Saturday, April 19, 2008

Inflation for Dummies.Take 2

Mises Institute blog recently had an interesting piece by Henry Hazlitt on "everything you need to know about inflation". Here's a key excerpt:

The word "inflation" originally applied solely to the quantity of money. It meant that the volume of money was inflated, blown up, overextended. It is not mere pedantry to insist that the word should be used only in its original meaning. To use it to mean "a rise in prices" is to deflect attention away from the real cause of inflation and the real cure for it.

Let us see what happens under inflation, and why it happens. When the supply of money is increased, people have more money to offer for goods. If the supply of goods does not increase — or does not increase as much as the supply of money — then the prices of goods will go up. Each individual dollar becomes less valuable because there are more dollars. Therefore more of them will be offered against, say, a pair of shoes or a hundred bushels of wheat than before. A "price" is an exchange ratio between a dollar and a unit of goods. When people have more dollars, they value each dollar less. Goods then rise in price, not because goods are scarcer than before, but because dollars are more abundant. [link]

Do read the whole thing. Hazlitt is the author of the extremely useful book Economics in One Lesson, which is a great introduction for economics for anyone. He's also the author of many other books found free on the Mises Institute site.

It's interesting how more and more economists keep giving pseudo-Austrian analysis on the current financial crisis in the U.S. and the problem of inflation. In a recent column Fuss-Budget of Lanka Business Online does much the same. Are we all Austrians now?

Economists in the Austrian School generally advocate a return to the gold standard, or a free-banking system , or 100% reserve banking (a currency board arrangement, etc) to tackle the problem of inflation and the creation of "bubbles resulting from malinvestment.

Related, my own version of Inflation for Dummies.


Dulan said...

Good post - I really enjoyed part 1.

Thanks also for the link to the book :)

Deane said...

cheers :)

Nick said...

Hey deane check this out:

Read the article on Sri Lanka up there on the front page.