Definition of Inflation

The definition of inflation has undergone a subtle change across the ages. Economists earlier used to define inflation in a certain way, now they define it in a slightly different way. Although the change in definition may seem to be innocuous and trivial, in reality that is not the case. The changing definition has completely changed the paradigm through which we address the problem on inflation and has therefore changed the measures that we usually adopt to control it. In this article, we will look at the old definition and the new definition, understand why the difference is not trivial and why it matters.

The Old Definition

Old economists defined inflation as an artificial increase in the money supply within an economy. In fact the term inflation has been borrowed from the metaphor of an inflated balloon which looks big but lacks any substance in it. Inflation was therefore purely a monetary phenomenon. Old economists did mention that rising prices was a symptom and an effect of inflation. Notice the difference, rising prices was the effect and not the way in which inflation was defined.

The New Definition

New age economists define inflation as the “sustained rise in prices of goods and commodities” across the economy. To the average person, this might seem to be stating exactly what is written above. However, there is a huge difference.

Notice the change from. artificial increase in money supply to state of rising prices. New age economists refer to the increase in monetary supply by a different term called monetary inflation whereas when they use the word inflation in common parlance, they are usually using it to mean price inflation.

The change in definition is therefore no where subtle or inconsequential. Instead, the ramifications of this definition change on inflation theory are massive.

Purpose of a Definition

The purpose of a definition is to help the reader unmistakably identify a given condition. The changed definition of inflation fails to meet this purpose. If we define inflation as rising prices, prices could actually rise because of a number of factors. Some of these factors may be legitimate whereas the others may not be. For instance, if rise in prices if because of supply side blockages and other logistical issues, there is very little that a central bank could do to bring down this price rise.

Cause vs. Effect

Also, the definition has to be clear about the cause and the effect of the phenomenon being observed.

  • An effect or symptom is what helps the user identify the existence of the phenomenon i.e. it helps in defining the problem

  • A cause on the other hand is what needs to be corrected to eradicate the problem i.e. it helps in creating a solution. The stability of the solution depends upon how permanently the disturbing cause has been removed.

The definition of inflation mixes up the two. Under the new definition, rising prices is a cause as well as the effect of inflation. Defining inflation in this manner obfuscates the real cause. It is for this reason that any study of modern day inflation must first begin by clearing up this confusion caused by this definition.

Historical Example

Inflation as a phenomenon has always been around. Earlier it was also referred to as debasement. It simply meant that the government would dilute the value of coins by removing pure gold and adding cheaper metals like bronze and copper in its place. Since gold content of the coins was reduced, more and more such coins came to be required to make purchases in later days.

Here too, artificial inflation of the money supply was the cause and rise in prices was a mere effect of the policy. Therefore in this case if we define the cause as debasement by government, we can come up with a relevant plan of action to prevent the cause and therefore prevent the problem completely.

On the other hand, if we define rising prices as a cause, we are stuck in a dead end loop. The cause seems like the effect and the effect seems like the cause. In the end it appears to be a complex self fulfilling prophecy when in reality it is just a simple cause effect relationship.

The dangers of inflation are looming over the world more than they ever did. This is because for the first time in the history of the world, all the countries have fiat currency. This means that they have the power to inflate simultaneously unchecked until the whole system comes crashing down.

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Managerial Economics