Part 1: Is Inflation The Same Thing As A Rise in Prices?

“U.S. Inflation Hit 31-Year High in October as Consumer Prices Jump 6.2%” reads a headline from the Wall Street Journal on November 10, 2021. 

Well, that sounds scary. But what does it mean? What in the heck is “inflation”, anyway? 

Is inflation the same thing as a rise in consumer prices? 

No! It is not. 

To be sure, this headline is important and contains information that every budget-conscious American shopper needs to be aware of. But whenever I see headlines like this, I always feel a not-so-slight slight twinge of frustration. Why? Because typically, the words “inflation” and “prices” are thrown together indiscriminately in a way that both conflates the two concepts and fails to adequately explain to the reader exactly why, and how, the inflation is happening. Confusion abounds…

Inflation is not the same thing as a rise in consumer prices. The rise in consumer prices is a result of inflation. Not the definition of inflation. Let me explain.

When you read the word “inflate”, what do you think of? Probably something inflating, or increasing, right? Every discussion of inflation is closely accompanied by a discussion of an increase in consumer prices, so it make senses in the mind of the typical reader that consumer prices must be the things that are “inflating”. 

It’s true that an effect of inflation is an increase in consumer prices. But inflation itself is actually a decrease in the value of money as a result of an increase in the supply of money. Whenever there is a greater supply of something, the value of that thing decreases. Money is no exception. An increase in the money supply means that every dollar is worth a little bit less, meaning you can purchase fewer things with that dollar. The purchasing power of that dollar has decreased. That is inflation. A crucial result of inflation is that because every dollar is worth a little bit less, one needs a greater number of dollars than they needed before the inflation occurred to buy the exact same item. This leads to an increase in consumer prices.

You might be thinking to yourself, okay, this is a sort of interesting hair to split. But why does it matter? If inflation and increases in consumer prices are so closely paired, what’s the problem with news headlines using them interchangeably?

Well, is inflation the only cause of increased prices? No! Far from it. 

As the typical American shopper knows, the prices of many goods and services they regularly consume are rising and falling all the time. When a grocery store has an excess inventory of produce they need to sell, the produce goes on sale and the prices drop. When a gas pipeline experiences a disruption, the supply of gas is temporarily limited, and prices increase to reflect this shortage. Differentiating inflation from an increase in consumer prices matters because increased prices can be caused by both changes in the underlying markets for those goods – supply and demand – and inflation. This crucial point is lost in any discussion that confuses the two.

Incidentally, the current state of the world in November 2021 is a perfect illustration of how inflation and increased prices get confused, and why it matters. In the subheading to the article quoted above, the WSJ elaborates that “pandemic-related shortages” and “strong consumer demand” continue to contribute to historic inflation. Well, it’s certainly true that shortages and increased demand will cause an increase in consumer prices, but they do not cause inflation. Shortages, increases in demand, and increases in the money supply (inflation) are each separate causes of increased prices. See what I mean?

Twenty months into the Covid-19 pandemic, we are still experiencing widespread and sustained disruption to local and global economies through government policies such as lockdowns, stimulus packages, and paying people to stay home instead of work. The WSJ points to two of these factors as contributors to an increase in consumer prices: disruptions in supply chains leading to global shortages as a result of lockdowns, and an increase in consumer demand as some sectors of the economy begin to reopen. Notice, these two factors are not inflation, though they lead to price increases. They are changes in the underlying markets as a result of disruptions to the economy. 

Closely related to an increase in consumer demand is the series of stimulus packages issued by the government since the pandemic began. The most recent stimulus package was the $1.9 trillion American Rescue Plan Act in March 2021. These packages arrived directly in the hands of consumers in the form of stimulus checks, thereby leading to both an increase in the supply of money – inflation! – and an increase in consumer demand. Take a look at the graph below of the total money supply in the United States:

See how the curve increases dramatically in the year 2020? Since February 2020, the total money supply in the United States has increased from $15.5 trillion to nearly $21 trillion in September 2021. In less than 2 years, the money supply has increased $5.5 trillion – the fastest rate of increase, by a long shot, since 1970 according to the graph. We’re talking trillions here. Is any normal person able to conceive of how much one trillion is off the top of their head? I sure can’t. Google to the rescue!

…And that still doesn’t really help me wrap my brain around this. Apparently, if you stacked $100 bills on top of each other, $1trillion would stretch 631 miles. That means the $5.5 trillion increase would stretch 3,470 miles. That’s 13.75 times as high as the International Space Station, or 670 miles longer than the width of the entire US from east to west. 

Remember back in the spring of 2020 when governments across the globe began initiating shutdowns in response to the pandemic? Many people believed that they were necessary. Remember hearing things like “we must prioritize lives over the economy” or “people over dollars”? At that time, I was deeply worried about the lockdowns, but knew that I couldn’t talk about it in the face of the shock of a new virus and its victims. That would be tactless. No one wanted to hear about the economic ramifications.

My purpose is not to debate the assumed necessity of lockdowns from a medical or political perspective. Instead, I simply want to make an economic observation: you cannot shut down entire countries and economics without creating far-reaching ramifications the likes of which no politician or doctor could measure or imagine at the time of implementation. People’s lives can’t be prioritized over the economy – the economy consists ofpeoples’ lives. The economy is people. It’s not either/or. Right now, we are experiencing a potent combination of both changes in the underlying supply and demand for various goods and services, and an overall increase in the money supply – leading to the highest annual year-over-year inflation we’ve seen in 30 years. Artificially increased prices and the structural distortions they create will affect all of us for decades, and will hurt the most vulnerable among us the most.

Speaking of supply and demand, recall our earlier definition of inflation as being a decrease in the value of money as a result in the increase in supply. Did you know that there is a supply and demand for money itself, just like any like any other good or service?

Stay tuned for Part 2 to this post…