Defining and Understanding Inflation

It really amazes me how many people are out there who talk and write about a subject, yet have little clue about how wrong they are.  There are people like Paul Krugman, who I find hard to believe are stupid.  In his case, I think he is a fraud, but I'm not positive.  But I do know there are a lot of people out there who really just don't understand what they are talking about.  There are also some who have some understanding, but have no idea how to articulate what they want to say.

I received this comment recently in response to a blog post I wrote 5 months ago:

"The purchase by the Fed of Treasury debt obligations on securities, could be inflationary only if the economy were at full production and full-employment. Inflation does not occur automatically if new money is created and introduced into the economy. If the additional dollars are able to match up with available materials, productive capacity and wages to newly hired employees at current prices, there will be no inflation.
Since creation of new money is the result of deficit spending, it would be the responsibility of the Congress and the President to determine that deficit spending is not likely to be inflationary. In a deep depression or recession, deficit spending is not going to be inflationary."

The person making this comment first needs to define inflation.  He must be using the modern establishment's definition of rising consumer prices.  I consider inflation to mean an increase in the money supply.  To distinguish the two different meanings, I try to use the terms "monetary inflation" and "price inflation", so as not to confuse anyone.

This is a good example of why the definition of the term is so important.  The commenter must be defining inflation as rising prices, otherwise his second sentence would be a complete contradiction.  Replace the term "inflation" with "new money creation" in that second sentence.  It would then read: "New money creation does not occur automatically if new money is created and introduced into the economy."  Again, it doesn't make any sense, so he must be referring to rising prices.

But even here, he is still wrong.  He says that the Fed's purchases can only be inflationary if the economy is at full production and full employment.  This is his first statement in the comment and it is completely absurd.  Either he did not articulate himself very well or he doesn't understand monetary policy and the economy.  I read his first sentence to mean that you can never have rising prices unless the economy is at full production and full employment (which he doesn't define).

The 1970's was not that long ago.  There was double digit price inflation, along with high unemployment.  How does he think the high price inflation came to be, other than the Fed buying assets (monetary inflation)?

Even now, we don't have zero price inflation.  Even by the government's measures, the CPI has been running at around 2%.  Isn't this price inflation, even if it is low?

In the commenter's third sentence, he says that there will be no inflation "if the additional dollars are able to match up with available materials, productive capacity and wages to newly hired employees at current prices".  Doesn't this completely contradict what was just said in his first sentence about price inflation only occurring at full production and full employment?

Price inflation has gone up virtually every year for the last 50 years (in the U.S.), so is he claiming that we have had full production, full employment, and dollars not matching up in every single year?

He then goes on to say that the creation of new money is the result of deficit spending.  While the two are certainly correlated, even this is incorrect.  You can have deficit spending and not have any new money creation.  State and local governments do it all the time.  It will be investors or other governments who buy the debt at the going interest rate.  Not all debt issued by the U.S. government is bought by the Fed.

Also, there doesn't technically have to be deficit spending for the Fed to create money either.  The Fed is buying mortgage-backed securities now.  It could buy stocks, gold, real estate, or fine art if it wanted to do so.  The Fed has a legal monopoly over the creation of money.  It can create money by buying almost anything.  Traditionally this has been U.S. treasuries, but not always.

To end the comment, he writes that deficit spending is not going to be inflationary in a deep depression or recession.  Again, let's assume he is talking about rising prices.  While high price inflation is not as likely in recessionary conditions due to the likely increased demand for money, it doesn't have to be this way.  Again, look at the 1970's.  Even Ben Bernanke admits that the Fed can cause rising prices at any time if it credibly threatens to increase the money supply enough.  So while high price inflation is less likely in a recession, the commenter is still wrong on this point.  You can have price inflation and recessionary conditions at the same time.

There is a lot of ignorance out there.  If you are just learning economics, it is important to think through everything rationally.  There are people out there who may sound like they know what they are talking about, even using big words and jargon to sound like an expert, but it doesn't necessarily mean they have much to say that is actually correct.