Tuesday, April 19, 2011

Paul Krugman is (Mostly) Right on the Definition of Inflation, Although He Gets Slick About It

Paul Krugman writes:
One thing I see here and there — on blogs, in comments, etc. — is the claim that inflation is defined not by the rise in prices but by the expansion of money and credit, with prices just as a symptom.

Actually, no. Words mean what they are taken to mean, and if everyone uses the word “inflation” to refer to the CPI, then that’s what it’s about. If you have a theory that says that inflation in this sense is always the result of money expansion, fine — but that’s a theory, not the definition.
Economists of the Austrian school are those mostly likely to refer to inflation as an increase in the money supply. It is obviously different than the sense in which the general public uses the term.

Krugman is correct in that the general public uses the term to mean an increase in prices--(although Krugman, slick as ever, wants to narrow the term to mean only an increase in the government released CPI number).

There is a very important reason some Austrians tend to stick to the older, less used, definition of inflation. By sticking with the older, less used definition of inflation, as an increase in the money supply, it focuses the debate where it should be, since it is the increase in money supply that causes distortions in the structure of the economy and also causes increases in prices.

But there also is a major danger for Austrians in using this definition with the general public and telling the general public that they are wrong when they refer to increasing prices as inflation.

First, the general public does use the word inflation to mean an increase in prices and, as Krugman correctly points out, those that use the term inflation to mean an increase in prices are not wrong:
Words mean what they are taken to mean...
Secondly, by stating that "an increase in prices is not inflation", Austrians are confusing the very people that they want to educate about the dangers of money supply increases. It is not wrong to call increasing prices inflation. It is a standard commonly used definition of inflation. How enlightening that definition is, is certainly another thing. But any Austrian telling a member of the general public they are wrong about inflation being an increase in prices is really getting off on the wrong foot and, forgive me guys, it is going to move you a bit into the nutso category.

The best solution to this problem I believe was created by Harry Browne, he was the first, as far as I know, to differentiate between price inflation and monetary inflation. These are the two terms I generally use here at EPJ, although I will sometimes simply use inflation when it is clear I am referring to inflation in the popular sense. But my use of price inflation and monetary inflation has not been with out critics. The most persistent critic has been Taylor Conant. Recently, in a comment to a post he wrote:
 "Price inflation" = more technical?

I just got done with Mises' section on Indirect Exchange in Human Action and he never once used the term "price inflation." He did decry people who used the term "inflation" to mean price increases and said it hides the true source of price increases. He referred to price increases as... price increases.

I am not sure what any Austrian gains by corrupting the terminology this way and relying on "more technical" terms like "price inflation"
Aside from Conant mostly using an argument that amounts to nothing but an appeal to authority, which I will ignore, Conant is simply wrong. By using the term "price inflation" you are signalling to the person you are conversing with that there may be other things to be looked at besides increases in prices, and that they legitimately have value in being called some kind of inflation. And there is nothing wrong with following up someones use of term inflation, in the sense of rising prices, with the comment, "Well that's price inflation, but the real problem is monetary inflation, which is an increase in money supply that ultimately results in a general price increase."

By doing this, you are automatically removing yourself from the nutso category of telling someone that inflation isn't and increase in inflation, when that is the common usage. It also eliminates one of the very few times Krugman has a legitimate point of attack against Austrians. But more important, by using the terms price inflation and monetary inflation, you are signalling to the person you are talking with that you have a much more detailed understanding of the topic then they do and that money has impact on the economy, versus starting off on the wrong foot and declaring that price increases are not inflation.

Every dictionary I looked at online has an increase in prices as part of their definition of inflation (though some of the definitions are very convoluted). The battle was lost a long time ago over the meaning of the word inflation, but we can win the war by differentiating between price inflation and monetary inflation. If you attack Krugman in the comments on the point that he fails to take account of the difference between price inflation and monetary inflation and that he, as an economist should know the difference, you blow him out of the water and educate the public at the same time.

I hasten to add that I am not against battling to protect the usage of some words, especially when they are words that clearly have mixed meaning in the public. For example, the word privatisation first started out to mean changing something from state control and placing the operations in the private sector. Politicians have attempted to co-opt this term to mean, allowing private businesses to run government operations, which is an entirely different meaning. Given that many in the public do not make the fine distinction and would accept both definitions, it is important to attempt to keep only the former as the term so that the general public can understand the difference. But this terminological battle on privatisation can only be fought because a specific definition has not been adopted by the general public and arguing the point can help make the two senses in which the term is used much more clear. The term is not ingrained enough in the general public psyche so that the general public will look at you as a nut job for being a stickler on the word.

That said, if at some point in the future privatisation clearly begins to mean private operators of public entities in the eyes of the public, I will give up the battle over the word and continue to fight the concept.


  1. Sometimes you write some very strong posts. This is another one of those!

  2. Another nice example where "words mean what they are taken to mean" is that the general public might call Krugman an economist; but anyone with a shred of economic knowledge recognizes he gave up the economic way of thinking long ago, and now only uses the technical terms of economics to make it sound like the things he's talking about have some sort of basis in science.

  3. Interesting... though I have a *slightly* different take.

    The definition I keep in my mind is one selected because it is the most meaningful IMHO... It is an increase in the money supply over and above the size of the economy to utilize it.

    Increasing the money supply for a growing economy and trade in that currency... defines overall price stability, does it not? Larger economies demand more currency to conduct business.

    My definition is rooted in money supply, and tied closely to drivers of price inflation.

  4. I must say that I myself refer when I can to "price inflation" and "monetary inflation" separately as well. Good discourse habits involve coming to terms; those participating in a discussion must know the intension of the concepts employed by each other if they are to understand what is being said. If an Austrian sticking to the archaic definition of inflation encounters a neoclassical, a Keynesian, or a mainstreamer in a debate, this may cause some needless confusion and disagreement. By resorting to "price inflation" and "monetary inflation" Austrians and orthodox economists can better come to terms.