Opinion and Economic Analysis

Hicks: Don't confuse inflation with supply and demand

July 26, 2014

Almost nothing in economics seems to confuse people as much as monetary inflation. That confusion leaves an intellectual void into which some of the least credible ideas of the modern world crawl.

Goods and services typically have a price dictated in currency, like our dollar. The prices for these goods can rise or fall for a variety of reasons. Sweet corn is cheaper at the end of July than at the end of June because it is more plentiful in July, and its price will rise again in late summer. This is simply supply and demand, not inflation.

We hear often about health care costs rising, but are they really? Almost no medical procedure is more costly now than it was a couple of decades ago. Health care costs and prices are falling, but we consumers are buying more of it because we are offered a dizzying array of medical services with which to make our lives better. This is also simply supply and demand, not inflation.

Inflation can occur only when the supply of the money used to make the transaction increases. Inflation is not due to some underlying change in the supply and demand for goods or services, but in an excess supply of the currency in which we measure the price of goods.

This growth in the money supply is a necessary, but not sufficient, condition for inflation to occur. We also need businesses that aren’t afraid to raise prices and workers who are unafraid to ask for higher wages.

In the wake of the Great Recession, we have had historic growth in the supply of money, but few businesses seem willing to boost prices and few workers feel inclined to demand higher wages. So, we have had modest inflation for several years.

This unwillingness to change prices has come as a bit of a surprise to many economists, including this one.

I know some readers think there is a grand conspiracy to lie about official statistics. That is nonsense of the first order.

It is true that inflation can be damaging and looms deeply over our future. This is especially true because the Federal Reserve has no historical example of a nation safely reducing the huge money supply we now have.

Still, the low inflation now is a sign of continued weakness in an economy that remains unable to grow and create jobs and opportunity. Why would the Obama administration lie about that? Moreover, does any rational reader believe this administration is sufficiently competent to hide such a large-scale lie?•

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Hicks is the George and Frances Ball distinguished professor of economics and director of the Center for Business and Economic Research at Ball State University. His column appears weekly. He can be reached at cber@bsu.edu.

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