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General Price Level and Inflation

  • Lester D. Taylor

Abstract

I turn now to what I have always thought are among the most difficult topics in economics, the concepts of the general price level and inflation. Inflation is, and always has been, easy to define as a rise in the general price level. But, what is meant by the general price level and what are its determinants? Of the two questions, the first is logically prior, for one has to know what the general price level is before changes in it can be discussed. The real task, accordingly, is to come up with a definition of the general price level that is fruitful for further analysis.

Keywords

Asset Price Aggregate Demand Natural Rate Purchasing Power Current Income 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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References

  1. 1.
    That all of the terms in fact are measured in some form or another is not the issue; the question is which of them can be meaningfully measured.Google Scholar
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    The Quantity Theorists - and Fisher, in particular - are dogmatic in connecting inflation to changes in the stock of money. As we have seen, excess aggregate demand is at root caused by excess monetization, so that there is truth in the dogma. In my view, however, it is better to see the problem in process terms, as the creation of a tide of purchasing power that floods onto the goods side of the pool of fluid capital and drives up market-clearing prices.Google Scholar
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    A major problem with quantity theorists, with the exception of Wicksell, is that they neither specify a reason why excess monetization occurs, nor do they spell out a mechanism whereby the excess purchasing power that is created eventually leads to inflation. The standard litany of quantity theorists is: “Suppose the quantity of money is doubled.” Clearly, the most fanciful deus ex machina for bringing this about is Milton Friedman’s helicopter that flies about spreading money to one and all.Google Scholar
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    I put aggregate supply in quotation marks in this sentence in order to distinguish aggregate supply as it is being conceived here from the aggregate supply that was defined in Chapter 3. Aggregate supply defined there refers to the flow of output that is currently emerging from production, whereas the aggregate supply defined here refers to the entire stock of goods embodied in the pool of fluid capital. The latter differs from the former by the addition of held-over inventories of finished goods from past production.Google Scholar
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    As discussed by Von Mises in The Theory of Money and Credit - and in great detail by Schumpeter in The Theory of Economic Development - demand-pull inflation necessarily results in `forced savings’. This is because the `extra’ purchasing power allows goods to be bid away (through higher prices) from those with lower willingnesses-to-pay. Indeed, Schumpeter saw this process as the essence of development, because it is the (new) purchasing power in the hands of entrepreneurs which allows resources to be transferred from old uses into new uses. Forced saving will be discussed below.Google Scholar
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    Since some production decisions take place at each point in time, the two pools defining aggregate demand and aggregate supply change continuously. Conceptually, therefore, changes in the general price level are also best viewed as occurring continuously, in response to the ebb and flow of the pool of purchasing power against the stock of goods embodied in the pool of fluid capital. However, as data are necessarily collected over intervals of time, rather than continuously, defining a price index that changes continuously is obviously a practical impossibility. Of existing conventional aggregate price indices, the one which comes closest to the continuously chained index which emerges from this discussion is the implicit deflator for GDP. This is because the implicit GDP deflator is, in principle, a current quantity-weighted index.Google Scholar
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    This follows from portfolio adjustment in which yields on different assets, including money, are equalized.Google Scholar
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    This might accordingly seem to imply a horizontal equilibrium yield curve, but this is not necessarily the case. The conventional view at present (at least in elementary money and banking textbooks) seems to be that long-term interest rates are determined as geometric means of expected short-term rates. [Cf., for example, Burton and Lombra (2000).] The normally positive slope of the yield curve is then seen as a consequence of the greater uncertainty which attaches to expectations the further they lie in the future. Another factor to be taken into account is the option loss associated with a long-term security as opposed to a short-term one. Since the future is unknown, an `investor’ unexpectedly needing money might have to sell a long-term security at a loss before its maturity. To compensate for this possibility, long-term rates will need to be higher than short-term rates. An additional liquidity premium will accordingly attach to short-term rates. For an analysis of this option effect, see Hlusek (1999).Google Scholar

Copyright information

© Springer Science+Business Media New York 2000

Authors and Affiliations

  • Lester D. Taylor
    • 1
  1. 1.University of ArizonaWilsonUSA

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