Why The Definition Of Inflation Matters

Why the Definition of Inflation Matters

NOVEMBER 28, 2022  BY MICHAEL MAHARREY   0   2

When people talk about “inflation” today, they generally mean rising prices as measured by the Consumer Price Index (CPI). But historically, “inflation” was more precisely defined as an increase in the amount of money and credit causing advances in the price level. Inflation used to be understood as an increase in the money supply. Rising prices were a symptom of inflation.

I find this change in definition problematic. But many disagree with me. They argue that I’m being pedantic and the definition doesn’t really matter all that much.

In a social media exchange, I argued that rising oil prices due to the invasion of Ukraine weren’t technically “inflation” but are better described as price shocks. Price shocks do, in fact, raise prices. And those price increases can cascade through the economy. But unlike price increases due to an increase in the money supply, decreases in other areas of the economy will ultimately balance out price shocks (absent inflation) as people shift spending patterns. For example, if people are paying more for gasoline, they may cancel vacation plans. This drop in travel demand will cause hotel prices to fall.

In contrast, a rise in the money supply (inflation) will cause a general rise in prices with no corresponding price decreases.

“Joe,” a commenter on Facebook, disagreed.

You’re wrong. What you call ‘price shock’ is in fact inflation. The BULK of inflation is in fact Fed debasing the currency as you note. The inflation of prices is also a function of market forces that have nothing to do with the Fed. These pale in comparison to adding mega-trillions of dollars to the currency supply.”

If you read carefully, you’ll see that Joe simply substituted the current definition of inflation for the historical definition. He lumped price increases caused by Federal Reserve monetary expansion and price shocks together under one banner — inflation.

So, what’s the problem?

I can understand why people might think that this is nothing more than semantical nit-picking. After all, word meanings evolve over time. When I insisted on the classical definition of inflation, Joe argued that there was no reason to hold fast to archaic terms.

That you believe modern vernacular of the term includes things you think did not used to be in the term is meaningless. Why should I care about anachronistic uses of terms? I speak in the modern vernacular. I, for example, don’t speak in Elizabethan English so I’m not a KJV kind of guy. Likewise, I won’t insist on something from the 70s, because economic policy 50 years ago doesn’t mean a whole lot to me right now.”

The problem is that this change in definition creates confusion. And I believe that is precisely why government officials and the academics who support them have worked to change the common meaning of inflation.

Economist Ludwig von Mises warned about this shifting definition decades ago.  In his essay “Inflation: An Unworkable Fiscal Policy, Mises reiterated the precise definition of inflation.

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.”

Over the years, the government, along with its apologists in the corporate media and academia, altered the definition. Why? To suit government purposes. The standard definition of inflation bandied about today is nothing more than government propaganda.

Mises explains the problem with this change in definitions.

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. . . . 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 terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.”

In other words, the modern definition allows policymakers to shift the blame to other things while continuing their expansionary monetary policy.

Keep in mind, the Federal Reserve (and all global central banks) constantly inflate the money supply as a matter of policy. After all, the inflation “target” is 2%!

In fact, inflation is a stealth tax.

The inflation tax is the primary way the US government finances its deficit spending. The federal government spends billions of dollars every month, but it doesn’t collect enough taxes to cover its costs. That means it has to run deficits. The Federal Reserve monetizes those deficits. In effect, it prints money. They call it quantitative easing, but when you boil it all down, they’re just inflating the currency. As the money supply grows, prices rise and you feel the pain every time you go to the grocery store or the gas station. The government is getting bigger and bigger, and families across America are bearing that burden through higher prices.

The government loves the inflation tax because it never has to accept responsibility for levying that tax. It can blame it on all kinds of other factors like corporate greed, the pandemic, or “Putin’s price hikes” (i.e. oil price shocks).

This is especially true if you redefine inflation as simply “rising prices.” You lose the ability to parse out the impact of monetary policy.

If we use the traditional definition of inflation as an “expansion of the supply of money,” the culprit becomes clear. Who expands the supply of money? It’s the Fed and the federal government. So, if you accurately define inflation, you know exactly who’s to blame. But if the government can fool people into believing that one effect of inflation is inflation, they can blame it on everybody but themselves.

This is not to say price shocks and other factors don’t cause prices to rise. This is not to minimize the impacts of those price increases on our lives. The point is it’s important to distinguish inflation – an increase in the money supply causing a general rise in prices – from other factors driving prices higher. Without a precise definition, we lose our ability to talk about the phenomenon of rising prices and monetary expansion with any precision. And the government gets away with harmful policies.

CPI, inflation, monetary policy