Inflation is a topic that interests a lot of people, especially those involved in the field of Economics and Finance. The history has taught the dangers of inflation and how it can be miserable to the people. So, what is Inflation? What’s the genesis of Inflation?
Getting to the general definition then Inflation is defined as the rise in the price level. Inflation leads to an increase in the price of goods and services that a common man consumes in their day-to-day life. It might not be accurate to put inflation as an increase in the price level. Milton Friedman said that inflation is always a monetary phenomenon which means that the cause is always correlated to the monetary policies of the central bank. On other hand, Austrians consider inflation to be an excess money supply. Interestingly, both sides agree that the central bank cause inflation but their definition of the term differ from one another. One says a high money supply leads to inflation and the other says a high money supply is inflation but both consider fiscal policies or other factors to be irrelevant.
The Keynesians differ from Free Marketers and divide inflation causes into demand-pull, cost-push, and built-in inflation. Demand-pull and Cost-push are due to an increase in aggregate demand and aggregate supply “shock” respectively. When aggregate demand is high, the prices rise and cause inflation, and when there’s a sudden fall in supply it might be due to wars, disasters, etc… also cause inflation. Built-in Inflation is basically blamed on the working class that keeps their wages high above the rate of inflation and practically it is portrayed to occur in the existence of unions.
A problem that seems in understanding the Keynesian view logically is ignorance of market mechanisms that allocate resources efficiently like no other. If the demand is high and the price rise, then they are happening because the value of the product has risen and that’s definitely not inflation whereas supply shocks are possibilities but apply the same logic where the market will reallocate the scarce resources efficiently. The prices aren’t mere numbers but bring in signals that send knowledge to people and help them take decisions that can be crucial for the economy. There’s no reason for a consumer to know why the supply shock happened but just needs signals and manage their budget constraints or choices accordingly. The Free Marketers even for their obvious and general dislike of unions don’t consider it fair to blame them for inflation but there can be a possibility that the government causes inflation to raise the nominal value of money to convince the unions and avoid them causing chaos, this is a good way to of politicians to keep both sides of the party, the unions and the capitalists convinced in the short-run.
Inflation can be called the excess money supply in the economy leading to devaluation of money lowering the purchasing power. A definition formed from the analysis will be liked by the Austrians the most. It is undoubtedly a monetary phenomenon. Therefore, the one to cause inflation is none other than the central banks of the countries that are affiliated with the government.
Wrong Price Signals
As earlier mentioned how prices carry knowledge and give signals to economic players to take decisions. The possibility of the price mechanism working efficiently is when they aren’t rigid and manipulated. Inflation raises the nominal value but not the real value and hence it causes the possibility that the wrong signals can be transferred to people that as well might lead to wrong decisions in the economy, these decisions can be related to entrepreneurship, investment, consumption, etc… Inflation is a big threat to price signals and this isn’t a problem that can be handled by anyone making the situation of both happen together because the knowledge that is transferred in the economy is tacit. Tacit knowledge can’t be expressed in words or numbers and hence aren’t possible to be expressed in statistical form too. This theory of F. A. Hayek led him to win Nobel Prize and the 2008 crash is considered to be related to this.
Robbery of Savings
Savings in this modern economics is considered to be a curse by some and seen negatively by many. But, a person saves to invest. If your saved money isn’t properly secured then there is a possibility of them getting stolen, you get to find out about them when you see the numbers are lower. But, there is also the possibility of your part of savings being stolen and you don’t even get to know exactly by what amount and can’t find it out too because the numbers are unchanged in your account. Inflation leads to a decrease in the value of money and hence the money saved by the people isn’t of the same value as it was earlier.
Inflation can be effective in the behavioral pattern of people as they would tend to start borrowing money instead of saving it which is what the Keynesians want. According to Keynes, a depression happens due to the shortage of aggregate demand which is because people tend to save a lot and it is important for the spending to keep flowing in the economy. Keynes’s theory was the increase in money supply first leads to a rise in output, income, and employment and after reaching the state of full employment, the flow of money supply leads to an increase in the price level. Investment has a direct relationship with inflation in general cases as an increase in the supply of money lowers the interest rates and increases the demand for loanable goods/investments. Therefore, it would be wise to not save and keep spending in the Keynesian model.
The Monetary theories
Monetary policies aren’t to be underestimated as they are capable of controlling the whole economy. Money isn’t merely a medium of exchange in the market economy but way more than that. After the Great Depression, economists moved away from the Gold Standard and the printing of money was on the central bank to do it efficiently. The remarkable work of Friedman and Schwartz explained the cause of the Great Depression which was the Contractionary monetary policy of the Federal bank. Milton Friedman was a monetarist and proposed a fixed monetary rule and says to expand the money supply equal to the rate of economic growth. The Austrians still believe in the Gold Standard and are followers of Mises-Rothbard whereas there is a rising popularity of Hayek’s concept of Denationalization of Money which lets private players issue their own money and compete with one another in the market. The concept is related to cryptocurrencies.
Keynesians see it differently and see central monetary control as a way to increase investment and bring a boom in the economy. Others mentioned are generally finding ways to not let inflation happen fearing Stagflation or uncontrollable inflation.
Inflation is indeed an interesting concept and definitely part of monetary economics but it is very casually and wrongly used by people and any increase in prices is termed inflation which isn’t the core meaning of the term.