Austrian definition of inflation without defining inflation to be something else?
And how is your definition of inflation "as a sustained rise in the general level of prices" not absolute? By your definition can there be any sustained rise in prices that is not inflation? Can there be any inflation which is not a sustained rise in prices?
Posted by: John T. Kennedy at March 1, 2004 06:14 PM
Let's assume it is John ... show me the exceptions that disprove it.
I've laid what I see to be the exceptions to the Austrian absolute on the table, and all I've gotten in return is dismissal with a hand wave and a cackle. Hardly a compelling argument.
Posted by: McQ at March 1, 2004 07:05 PM
"Let's assume it is John ... show me the exceptions that disprove it. "
Assume what?
"I've laid what I see to be the exceptions to the Austrian absolute on the table..."
All you've done is point to rises in prices which are not related to increases in the currency supply. That's not an exception to the Austrian definition which never claimed inflation was the only cause of rising prices.
You only get your result by *defining* inflation differently from the Austrians, so where is the exception?
Posted by: John T. Kennedy at March 1, 2004 09:13 PM
John ... I don't have the time nor the patience to play games.
I defined inflation ORIGINALLY in the first article. You and Billy took exception to that. The burden isn't on me, its on YOU. If you've something to say, then say it and quit playing silly games.
I've restated my definition in this article and I've provided cites which both support my definition and appear to refute yours.
Ball's in your court. If you have something to say which is relevant to the difference between these two definitions, then by all means do so.
If not that's fine too ... but I don't intend to continue answering nonsense queries and vague claims which don't advance the discussion.
Both you and Billy are better than this, and I'm not interested in anything short of your best.
That's not an exception to the Austrian definition which never claimed inflation was the only cause of rising prices.
The claim was never made that "inflation was the only cause of rising prices", John ... that's a red herring.
Posted by: McQ at March 1, 2004 09:35 PM
I know I'm late (very late) to this thread, but I just found it and wanted to elaborate on why the distinction between an increase in the money supply and an increase in the general price level is important.
As I also accept the definition of inflation as an increase in the supply of money, I'll try to add to Billy's comments as to why it is important. It centers on the non-neutrality of money and the implications for the structure of production in the real economy.
Where the definition of "inflation" matters is in distinguishing between real vs. monetary effects on prices, as relative changes in prices produce incentives (the profit incentive) for the real structure of production to change.
McQ- What you call "inflation", I'd call "price inflation" to distinguish it from an increase in the supply of money.
Why is the distinction important? It’s important because it concerns the real structure of production. Suppose the price of oil goes up 50%, while all other prices remain the same. What's the cause? And what are the ramifications to the underlying real structure of production (allocation of scarce resources)?
If the price of oil increased because of a supply shortage, the market participants take this as information to reduce demand and to invest more in expanding the supply of oil (changing the real structure of production and allocation of scarce resources).
If the price of oil increased because of an increase in the supply of money because the new money first was seen in oil prices, it would lead to giving the same incentives to market participants - reduce demand and increase supply. Again, a change in the real structure of production. However, this is just the first stage of an increased monetary supply. Eventually all prices will increase (in theory) by the same proportion – the percentage increase in the money supply. By definition, there has been no change in the real economy (no changes in supply or demand - preferences), just an increase in the supply of money.
So why is this distinction important? If there is an increase in the supply of money, and market participants view the cause of a relative price increase (and the key here is "relative" - non-neutrality of money, where new money is first seen in certain goods before it is seen in all goods) as new information supporting a change in the supply or demand of a good (a change in the real economy), the market will be taken out of equilibrium as more production is shifted to oil relative to other goods.
As the relative increase in the price of oil vs. other goods is caused by an increase in the supply of money, eventually, all goods will show this increase. The relative increase in oil prices is only temporary. As the increase in money is felt by all other goods, when this happens, the price of oil will be decreasing *relative to other prices*, which warrants an increase in demand or a reduction in supply of oil. So the increase in supply of oil in response to the higher relative oil prices has to eventually be undone as there was no change in the real economy (supply and demand).
Note that I am also distinguishing between the real effects on supply and demand vs. the monetary effects on supply and demand. The important distinction being monetary effects on supply and demand are inefficient (in the free market sense) because they will eventually have to be undone. In contrast, real changes in supply and demand should change the structure of production in the market because they are permanent and won’t be undone in the future.
Posted by: F. F. at November 13, 2004 03:58 PM