Technology and financial innovations

Inflation is usually misdefined as a period of generally rising prices. Inflation, properly defined, is an expansion of the money supply. The problem is what we mean by “money supply.” Traditional definitions such as M1, M2, etc. have become less useful as a result of technology and financial innovations. Currently traditional measures of money are increasing while private sector debt is contracting and government debt is increasing. On balance, I believe total debt has actually increased, although there appears to be substantial contraction to come in the banking system as a result of overstated assets.

Rising prices is one of the effects produced by the “cheapening” of money. No index is capable of properly measuring these effects. All indices are subject to measurement errors. More importantly, all indices suffer from weighting and inclusion decisions. The Consumer Price Index (CPI) is published by the BLS and assumed to be a proxy for the effects of inflation. It purports to measure the rate of price changes for a typical consumer. It does so imperfectly, even with honest and accurate measurements. Inflation effects are not limited to consumer goods. Often they are felt in financial assets and capital goods (housing, capital investments by business, etc.) long before they show up at the consumer level.