Oct 082010

Lawrence H. White in The Concise Encyclopedia of Economics in 2008 writes that inflation is the ongoing rise in the general level of prices. Thus, the overall purchasing power of the monetary unit, such as the U.S. dollar, falls over time and buys less each year.

  • Economies on gold or silver standards sometimes experienced inflation, however, the inflation rate rarely surpassed 2% per year. Furthermore, over the course of centuries the inflation rate was close to 0%.
  • “Economies on paper-money standards, which all economies have today, have displayed much more inflation.”
  • Sustained inflation has historically always been due to the sustained increase in the money supply.
  • The rate of increase in the money supply, or monetary expansion, is the dominant factor for inflation. Countries with high money growth have high inflation. Money growth is not the growth of wealth, but the growth of the money supply (see above).
  • Similarly, decades with rapid money growth had high inflation.
  • “The dominance of money growth in accounting for inflation is especially pronounced in hyperinflation.”
  • To control inflation requires the central bank (the Federal Reserve is the central bank in the U.S.A.), which controls the money supply, “to refrain from expanding the money supply too rapidly”
  • For people that hold non-interest bearing money, for example in a bank account, inflation “subjects them to the equivalent of a higher tax on their money holdings.”
  • What is the optimal rate rate of inflation? One proposal is to achieve a zero nominal interest rate. Therefore, the inflation rate would be negative 2-3 percent annually.
  • Another proposal “favors zero inflation as the policy that minimizes uncertainty about future inflation, thereby best facilitating financial contracts; and that minimizes the distortions associated with unindexed taxes”
  • Another proposal “makes a case for falling prices in an economy with ongoing productivity improvements.” Therefore, it is beneficial to let prices fall as efficiency increases and using monetary expansion to raise other prices does not increase efficiency.

To read the entire article, click on Inflation.

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