You’ve probably heard that inflation is defined as “the gradual increase in the price of goods over time.” Sounds like a simple definition of inflation, right? Well, not quite. The gradual rise in price is only one part of inflation. Think of the rise in price as the ‘second half,’ ‘part II’ or ‘the symptom’ of inflation.
Ok…so it doesn’t really define inflation then, does it? Let’s see what Webster’s dictionary defines inflation as:
“a continuing rise in the general price level usually attributed to an increase in the volume of money and credit relative to available goods and services”
Here’s the missing piece! Inflation happens because of an increase in the supply of money. The more money that’s created, the less your dollars are worth. That what causes your dollars to lose value – that’s what is behind the word inflation.
How To Cure Inflation
Milton Friedman, one of America’s greatest economists and author of Free to Choose and Money Mischief, defined the cure of inflation to be this:
The only cure for inflation is to reduce the rate at which total spending is growing.” The side effect to his suggested fix is this: “There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked.”
I hope this helps as you to understand inflation. We all feel the symptoms of inflation, but understanding the cause and cure of inflation is often left out of the conversation.
Your thoughts?
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{ 3 comments… read them below or add one }
Thanks for the insight Tim.
According to Friedman’s statement, it’s unfortunate that reducing spending would result in unemployment even though it’ll curb inflation.
But as far as an “investment cure,” TIPS keep pace with inflation, and stocks generally outpace inflation over the long haul.
No one wants to see higher unemployment, so that’s definitely an unfortunate side effect of reducing spending. Though…with unemployment still high…it makes you wonder how much the spending is doing. OR it makes you wonder how much worse off we’d be if there wasn’t spending. (Kinda hard to run split tests with a country…)
I need to do research TIPS some more. Would love to have a great article about TIPS! And I agree with you 100% about stocks – over the long haul, it’s quite the hedge against inflation.
Thanks for your always-thought-provoking comments!
Hi Tim,
Like you said, inflation happens when the money supply is increased… Now you would think that would make the Federal Reserve stop printing new money… but nope. They just keep on printin’ it up! Fingers crossed that we go into hyperinflation. My mortgage would be paid off so quick! I’m kidding of course, but that’s the direction they’re taking us on right now. My suggestion, invest in silver and gold.
Humbly Yours,
The Mayor
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