Nick Rowe has a post on selling the public a policy by using language that speaks directly to the objective economists have in mind. His example is the Austrian definition of inflation, and he makes the connection between defining the term as an “increase in the money supply” and the objective of increasing nominal incomes. It’s an interesting post, although I want to talk about the much more boring topic of the Austrian definition of inflation.
First, I must correct Rowe. He writes that Austrians define inflation as an increase in base money. Austrians care more about the broad money supply, and credit especially. In fact, apart from an exploitation of the money multiplier theory (which has come to bite some Austrians in the ass these past few years), base money is almost unimportant.
Second, what the Austrian theory of inflation really says is, “Inflation is everywhere a monetary phenomenon.” It’s just that, during this recession, since official inflation statistics have poorly treated those who predicted high inflation, some of these people prefer to instead look at base money. But, like Rowe writes, this approach is “a bit daft.” Austrians essentially see inflation as a rise in the price level, like everyone else, but the focus on changes in the money supply is to emphasize the root cause of inflation. To detach the price level from changes in the money supply would render the definition valueless, because it becomes a tautology. What the definition does, instead, is define a theoretical relationship between two variables.
What this means is that there really is no “Austrian” definition of inflation. The Austrian definition is the Monetarist definition.
Update: From Human Action,
The semantic revolution which is one of the characteristic features of our day has also changed the traditional connotation of the terms inflation and deflation. What many people today call inflation or deflation is no longer the great increase or decrease in the supply of money, but its inexorable consequences, the general tendency toward a rise or a fall in commodity prices and wage rates. This innovation is by no means harmless. It plays an important role in fomenting the popular tendencies toward inflationism.
— p. 420 (emphasis mine).
If we lived in the 1970s, I think Mises’ point would be easier to understand. If we detach changes in the price level from changes in the money supply, we can explain the former through various processes (e.g. cost-push) that Mises thought were wrong. Changes in the price level, for Mises, are always and everywhere a monetary phenomenon. By making this link clear by defining inflation as changes in the money supply, it also arms Austrians with an easy way of fighting monetary policy (which Mises does over the next couple of paragraphs). If inflation is bad, and monetary policy causes inflation, then monetary policy is bad. But, the consequent change in the price level (and, more importantly for Mises, changes in relative prices) is still key, otherwise why would he make reference to the ambiguous statement “great increase or decrease” and why would changes in the money supply matter.
Also, it’s worth remembering that the big defining economic moment for economists of Mises’ age were the central European hyperinflations that followed the First World War. Because of these experiences, there was a great push back against easy monetary policies. The belief was any easy monetary policy at all would lead to very high inflation (a la France) or hyperinflation (e.g. Germany, Austria, and Poland). Within this limited framework, Mises’ emphasis on the link between the price level, the supply of money, and monetary policy makes sense. But, the conditions that led to high inflation in central Europe during the 1920s are not the same as the conditions of today, or the conditions of the 1930s for that matter.