by Algy Moncrieff

Created on: July 22, 2009   Last Updated: July 24, 2009

The argument that inflation does not exist is about as plausible as the argument that the moon is made of cheese or that 1 + 1 = 3. Inflation occurs, is specifically and easily measurable, and indeed most people in day to day life know this full well. The only reason people are able to deny the existence of inflation is when a) it's not there, for instance in an extreme recession, or b) when they are getting their terms mixed up. To that end, we need to start with a definition of inflation:

From my textbook "Macroeconomics" by N. Gregory Mankiw and Mark P. Taylor, inflation is defined simply as "an increase in the overall level of prices". On this definition, which indeed is the only definition you will receive from any economist worth his salt, it cannot be denied that inflation does exist. Every time we go to the gas station and fill the car up, noting with annoyance that the price has gone up, we have witnessed inflation. Every time we say "of course, money was worth more in those days", we have referred to inflation. And when we look to an economy such as Zimbabwe's and note wryly that you used to be able to buy a large house for the price of a banana in today's money, we clearly are experiencing inflation - hyperinflation in fact.

It is worthwhile however, to examine where the confusion comes into what should be a simple question to answer. What many people become confused by is whether an increase in the money supply necessarily causes inflation, whether this is from the central bank printing money or banks maintaining a smaller reserve-deposit ratio. The famous monetarist economist, Milton Friedman, once said that "inflation is always and everywhere a monetary phenomenon."

Indeed it is easy to see how more money in the economy might cause prices to go up. If you gave everyone in the economy $10 and told them to do what they want with it, then a very great deal of this money would be spent instantly. Shops would quickly realise that demand for their products had gone up, and because of this put their prices up. And there you have it: inflation. It seems hard to deny that an increase in the money supply will therefore lead to some inflation.

However, there need not be an increase in the money supply for there to be inflation. Inflation comes in two forms "demand pull" (such as occurs when you hand everyone ten bucks and tell them to spend it) and "cost push", when the costs of firms goes up, causing them to increase their prices. Both cases can occur without an increase in the money supply. Perhaps there might be a sudden fad where everyone flocks to the stores to buy some product, which would also cause the costs to go up. Of course if their income has not changed, then they will have to spend less on some other product, but this is only likely to affect the price of the product that has less spent on it in the long run, and indeed data supports this hypothesis.

The question of whether inflation is a monetary phenomenon is a difficult question to answer, but the question of whether inflation really exists is not difficult at all. Of course it is, and every day we base our lives on this knowledge.

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