Subject: Definition of Inflation Newsgroups: soc.retirement, sci.econ, misc.invest.stocks, misc.invest.financial, misc.invest.misc, talk.politics.theory On Mon, 28 Apr 1997 10:28:24 -0700, jim blair wrote: While not all economists agree as to how to define inflation, most consider it to be a monetary thing: expansion of the money supply faster than some criteria. wfhummel@pacbell.net (William F. Hummel) wrote: >You are confusing the definition of inflation with a cause of inflation. >Inflation is simply an increase in the price of the average goods and >services over the period in question. "Inflation" is just short hand for >"price inflation". It can result from either too rapid a growth rate in >the money supply or too slow a growth rate in the supply of goods and >services. The latter might occur as a result of some natural disaster or >an oil embargo for example, and the average price would rise even with a >steady rate of growth in the money supply. Since the money supply is >(indirectly) controlled by the Fed, it is easy to blame inflation on poor >monetary control, not recognizing that the root cause can be elsewhere. Date: Fri, 02 May 1997 02:23:50 GMT From: lsp@tiac.net (Lee & Sue) Reply-To: lsp@tiac.net Actually (sorry Mr. Hummell, I'm not picking on you - I agree with what you are saying here), the classic definition of inflation by economists was "inflation" of the money supply whether this had any effect on prices or not. Around the time of the mid to later seventies there was a shift in how "inflation" was defined to mean "price inflation". You see both uses of "inflation" in the literature with no end to the confusion resulting from this. It's not unusual for two people to have furious debates about this inflation thing only to find out they are talking about two different kinds of inflation. As we see from the following, the original writer is talking about "inflation of the money supply": >>The general rise in prices that follows the inflation of the money supply >>is seen as a result of inflation. The increased costs/prices that affect >>some items but not others would not BE inflation; but if the Federal >>Reserve took steps to expand the supply of money "too fast" (by >>lowering interest rates for example) THAT would be inflation.---jeb >------------ William F. Hummel wrote: ... However this definition of inflation - an expansion of > the money supply - strikes me as absurd. An expanding money supply is an > essential feature of any growing economy. There is nothing undesirable > about such growth. In fact the economy cannot grow without an increasing > money supply. Nor does that growing supply imply a general increase >in prices (the meaningful definition of inflation).. Hi, Not "expansion of the money supply", but "expansion at a rate that is TOO FAST". Even the monetary theorists agree that the money supply should expand. It should expand at about the same rate as "goods and services". As a practical matter, the Federal Reserve regulates the money supply rather indirectly by using the re-discount rate. Alan Greenspan et.al raise or lower that based on various things; but since the early 1980's they have done a good job. The economy has been expanding nicely, and inflation has been low. I was surprised to learn that the definition of inflation had been changed since I was in school. Historically, inflation has been defined as a rapid increase in the supply of money. I think that was the accepted definition from the early days of economic thinking (late 1700's) until the 1970's, when it became defined (by some) as an increase in the general price level. THE ORIGINAL DEFINITION The main problem with the original definition was "money supply increase faster than WHAT?" The supply of money SHOULD increase. Inflation (BAD) is only when the money increases TOO FAST. The idea was that the supply of money should increase at about the same rate as the supply of goods and services that the money buys. Then the overall price level will remain steady. If the money expands faster that what it buys, there will be a general price rise. If the supply of money falls, or expands too slowly, it will trigger a recession/depression. This is hard to see in practice, since the price of any particular product or service is constantly changing. And new products are constantly appearing on the market. But the GNP is a measure of the total size of the economy: the sum of the good and services. So the supply of money should grow at the same rate as the GNP, at least as averaged out over a several year interval. This is because if a drop in GNP (recession) were to trigger a reduction in the money supply, this would set up a positive feed back loop leading to a depression. But the GNP is measured in the same units as the money supply: dollars for the USA, pesos for Mexico, etc. If a X% increase in the supply of money causes an X% increase in GNP just by increasing the prices of all the goods and services by X%, the money supply rate of growth could be seen as "just right" while there is no "real growth" and the prices are rising. And for large X, rising very fast. So the problem is to call it inflation when the money supply increases faster than WHAT? In practice the rate of "real" growth in the industrial economies has been in the range of 2% to 5%. So this has been seen as a target range. But even money supply increases faster than this may not cause a general price rise. I think the US money supply increase has been greater than this lately, but price inflation has been low. Why? Mostly, I think, because a lot of the "extra money" has been going abroad, where it is not being used to bid up prices here. (yet?). Foreign workers send US dollars home, and they are now being used as a secondary currency in many countries. The "trade gap" reflects dollars going abroad. ------INSERT: That comment brought these replies: Subject: Re: The Inflation Defined & Oil Date: Wed, 14 May 1997 09:36:30 GMT From: postmaster@127.0.0.1 (Warrl kyree Tale'sedrin) Reply-To: warrl@blarg.net Organization: None -- just look at my desk! Newsgroups: soc.retirement, sci.econ, misc.invest.stocks, misc.invest. financial, misc.invest.misc, talk.politics.theory I read a few years ago that the amount of