Boom To Bust: How Inflation Turns Into Deflation

In order to understand the effects of inflation it is helpful to understand that inflation is not a general rise in prices as such, but an increase in the supply of money which then sets in motion a general increase in the prices of goods and services in terms of money.

Consider the case of a fixed stock of money. Whenever people increase their demand for some goods and services, money is going to be allocated toward these goods and services. In response, the prices of these goods and services are likely to increase—more money will be spent on them.

Board, Blackboard, Economy, Inflation, Money

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Since we have an unchanged stock of money, less money can now be allocated toward other goods and services. Given that the price of a good is the amount of money spent on the good, this means that the prices of other goods will decline, i.e., less money will be spent on them.

In order for there to be a general rise in prices, there must be an increase in the money stock. With more money and no change in the money demand, people can now allocate a greater amount of money toward all goods and services.

According to Mises in Economic Freedom and Interventionism,

Inflation, as this term was always used everywhere and especially in this country, 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. (p. 99)

Inflation is a process in which the last recipients of newly created fiat money are impoverished while the early recipients of this money are enriched. This process of impoverishment is set in motion as a result of an increase in the money supply.

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