According to the Economic textbook,- Private and Public Choice. 12th Ed., inflation is the sustained increase in the general level of prices. As inflation increases, there will be a rise of prices for goods and services. In order to determine an approximate inflation rate, economists commonly use CPI (consumer price index) and GDP (gross domestic product) deflator for their measurement analysis. The text lists two types of inflation.
1- Unanticipated inflation
2- Anticipated inflation
Unanticipated inflation is an unexpected Increase in price levels that most individuals were unaware of. Anticipated inflation is the expected increase in the inflation rate. (Gwartney, Stroup, Sobel, Macpherson, 2008).
In contrast from contemporary economics, Ludwig Von Mises stated the classical definition of inflation “means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check.” Mises also noted that “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.”(mises.org). To sum up the difference, the textbook says that the rapid expansion of a nation’s stock of money causes inflation where Mises would argue that inflation is the expansion of money stock in itself and just one result may be higher CPI. An example of how inflation (textbook definition) can be misleading is if price levels are meant to decrease 5%, an expansion in the money supply can cause prices to remain steady or slightly increase but we will say the CPI is 0% after the expansion. The difference in what the price is without monetary expansion and the current price could be considered inflation (5%) even though we see no change in the actual price. The problem is determining what the “would be” price/cost is before a monetary expansion because the prices can become distorted and do not impact the all sectors of the economy in the same way. Based off the modern definition, there is no inflation however based on the classical definition, there is inflation.
A potential unintended consequence with a modern definition of inflation could be that by continuously printing money, the Fed “diverts real funding away from wealth generators toward the holders of the newly created money. This sets in motion the misallocation of resources, not price rises as such. Moreover, the beneficiaries of the newly created money-i.e., money "out of thin air"--are always the first recipients of money, for they can divert a greater portion of wealth to themselves. (Frank Shostak, 2002) With an artificial monetary credit expansion, comes an artificially lower interest rate, which often sends signals to speculators, regular investors, and consumers to buy and/or continue to buy instead of saving. This can send the wrong signs to the market, leading to a “bubble” within an economy. Ups and downs are natural in a market economy but they are often compounded by the Fed flooding banks with newly created money (monetary expansion) which can result in digging a hole even deeper. Economists may not anticipate actual inflation beyond just price increases based off the CPI and other measurement instruments, resulting in an exponentially larger “bubble” within an economy. If we are to regard inflation as a general rise in prices, we could reach misleading conclusions regarding the state of the economy.
Depending on one’s definition of inflation, the economy could be seeing massive inflation (classical definition) or the economy may be somewhat stabilized (modern definition). Even based on the textbook definition of inflation, Gerald O’drescoll of the Cato institute adds just one of the numerous cautions to the chairman of the Fed, Ben Bernanke, after several senior Fed officials’ warnings that “Most economic forecasters profess to see little inflation risk. They need to reconsider their forecasts in light of the inflation warnings from within the central bank” (Cato.org, 2009). My empathy goes to the elderly on fixed incomes and numerous other groups who are not able to increase their income or savings to keep up with a monetary system of constantly expanding credit. Many are currently on pay freezes, like myself for over two years, and a higher CPI could be devastating to many people’s standard of living and purchasing power. A bill growing in popularity with the American people is to fully audit the Federal Reserve (HR: 1207 or S: 604). The Federal Reserve transparency act is very important as they have never had a full audit since its inception on 1913.
Gwartney D.J., & Stroup, R.L., Sobel, R.S., Macpherson, D.A. (2009). Economics: Private and Public Choice. 12th Ed. Ohio: South-Western College Pub.
Mises, L. (1951). Inflation: An Unworkable Fiscal Policy. (Online) Ludwig von Mises Institute. Retrieved October 27, 2009, from http://mises.org/efandi/ch20.asp
O’Driscoll, G. (September 30, 2009). Inflation Warning. (Online) CATO Institute. Retrieved October 27, 2009, from http://www.cato-at-liberty.org/2009/09/30/inflation-warning/
Shostak, F. (2002). Defining Inflation. (Online) Ludwig von Mises Institute. Retrieved October 27, 2009, from http://mises.org/story/908