What You Should Know About Inflation

In an earlier chapter I declared that inflation, always and everywhere, is primarily caused by an increase in the supply of money and credit.

There is nothing peculiar or particularly original about this statement. It corresponds closely, in fact, with “orthodox” doctrine. It is supported overwhelmingly by theory, experience, and statistics.

But this simple explanation meets with considerable resistance. Politicians deny or ignore it, because it places responsibility for inflation squarely on their own policies. Few of the academic economists are helpful. Most of them attribute present inflation to a complicated and disparate assortment of factors and “pressures.” Labor leaders vaguely attribute inflation to the “greed” or “exorbitant profits” of manufacturers. And most businessmen have been similarly eager to pass the buck. The retailer throws the blame for higher prices on the exactions of the wholesaler, the wholesaler on the manufacturer, and the manufacturer on the raw-material supplier and on labor costs.

This last view is still widespread. Few manufacturers are students of money and banking; the total supply of currency and bank deposits is something that seems highly abstract to most of them and remote from their immediate experience. As one of them once wrote to me: “The thing that increases prices is costs.”

What he did not seem to realize is that a “cost” is simply another name for a price. One of the consequences of the division of labor is that everybody’s price is somebody else’s cost, and vice versa. The price of pig iron is the steelmaker’s cost. The steelmaker’s price is the automobile manufacturer’s cost. The automobile manufacturer’s price is the doctor’s or the taxicab-operating company’s cost. And so on. Nearly all costs, it is true, ultimately resolve themselves into salaries or wages. But weekly salaries or hourly wages are the “price” that most of us get for our services.

Now inflation, which is an increase in the supply of money, lowers the value of the monetary unit. This is another way of saying that it raises both prices and “costs.” And “costs” do not necessarily go up sooner than prices do. Ham may go up before hogs, and hogs before corn. It is a mistake to conclude, with the old Ricardian economists, that prices are determined by costs of production. It would be just as true to say that costs of production are determined by prices. What hog raisers can afford to bid for corn, for example, depends on the price they are getting for hogs.

In the short run, both prices and costs are determined by the relationships of supply and demand—including, of course, the supply of money as well as goods. It is true that in the long run there is a constant tendency for prices to equal marginal costs of production. This is because, though what a thing has cost cannot determine its price, what it now costs or is expected to cost will determine how much of it, if any, will be made.

If these relationships were better understood, fewer editorial writers would attribute inflation to the so-called “wage-price spiral.” In itself, a wage boost (above the “equilibrium” level) does not lead to inflation but to unemployment. The wage boost can, of course (and under present political pressures usually does), lead to more inflation indirectly by leading to an increase in the money supply to make the wage boost payable. But it is the increase in the money supply that causes the inflation. Not until we clearly recognize this will we know how to bring inflation to a halt.