Economists Do a Lousy Job Teaching Students about Inflation

Abstract

Inflation was not always defined as an increase in the price level. It used to be defined as an increase in the money supply. Then, in the discussion of the definition, it was noted that such increases were often accompanied by increases in prices of both assets and goods. The increase in the money supply was the inflation; the rise in the price level was an associated effect of inflation. That definitional focus of inflation on the money supply was abandoned as economists started to develop better measures of the price level. As they explored the problems with measuring the price level, they developed conventions as to what goods would be included in “inflation.” Eventually, inflation became thought of as the change in the price level of produced goods. Economists created formal measures of output (produced goods) and price indices, developing well-specified concepts such as real GDP, GDP Deflator, CPI, core CPI, and CPE, among others. People’s conceptions of inflation followed those formal measures, and earlier monetary definitions of inflation faded. That led to the way most people think of inflation today — as an increase in the price level of goods as measured by a produced goods inflation index. What is left out of these “produced goods price” definitions of inflation is assets. Thus, as inflation has become associated with changes in the price level of produced goods, the price of assets slowly moved out of definition of inflation, and what might be called asset inflation fell from economist’s radar screen. The problem with that definition of inflation as only relating to produced goods is an arbitrary convention — a convention that hides the inescapable definitional ambiguity surrounding inflation. It is that definitional ambiguity that makes it difficult to discuss the recent history of inflation, which has experienced large increases in the money supply, but only small increases in the goods prices. Is this an inflationary period? It would definitely be an inflationary period in the earlier money supply definition of inflation. In that earlier definition, the increases in the money supply would be seen as the likely cause of an asset inflation.