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.

15 thoughts on “Inflation

  1. genecallahan

    Jonathan there is a big and significant difference between saying exposure to germs CAUSES the flu (analogous to the monetarist position) and saying that exposure to germs IS the flu (analogous to the position of some Austrians). The first variant allows that if, say, the person has been vaccinated against the flu, they might not get it. (Or, analogously, if we are in a demand-riven slump, printing money may not cause is inflation.) But in the second view, the vaccination is irrelevant: you were exposed, you have the flu, period.

    No definitions are wrong, but the first one appears far more useful to me.

    1. JCatalan

      I don’t see a problem with looking at maintaining the price level as inflationary. What I see is a debate over whether or not all inflation is bad. I do think that a lot of Austrians do say that exposure to germs is the flu. I think they’re interpretation is wrong, and I think their interpretation is driven by: 1. Mistaken inflation expectations; 2. opposition to all monetary policy; 3. a drive to distinguish Austrianism from the “mainstream.” The thing is, if Mises really meant that “exposure to germs is the flu,” he wouldn’t have made the ambiguous qualification of “great” when deciding by how much the money supply has to change to qualify as inflation.

      1. Dan(DD5)

        Never mind that the there is no real “price level”, that this “price level” depends on your completely arbitrary definition of it, your “no problem” of treating inflation basically says: Any increase in the money supply that is offset by a rise in [reservation] demand for money is not inflationary. Or to put it differently: Any rise in the money supply that prevents the “price level” from falling is not inflationary. Fine! then what is it? You can define any term how you want, I grant you that, but please come up with a different (or new) term for when we don’t get a fall in, say 20% drop in commodity prices and wages due to an increase in the money supply.

        1. Dan(DD5)

          In this respect, Austrians basically stating the fact that an increase or decrease in the money supply is the only part that you can objectively define and quantify. Anything else is basically outside the realm of science. Why not quote Mises stating that also from Human Action – It’s a term invented by politicians and not economists.

          1. Dan(DD5)

            You are avoiding the question.

            Objectively define price level please. Don’t tell me about how the “price level” theorist draws upon real market conditions, e.g, prices that can be objectively defined and measured.

            Here I’ll make it easy for you.
            I have a market with only 3 commodities:

            1. 2500 chairs – $15/chair

            2. 500 of 12 ounce packs of Almond flour – $8/pack

            3. 5000 red shoes – $29/shoe

            Please objectively define the price level.

          2. JCatalan

            Here’s a dictionary’s definition: “The average of current prices across the entire spectrum of goods and services produced in the economy.”

            Here’s another way to put it: average nominal income. If you multiply the average nominal income by the number of people/things earning a return you get the total money supply. (This would be an alternative to using prices; but there are alternative measures of the price level.)

            But, your question doesn’t make any sense. What does it mean to “objectively define” something? Every definition is, in a sense, subjective. That’s why no definition is ever wrong. What’s important is a definition’s usefulness. This is why there are alternative definitions of the price level.

          3. Dan(DD5)

            Of course you think I don’t make sense because you fail to see the obvious as do most people.

            Define the radius of a circle.
            Define a triangle.
            Define Force, acceleration, velocity, etc…….

            All of the above can be theoretically defined (and measured) precisely, thus, they can be quantified.

            Price level cannot. So what if there is a definition in the dictionary.

            Price level, according to your own dictionary definition, is a concept that cannot be realized. It’ nonsensical because you cannot perform a sum operation on heterogeneous units. This isn’t Austrian economics, but simple math! The definition in your own dictionary requires you to add chairs and tables and wine and so on……….

          4. Dan(DD5)

            Go to any mathematics professor and ask them how to sum up 4 volts + 500 Joules + 5 grams + 2.5 mol H2O (water)…

            see the reaction…

          5. JCatalan

            Oh, so all of this is really about aggregates.

            But, I can add prices together, Dan, and then I can divide it by some number of total units… “basic math.” You’re trying to accuse economists (who use the concept of the price level) of something they’re not doing — confusing a chair for a stool.

            I wonder why economists talk about an average wage. Jeez, what’s an engineer + a teacher?

          6. Dan(DD5)

            NO! you can’t average prices of heterogeneous goods. I’m not sure what part of that you are objecting to. I see no attempt by you to actually refute that. The price level is meant to reflect average of all prices across all goods. It’s in your definition also so what is the argument here. It just sounds like you’re trying to disagree at all costs.

            You are telling me that you can take all the money transactions in the economy and add them all up. Of course you can! But that’s just the total money spent. That’s not the price level. Indeed, a rise in total money spent (assuming zero reservation demand for money for simplicity) is a darn good definition of inflation, but that is precisely the Austrian definition of an increase in the supply of money. Not of prices.

  2. Pingback: Austrians Are Not Redefining Inflation

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