One thing I learned when I took economics in university is that I don’t think a lot of people actually realize that economics is actually mostly just theoretical. It’s functionally just a bunch of theories.
For example, there is the monetary theory of inflation, also called the monetarist theory of inflation. You might not know the term, but you’re probably familiar with the theory:
Increase in the money supply increases inflation
This is a prime example of what I’m talking about.
For this theory to be true, it requires a boatload of assumptions.
- The money supply increases
- The increase in supply makes it to consumers
- Consumers aren’t putting the extra money in savings
- Consumers aren’t using the extra money to pay down debt
- Consumers spend the money in the market
- That spending is higher than normal spending, leading to increased demand
- Companies don’t respond to the increased demand by making workers produce more
- Companies don’t respond to the increased demand by hiring more workers
- Companies don’t respond to the increased demand by investing in machinery to automate production
- Companies don’t respond to the increased demand by increasing inventory
- No other factor has increased demand
- Companies raise their prices
This is the problem. These theories exist in a vacuum and are only true in very specific circumstances. But people who parrot this theory always leave this part out.
In this case, the market is very complex.
Consumers may not get all that extra money supply, and if they do, they may not spend it on more goods and services. If they do spend it in the market, companies may just increase supply instead of increase prices.
It’s not set in stone that an increase in money supply must lead to an increase in inflation.
There is only one thing that directly causes inflation: companies raising prices.
You see, inflation is the increase in the prices of goods and services in the economy. And if those prices increase, it’s because those who set the prices increased them.
Remember, inflation is not an autonomous phenomenon. It’s just a measurement.
Inflation affects the economy in the same way that a thermometer affects the weather.
Inflation measures the difference between the cost of goods at one point in time and the cost of the same goods at a later point of time.
Inflation measures that difference; it doesn’t cause that difference.
The costs of those goods are set by the companies who sell those goods. If they increase their prices, it’s because they chose to increase their prices.
Now, it may be possible that those who decided to increase their prices did so because they thought demand for the products and services was too high, but that’s certainly not the only factor they consider when deciding to raise their prices.
Maybe a drought halfway across the world devastates production of raw materials they need for their products, leading to an increase in the price on the reduced supply of that input.
Maybe a war in another country leads to an increase to the price for the energy they need to produce their product.
Maybe they opened multiple locations or bought new machinery, driving up their operating costs.
Maybe their unionized workers recently won a new contract, which includes wage increases, or maybe they hired more workers.
Maybe their shareholders are demanding better dividends.
Maybe their competitors are raising their own prices.
The list goes on.
Even so, none of these directly increase the prices of goods and services in the market. They are all simply factors that are considered by those who do choose to increase those prices.
Even if their reason for increasing prices is reasonable, they are the ones causing inflation.
The government doesn’t cause inflation. You and I don’t cause inflation.
Companies cause inflation.