US currency which appeared to be STABLY out of the country -- in use as savings or a secondary currency in other countries, not likely to return to the US any time soon, or (to put it in other worlds) claims upon the material wealth of the United States which are unlikely to be cashed in -- was equivalent to a loan of $20 to the US by every man, woman, and child living anywhere outside the US. And 15 May 1997 12:16:45 GMT From: eflahert@garnet2.acns.fsu.edu (Edward Flaherty) Organization: Florida State University From the Capital Account on the Balance of Payments, which is published monthly in the _Federal Reserve Bulletin_, you can see that there is a large net inflow of financial capital into the U.S. What is this stuff? It's dollars which left the U.S. at some point in the past and are now returning in the form of demand for U.S. exports of goods or services, demand for U.S. financial assets like stocks or bonds, or demand for U.S. real estate. There is, however, a certain number of dollars, about $300 billion according to the Fed's estimates, which always seem to stay outside the U.S. This is not harmful to the U.S., in fact it is beneficial. In essence, what this means is that the U.S. traded bits of paper which cost about 4 cents each to print for valuable goods and services, which means we made a 96 cent profit on each single, a $4.96 profit on each $5 bill, and so forth. This is a *fabulous* deal for the U.S. -- Edward Flaherty Web Site: Department of Economics http://garnet.acns.fsu.edu/~eflahert Florida State University Fax: (904) 644-4535 eflahert@garnet.acns.fsu.edu ------END OF INSERT There is also the question of how to measure the "money supply"; it is no longer just currency (printed bills and coins), but bank deposits and credit. WHY THE CHANGE? All of these COULD have been reasons to change the definition from "money supply" to "price level", especially since the Bureau of Labor Statistics now measures the Consumer Price Level. But the new definition has some problems too. There is the debate over how to measure the CPI (see the Boskin stuff on my web page). And the problem of timing; by the time a money supply increase actually shows up in the measured CPI, it takes a drastic action by the Federal Reserve, and maybe even a recession to stop the inflation. As happened during the early 1980's. The critics of Alan Greenspan think that if he would just keep the rediscount rate (and thus bank interest rates) low, the economy would grow fast enough to keep ahead of the increase in the money supply. What's In a definition? The common saying is that "you can't argue with a definition." But people do. The way things are defined shape the way people think about them. Rather like George Orwell's idea, expressed in the novel 1984 and again in an essay, that the words we use shape and limit our thoughts. If inflation is seen as being a general price rise, it could have many causes. Including higher interest rates (the cost of money), or the rise in the particular items that are seen as "leading the inflation". Wages or oil or food, or whatever your political inclination causes you to focus on. The greed of THOSE PEOPLE could be the CAUSE of inflation. And maybe wage and price controls can cure it. In my file on "Inflation & the Federal Reserve", it is suggested that when the Federal Reserve raises interest rates THAT causes inflation, since the interest people pay is one of the items in their cost of living. OIL AND INFLATION The move to change the definition from rapid money supply expansion to rapid rise in prices came during the 1970's. I wonder if this was not a result of the jump in oil prices. According to the conventional view that inflation is always, as Milton Friedman claims a "monetary phenomena", if the price of oil rises, the response should be to use less of it. In the US this would mean investing in public transportation, rail, smaller cars; even car pooling, ride sharing and bike paths. This idea is so unacceptable in the US, that something else must be done. The oil price increase must be the CAUSE of inflation. And so, since gas/oil costs more, the money supply must be expanded so people will have more money to buy their gas at the higher price. This and price controls, rationing, buying gas on only odd or even number days, etc. But these do not deal with the basic problem: the USA burns about twice as much oil as we "produce". (Of course EXTRACT is a better description: see my web page file "It All Depends on How You SAY IT!"). More dollars in circulation does not address that fact. Paying for imported oil accounts for close to half of the US balance of payments deficit. Many economists think that the trade balance should be considered on a country-by-country basis. If we just closed the trade gap with Japan, all would be well. See Lester Thurow's THE FUTURE OF CAPITALISM (reviewed on my web page) for an example of this kind of thinking. But viewed on a product basis, the "problem" is not "Japan" but "oil". WE "need" it, and THEY have it. And we respond by spending billions to subsidize highway construction and cultivate ever greater dependence on cars. See the "Gas Tax" file on my web page. With the "price rise" concept of inflation, there is a certain logic to the suggestion that the stagflation of the 1970's was because the money supply was not expanded fast enough to keep up with the rising price of oil. There is even a kind of logic to the quote from the Russian economists (one of my very favorite). Recall that the Ruble was at one time worth $1.60. But with the fall of the USSR, Russia was experiencing rising prices. If things COST more, then people need more money to buy thing with, so the government decided to expand the money supply. But people could still not "keep up with inflation". Finally, the economist explained that the basic problem with the Russian economy was that they could not print 1000 ruble notes fast enough to keep up with inflation. If only they could print them faster, maybe they could beat inflation! ,,,,,,, _______________ooo___( O O )___ooo_______________ (_) jim blair (jeblair@facstaff.wisc.edu) Madison Wisconsin USA. This message was brought to you using biodegradable binary bits, and 100% recycled bandwidth.