Inflation

Today I was reading a book by Murray Rothbard, and I hope I learned something about inflation and the business cycle. First, let me get clear about definitions. I read in my economics textbook that inflation is a general rise in prices. To me, this says that there is no good definition of inflation. I suppose that during any given time period, some prices will have gone up and others down, but what proportion of prices have to go up for the rise in prices to be "general"? Obviously, this definition is as good as it can be, and there would be no benefit to making it more precise. Perhaps if I consume only one item, wheat, then inflation to me would mean that the price of wheat is rising. But any one consumer will consume a great number of items, and not all consumers consume the same set of items. So inflation must need to be measured by some kind of average, squishy number.

Next, what can I say about the cause of inflation? Let's suppose for now that the money supply is fixed in an imaginary economy. It's reasonable to also suppose that not all of the money supply is circulating. Any given person in this economy will probably consume a certain amount and save a certain amount, with those being the only two options. But what would happen if consumption started to increase while the number of goods in the economy stayed the same? This extra desire for consumption relative to the same number of goods would drive their prices up. I think this is called demand-pull inflation.

Let me now take this a little further and more general. It seems that any time the amount of money being offered for goods rises with the amount of goods staying the same (or decreasing) then prices will go up. I believe this is just what the law of demand claims. And so the inflation I just described seems like nothing but a corollary of the law of demand. Now I wonder how else this rise in circulating money relative to goods can happen. From reading Rothbard's book it seems this can also happen as a result of government creating new money, which he reasonably claims they would do as an easier alternative to taxation. If new money is created by government, then it seems there would have to be some inflation. But the inflation would be uneven. The initial recipients of the new money would be able to spend it at un-inflated prices. Eventually, later recipients would have to suffer the inflated prices, as would those who were saving money which turned out to be spent at inflated prices. Maybe there is some good to money creation by government, but it does not seem to do any good for those who see their monetary units decline in real value as a result.

Rothbard also explains that inflation is also a cause of the business cycle, which is a cycle of high and then low employment and real GDP. Here's how money creation by government seems to cause this cycle. Suppose that the newly created money is loaned to businesses, who intend to use this money to invest in future growth. What I mean by that is that this money business put to use does not increase their output in the present, but will do so at some time in the future. The problem with that is that these counterfeit loans to business do not reflect savings on the part of consumers. If they did, then it would be some indication of consumers deferring consumption for the future. But the loans are not of the result of savings and consumer willingness to defer consumption. So, what we have is business planning for greater future output, rather than present output, and consumers wanting greater present output. Because of this mismatch, the businesses will then find it best to liquidate the original investments, and I suppose the misdirected energy and resources which results in the down side of the business cycle.

Now, I'm sure that I've gotten a lot wrong about this. But like most arguments I read concerning economics, it seems that if the premises are true, then the conclusion does logically follow. I guess the controversy lies in whether the premises are really true. With this explanation of the business cycle, I'll take the premise that the counterfeit loans cause businesses to devout resources to future output. If that doesn't turn out to be what consumers want, then why don't businesses just re-employ those resources to the present? It seems that part of being successful in business would be to adjust to consumer demands.