Two Percent Inflation Is A Lot Worse Than You Think

The question then arises: If CPI does not do an adequate job of measuring inflation, how should we measure it?

The original meaning of inflation, and the one that Ludwig von Mises used, was defined as an increase in the supply of money. This leads to a decrease in the purchasing power of money (PPM), but this decrease in PPM is a result of inflation, not inflation itself.

In Austrian theory we know that the purchasing power of money is determined by 1) the total demand for money to be held as cash balances and 2) the stock of money in existence. Based on this knowledge, measuring the change in the money supply can give us important insight into one of the two factors that determine PPM. In this case, M2 is used, which includes cash, checking deposits, and highly liquid money substitutes such as saving deposits and money market securities.

Using BLS data we find that the M2 money supply grew from $3.83 trillion in 1997 to $13.22 trillion in 2017, for an average yearly increase of 12.25 percent.

This 12.25 percent is far higher than the 2 percent inflation we are repeatedly told to believe is occurring. The large disparity between M2 growth and CPI inflation can be partially accounted for based on the increased productivity that comes about from an increase in capital per person and the existence of new technologies. These factors contribute to an increase in quality of life for all people in a progressing economy in the form of lower prices, but current monetary expansion not only stifles these positive deflationary forces but also brings about nominal price inflation.

Additionally, since money is not neutral, new money entering the economy will not raise prices or wages uniformly. The recipients of new money creation benefit, while everyone else tends to lag behind. Empirical data support this conclusion, seeing as real wage rates of non-management private-sector workers have been practically stagnant since the 70s, even with large increases in productivity. Regardless, the Cantillon effect tells us that the first to receive and spend newly created money benefit at the expense of the rest of society, since they get to buy goods at their original prices and by the time this new money is received by others, the prices of goods have already increased.

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