Why Does the Definition of Inflation Matter?

We discussed the definition of inflation in a lot of detail in the previous article. The previous article was meant to bring to the readers notice that the current definition of inflation is flawed. Instead a previously used definition was capable of defining the concept in a much better manner. This brings up the question, “why does the definition even matter so much?”

We will dedicate this article towards answering this question. In the remainder of this article, we will discuss the negative effects that have taken place because of the failure to define inflation correctly. In this article, we will state why the definition of inflation matters!

A well defined problem is a problem half-solved. Similarly, a badly defined problem is a problem further away from resolution. The wrong definition of inflation leads to confusion. The underlying causes that are bringing about the inflation are never discussed. Instead, the effect of inflation is assumed to be its cause. There are many economists in the world that can solve the problem of excess debt, excess government spending and so on. However, if instead of the problem, they are given its effect to work with i.e.rise in prices, there is very little that they can do to control the situation.

Also, since inflation is defined as rise in prices, it is also measured as rise in prices. Now, this creates some very big problems.Firstly, it is extremely difficult to find out on average, how the prices of all the goods in the world have changed over the past year or so and come with an accurate figure. This creates other problems like indexing and what should be included in the index and what weight should be assigned to it? Also, it creates other issues like updating the index over and over again as time progresses. All these lead to incorrect measures of the gravity of the situation. Wrong data becomes the basis for wrong decision making!

Defining inflation as a rise in price obfuscates the data relating to the true cause. For instance, prices could rise as a result of shortage or because of logistical errors. This creates confusion. The primary tool of the government to fight inflation is monetary policy. Now, there is very little the government can do by increasing and decreasing interest rates as far as supply side issues are concerned. Hence, defining the problem incorrectly leads us to the wrong causes.

If inflation is caused by inflating the monetary medium i.e. by printing more currency, then we know for a fact that should be held accountable for a rise in inflation. The currency of any country is usually in the hands of its government. Hence, a rising inflation should be blamed on the government and its operations rather than supply side shortages and other such excuses used to deflect the attention from the root cause.

As customers, it makes no sense for us to argue with the shopkeepers or other counterparties. They may be charging us the higher price, but they too are affected by inflation caused by government policies. Almost all inflation is exclusively caused by government’s bad monetary policy.

Now, since the problem has been defined incorrectly in the first place, it is not shocking to see that almost everyone approaches the problem of inflation with the wrong mindset. Economists that have defined inflation as rising prices have implicitly suggested the use of regressive policies like rationing, price fixing and quota systems to hold the system in place. However, empirical evidence is 100% clear in its record. These measures have never proven effective over any time period and end up creating more problems than they intended to solve.

Hence, this wrong definition has caused decades of lost time and opportunities as well as billions of taxpayer dollars have been spent on dead-end programs.

The wrong definition of inflation has completely changed the nature of the study of inflation. What was once a simple cause and effect science is now being considered extremely complex and confusing. Myths and misconceptions about inflation are common. It is this muddled thinking that is causing the problem of inflation to perpetuate even further. The solution therefore begins by first clarifying the myths and misconceptions and starting new.

So, what’s in a definition? It seems like a lot is dependent on this definition. Hopefully you as readers will be able to point out the exact flaws in this modern definition, the next time you are exposed to it!

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.