Authored by Frank Shostak via The Mises Institute,
In his New York Times article of March 27, 2018 — “Immaculate inflation strikes again” — Paul Krugman argues that those economists who are of the opinion that the key factor that causes inflation is increases in money supply are very wrong.
According to Krugman, the key factor that sets in motion inflation is unemployment. While a decline in the unemployment rate is associated with a strengthening in the rate of inflation, an increase in the unemployment rate is associated with a decline in the rate of inflation.
Note that for Krugman inflation is about general increases in the prices of goods and services, which is a flawed definition. To ascertain what inflation is all about we have to establish how this phenomenon emerged. We have to trace it back to its historical origin.
The Essence of Inflation
The subject matter of inflation is “an act of embezzlement.” Historically inflation originated when a country’s ruler such as king would force his citizens to give him all their gold coins under the pretext that a new gold coin was going to replace the old one. In the process, the king would falsify the content of the gold coins by mixing it with some other metal and return diluted gold coins to the citizens.
On this Rothbard wrote,
More characteristically, the mint melted and recoined all the coins of the realm, giving the subjects back the same number of “pounds” or “marks”, but of a lighter weight. The leftover ounces of gold or silver were pocketed by the King and used to pay his expenses.1
On account of the dilution of the gold coins, the ruler could now mint a greater amount of coins and pocket for his own use the extra coins minted. What was now passing as a pure gold coin was in fact a diluted gold coin.
The increase in the number of coins is what inflation is all about. As a result of the increase in the quantity of coins (inflation of coins) that masquerade as pure gold coins, prices in terms of coins now goes up (more coins are being exchanged for a given amount of goods), all other things being equal.
Note that what we have here is an inflation of coins, i.e., an expansion of coins. Because of inflation, the ruler can engage in an exchange of nothing for something (he can engage in an …read more