The Great Inflation Illusion: Decoding the Money Mirage

Historically, inflation always referred to an increase in the money supply, whereas nowadays it refers to an increase in prices.

This shift in the definition of inflation lets central banks get away with their fraudulent business. Thus, the original definition must be reestablished. We must, by all means, switch the focus from the symptoms to the disease.

The CPI Deserves Less Attention

The lure of the Consumer Price Index (CPI) doesn’t just undermine price inflation, but also camouflages monetary inflation. Everywhere in the media and academic circles CPI is used as the main measure of “inflation.” Along with this index, “experts” sometimes talk about producer price indexes and personal consumption expenditures.

Although these indexes can provide an estimation of where the economy is headed, they are lagging indicators. Price inflation is a symptom of monetary inflation. Hence, a good economist must identify the cause of rising prices, just like a good physician must find the disease that causes the symptoms.

Monetary inflation is not always the cause of rising prices, though. Market prices change by the means of supply and demand. Thus, an increase in the price of a good or service is the result of the demand for it exceeding the supply of it.

Some prices on the pseudo–free market will change due to natural changes in supply and demand. Such changes depend on people’s tastes and preferences. Yet, often, the changes in supply and demand are unnatural. Some unnatural changes include market regulations, price controls, and monetary inflation.

Consequently, the CPI will not reflect only monetary inflation since prices fluctuate with both natural and unnatural changes in supply and demand. Another thing to consider about price inflation is the Cantillon effect. The largest price increases will typically be where large amounts of money are first injected.

Not only must the Cantillon effect be considered, but the growth rate of goods and services must be considered too. Suppose there was a price index that could include all prices in the economy. In this hypothetical economy, the money supply is increased by 10 percent at the same time that the total amount of goods and services is increased by 30 percent.

All things being equal, we should expect a drop in the price index, just as we should have had the money supply remained unchanged. However, since it didn’t remain unchanged, the price index dropped less than it would have otherwise.

Focus on Money Supply

The true money supply (TMS) metric, created by Murray Rothbard and Joseph Salerno, is the best money supply metric and thus the best measure of inflation (and deflation). It is based on the Austrian definition of money, on which Rothbard writes, “Money is the general medium of exchange, the thing that all other goods and services are traded for, the final payment for such goods and services on the market.”

Thus, the TMS must include all money substitutes used as a medium of exchange. Also, it must exclude all substitutes that other economic schools count as money.

The Mises Institute provides regular updates on the TMS, along with the M2 money supply. It’s a great tool for every market forecaster to use in addition to other tools.

The best use of the TMS, however, is to show everyday people that the money supply is inflated. Perhaps they would raise their eyebrows if they could see the sevenfold growth in the money supply during the past thirty years.

Originally published by Andreas Granath at Mises Institute