The Curse of Inflation

Important Update from the blogger: I have lost count on how many visitors visited this article. Unfortunately, along with my growing understanding on the very issue, I must confess that my thought in the later part of this posting has been flawed, so it a serious revision is in order. Please accept my apologies. As a quick fix, I have crossed the lines where I think I was mistaken. Suffice it to say here here that inflation is man-made; and as long as governments keep printing money "out of thin air," inflation will haunt us.

A household word practically at the tip of every tongue, inflation is an invisible hand that curtails what every unsuspecting citizen earns, like any other authority-imposed taxes. Ours is the age of inflation; its existence goes so much without saying that one would be equally damned whether or not to question about it.

What is inflation by the way? What do we know about it? Can we live without it?

By popular definition inflation is "an increase in the general price level, which results in an excessive or persistent increase, causing a decline in purchasing power" [G. Mankiew]. Having witnessed how prices move all this time, you'd probably agree with the casual definition.

Yet that definition actually does not define inflation; rather, it only defines the consequences of inflation. It does not tell us what it is and what causes it.

There is another, and relatively older, definition saying that inflation is "an increase in the amount of money and credit in relation to the supply of goods and services." This irrefutable proposition offers a clearer and more straightforward definition of what inflation is. It seems rather strange to me if this more straightforward definition is often neglected or "abandoned" by many economists today--I haven't seen it quoted so except in "out of date" texbooks and dictionaries (maybe I just need to search more). Anyway, in simpler terms, inflation means there is more money pursuing the available goods or services.

Since inflation essentially concerns the behavior of money, the concept and nature of money cannot escape the discussion about inflation; but this is beyond the purpose of this posting. Fiat money, or the money as we generally know today, is a kind of limited good in itself. It is subject to the supply and demand. Thus, inflation can happen under any of the following supply-demand circumstances:

a) The supply of money goes up; b) the supply of goods/services goes down; c) the demand for money goes down; and d) the demand for goods/services goes up.

At the time of this posting, in Indonesia there has been a new frenzy about buah merah, or the red fruit of Papua. This fruit is believed by many to have amazing potency to cure various diseases. Its market price, sold as elixir, has remained on the increase. Three months ago, a relative of mine bought the elixir at Rp. 100,000 a bottle. Last week, a colleague sold it to two other colleagues at Rp. 375,000 each. Has inflation occured? Yes, it has; it has caused a price increase, albeith perhaps just a temporary phenomenon, hardly imparting pressures other goods.

What if a government increases the price of fuel, which as a result, causes other prices to move correspondingly? Has inflation taken place? Indeed; in this case inflation is working itself as a force towards price readjustment following some sort of price distortion. This kind of inflation is more long lasting and 'infectuous".

An important feature of the price increase from such inflation is that it does not happen at once; it happens sequentially and needs time before it peaks up and eventually steadies or abates. (Bank Indonesia has been criticized for not moving quickly to tamper inflationary pressures caused by the government's decision to remove the fuel subsidy. Moreover, the rising price of world's crude oil has been reason enough to be worried of global inflation.)

To return to the 2nd definition above, the major cause of inflation is the increase in the supply of money. Of course, as implied in the case where demand increases, inflation can occur for other reasons. Still in Indonesia, in areas struck by natural disasters in North Sumatra, which destroyed the supply systems, we saw an almost immediate rise in prices, as goods were becoming scarce relative to money. Yet this kind of situation is extraordinary; for the most part, it is caused when the money supply rises faster than the supply of other goods and services. This is a strong reason why that any effort to combat inflation in any country should attack the causes of increase in the money supply.

A systematic increase in the amount of money and credit occurs through and by banking activities. Most banking activities in the world have been possible through the so called credit formation due to the adoption of the fragmentary reserves by the central bank. Thus, a great many factors of inflation rests with the central bank, an institution that, ironically, vows to "maintain stability" and "curb inflation."

In a world shrinking with globalization, in a more and more open economy where capital can trottle the globe at a time when exchange rates are allowed to float freely, the phenomenon of inflation has aggravated and become so complicated that no country may be able to solve it singlehandedly if it so aspires. The world's economy has interlocked in such a system, and most governments and central banks are preoccupying very hard with the efforts to curb the consequences of inflation without addressing its main cause.

This brief article has tried to hyphotesize that the interlocking of the world's economy under the present hedonic monetary arrangement cannot mean otherwise than that inflation has been and will remain with us. With no alternative system on the horizon, it seems that the curse of inflation will remain with us for a very long time--perhaps for as long as we live.