Do Price Increases or Money Supply Increases Misallocate Resources?

Inflation is defined as general increases in prices of goods and services

• A decline in unemployment or an increase in economic activity are seen as potential inflationary triggers, while other factors, such as increases in commodity prices or workers' wages, are also regarded as inflation triggers.
• Many experts also believe that inflation causes speculative buying, generating waste.

The Essence of Inflation

• Real incomes of wealth generators decline not because of general rises in prices, but because of increases in money supply
• Increases in the money supply through the exchange of nothing for something divert wealth away from wealth generators towards the holders of the newly generated money
• This is what sets in motion the misallocation of resources, not price rises

Oil Prices and Inflation

• If the price of oil goes up and if individuals continue to use the same amount of oil as before, individuals will be forced to allocate more money to oil. If one's money stock remains unchanged, less money will be available for other goods and services, which would drive down the prices of other goods.

Can Inflation Expectations Trigger a General Price Rise?

• Once individuals start to anticipate higher inflation in the future, they raise their demands for goods at present thus bidding the prices of goods higher
• The consumer determines whether the price set is "right" so to speak
• If the money stock did not increase then consumers will not have more money to support general increase in prices

Can Prices Be Stable under Inflation?

• If for a given stock of goods an increase in the money supply occurs, this means that more money will be exchanged for given goods, all other things being equal
• The purchasing power of money in these situations will fall, increasing the prices of goods
• In this case, a general increase in prices will be associated with inflation

Conclusion

• Contrary to the popular definition, inflation is not about general rises in prices but about increases in the money supply.
• General increase in prices as a rule develops because of the increase in money supply
• Policies that are aimed at countering inflation without identifying what is it all about only make things much worse 

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