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Which came first, more money or higher prices?

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Andrea Comas / Reuters / File

(Read caption) Bundles of money worth two million euros ($2.7 million) are displayed at a police headquarter in Madrid January 18, 2011. Does inflation simply mean that there is an increased supply of money?

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Inflation, as commonly understood, is a general rise in prices, as measured by some index, such as the CPI, RPI or RPIX. On such an understanding, high commodity prices driven by strong demand (or limited supply) are ‘inflation’. So is an increase in a sales tax (like VAT). This is what we are hearing from the Bank of England at the moment.

But is this view of inflation correct? Austrian school economists don’t think so. To them, inflation is an increase in the supply of money. Rising prices are merely one consequence of that underlying phenomenon. As Ludwig von Mises puts it:


Inflation… means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check. But people today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise. The result of this deplorable confusion is that there is no term left to signify the cause of this rise in prices and wages. There is no longer any word available to signify the phenomenon that has been, up to now, called inflation… As you cannot talk about something that has no name, you cannot fight it. Those who pretend to fight inflation are in fact only fighting what is the inevitable consequence of inflation, rising prices. Their ventures are doomed to failure because they do not attack the root of the evil. They try to keep prices low while firmly committed to a policy of increasing the quantity of money that must necessarily make them soar. As long as this terminological confusion is not entirely wiped out, there cannot be any question of stopping inflation.



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