Wednesday, May 23, 2007

Monetary Policy and Inflation (2) - Definition

A serious obstacle to understanding inflation is the fact that the meaning of word has changed. The word inflation is now commonly used as a description of the CPI. Whenever the CPI increases, the news media announce that inflation has increased. However, a little thought about the meaning the word “inflation” gives a hint that something is wrong with this view.

The word “inflate: means blow up, dilate, enlarge, swell or expand”. The word inflation was used in the economic context to describe what was happening to money. The amount of money in circulation was expanding rapidly or being blown up like a balloon. Inflation was a description of a situation where the volume of money was being increased excessively. The consequences of this inflation of the money supply was rapid increase in prices. Over time the word inflation has changed to mean a rapid increase in the general level of prices.

The meaning of words change all the time, but we need to understand what is going on here. The word inflation was once used to describe the cause of the problem, whereas now it is used to describe the result. People have started to think that the result is the problem and forgotten about the cause of the problem. That is nice for those who are the cause of the problem, because they go unnoticed, but it does not help us to resolve it.

The verb inflate always has a subject. Someone pumps up the tire. Someone blows up the balloon. It cannot inflate itself. Nor can the money supply increase itself. If the money in circulation has expanded rapidly, someone has inflated it. We must not respond to the change in the meaning of word inflation by drifting into a view that inflation just happens. A rapid increase in the price level is caused by inflation of the currency.

Inflation of the money supply does not just happen, but is caused by someone. The expansion of a balloon cannot be stopped by squeezing it. The person inflating it must stop blowing into it. To get rid of inflation, we must stop those who are doing the inflating.

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