What do we mean by inflation? General Price rise or rise in money supply?

From an ignored term, inflation stands for anything inflated these days.

However, for macro people inflation is critical. There is always this thing you keep reading about how monetary policy should lower inflation (though in developed countries the demand is for raising inflation).

The original inflation implied rise in money supply. But today when we say inflation, we actually mean the rise in price level. This rise in price level is actually an outcome of the rise in money supply. We need to distinguish these ideas clearly as we teach.

Frank Shotsak explains:

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. But 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.

….

This increase in the money supply — not changes in prices —  is what sets in motion the misallocation of resources. Moreover, the beneficiaries of the newly created money (i.e., money out of “thin air”) are always the first recipients of money, and so they can divert a greater portion of wealth to themselves. Obviously, those who either do not receive any of the newly created money, or get it last, will find that what is left for them is a diminished portion of the pool of real wealth.

Additionally, real incomes fall not because of general rises in prices as such, but because of increases in the money supply, which gives rise to non-productive consumption. In other words, inflation (i.e. increases in money supply) undermines the production of real wealth, which over time lowers individuals’ living standards. 

General increases in prices, which follow increases in money supply, is an indication — as it were — that the erosion of peoples’ purchasing power has taken place.

In this case, it is not the symptoms of a disease, but the disease itself, that causes the physical damage. Similarly, it is not a general rise in prices but an increase in the money supply (i.e. inflation) that inflicts the physical damage on wealth generators.

Someone in the comments section says: In my ECON classes I use the terms “monetary inflation” and “price inflation” and point out that the first causes the second.

Hmm..

How these basic ideas get lost overtime…

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