Inflation Is Not Price Increases. Inflation Causes Price Increases.
Why is inflation regarded as bad news? What kind of damage does it do? Popular commentators maintain that inflation causes speculative buying, which generates waste. Inflation, it is maintained, also erodes the real incomes of pensioners and low-income earners and causes a misallocation of resources.
Despite all these assertions regarding the side effects of inflation, the popular way of thinking cannot tell us what causes all these bad effects. Why should a general rise in prices hurt some groups of people and not others? Why should a general rise in prices weaken real economic growth? Or how does inflation lead to the misallocation of resources? Moreover, if inflation is just a rise in prices, surely it is possible to offset its effects by adjusting everybody’s incomes in the economy in accordance with this general price increase.
Why Price Indices Cannot Establish the Status of Inflation
Despite its popularity, the idea of a consumer price index (CPI) is flawed. It is based on the view that it is possible to establish an average of prices of goods and services, which is not possible.
Suppose two transactions were conducted. In the first transaction, one loaf of bread is exchanged for $2. In the second transaction, one liter of milk is exchanged for $1. The price, or the rate of exchange, in the first transaction is $2/one loaf of bread. The price in the second transaction is $1/one liter of milk. In order to calculate the average price, we must add these two ratios and divide them by two; however, it is conceptually meaningless to add $2/one loaf of bread to $1/one liter of milk.
On this Murray N. Rothbard wrote:
Thus, any concept of average price level involves adding or multiplying quantities of completely different units of goods, such as butter, hats, sugar, etc., and is therefore meaningless and illegitimate. Even pounds of sugar and pounds of butter cannot be added together, because they are two different goods and their valuation is completely different.
Historically, inflation occurred when a country’s ruler such as the king would force his citizens to give him all their gold coins under the pretext that a new gold coin was going to replace the old one. In the process, the king would falsify the content of th
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