I constantly hear people refer to the CPI as the best measure for inflation. However, this does not make sense to me because the way I understand the CPI, it represents the price level of a market basket of consumer goods and services.
My question then, I believe, has two parts:
1) What should be the definition of inflation? Is it widely accepted that the definition of inflation is simply a rise in prices? Or is there belief that inflation is always and everywhere a monetary phenomenon as Milton Friedman said?
2) If we do define inflation is purely an issue of monetary policy, then how can we separate the change in a price due to supply and demand factors versus the change in price due to too much (or too little) money in circulation?
I recently brought up this example to one of my colleagues: What if there were a fire at an oil production facility that causes a drop in the supply of oil. And, keeping all other things equal, this causes a rise in the price of oil, which would increase the CPI. Surely people cannot believe that we should be categorizing this as inflation? The response I received was that the CPI would be adjusted for the fact that there was a fire at the oil facility. But how can we know exactly the amount by which it should be adjusted? Or how would we even be able to come up with a ballpark estimate of what the price change is due to supply and demand factors versus monetary factors?
Perhaps it would help me to know the details of how the CPI is calculated and/or adjusted, but I feel that the price changes of a basket of goods and services are a consequence of supply and demand as well as monetary policy. But how can they be separated?
Does anyone have thoughts on this? Are there any materials or books you would recommend for further reading on this topic?
Jonathan M. F. Catalán: DD5, What, bank deposits need not be in circulation? I never said they weren't. They aren't de facto in circulation, but they can be if the money in these deposits are being spent electronically (or funds are being withdrawn and spent, et cetera). By the way, from Human Action (1998), The endeavours to expand the quantity of money in circulation either in order to increase the government's capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation. (p. 225).
DD5,
What, bank deposits need not be in circulation?
I never said they weren't. They aren't de facto in circulation, but they can be if the money in these deposits are being spent electronically (or funds are being withdrawn and spent, et cetera).
By the way, from Human Action (1998),
The endeavours to expand the quantity of money in circulation either in order to increase the government's capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation. (p. 225).
My point is that Mises in that previous quote doesn't necessarily refer to "inflation" as just an increase in circulating money, but an increase in the money supply in general. Anyway, it's only a definition. The affects of "inflation" can be accounted for only once your terms have been defined. People seem to think that the debate over how prices are affected is a debate over the definition of "inflation".
What is the purpose of the quote you just posted now? You'll have to explain to me. Obviously, money cannot affect relative prices magically without ever commanding on goods.
If you want to define inflation as an "increase in money" then OK. I don't know if that is what Mises really meant. It's possible that you are right. I would have to read that book in context (whatever book that quote is taken from).
I think, though, that one has to remember that the Austrian definition of inflation is still relevant to a change in prices. However, Austrians detached themselves from the mainstream definition (or, perhaps more accurately, never accepted the re-definition) because the original definition maintained causality. Changes in prices from changes in the quantity of money in circulation were separated from changes in prices due to a change in preferece (or distribution of a fixed amount of money in circulation). I think by defining inflation as simply an "increase in money supply" detaches the word from the original purpose, which was to maintain causality between changes in money and changes in prices. True, increases in the amount of money may lead directly to an increase in the quantity of money in circulation, but the latter is the most relevant part related to the consequence change in [relative] prices.
I know this is an "eternal" debate between more Rothbardian (and I don't mean to regard them as "non-Misesian"; neither side is "non-Misesian") scholars and "Hayekian" scholars (free bankers, namely), and I obviously do not have sufficient command of all of Mises's writings to really speak authoritatively .
Jonathan M. F. Catalán:I think by defining inflation as simply an "increase in money supply" detaches the word from the original purpose
As Mises will explain to you later in the course of your reading, the original purpose always served a pseudo-economic purpose. Mises then rejects the entire concept and declares that it serves no purpose in economic analysis. I tend to agree with him on that.
Jonathan M. F. Catalán:I know this is an "eternal" debate between......
There is no "eternal" debate in my opinion. That some "free bankers" (and I won't name names) reduce the argument over what does or does not distort prices to one over the definition of inflation shows that they do not understand the causal effects as well as they think they do.
It's only a definition.