Inflation
This article is part of the Basic Liberalism Course -> Module 5: Notions of Austrian Economics
Last updated: 2026-05-01
Inflation
1. The Modern Definition (The Symptom)
The generalized and sustained increase in the prices of goods and services existing in the market during a period of time.
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Generalized:
- It is not just that the price of tomatoes rises, but that almost all prices rise.
- It is not an isolated increase in a price (that is a “relative price increase”), but a general phenomenon that reduces the purchasing power of money.
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Substitute for value:
- Under this view, inflation is measured through indices like the CPI (Consumer Price Index).
2. The Classical and Austrian Definition (The Cause)
For thinkers like Mises or the classical economists, the original definition of inflation was not the increase in prices, but the increase in the quantity of money (money supply) above real demand.
- From this point of view, the increase in prices is simply the consequence of inflation (the symptom), while real inflation is the "swelling" of the money supply.
- If money "inflates" (its quantity increases without backing in production), its purchasing power necessarily falls.
3. Inflation as "Loss of Purchasing Power"
Another very useful way to define it is by looking at the currency: inflation is the fall in the value of the monetary unit.
- It is not that things are more "expensive" because they are worth more, it is that your money is worth less.
- Imagine that money is a ticket to claim goods in the market. If you print twice as many tickets but there is the same amount of goods, each ticket now entitles you to half a good.
4. Inflation as a process
Inflation is a monetary phenomenon: an increase in the money supply (money + bank credit) above the real increase in the production of goods.
But it goes much further than “higher prices”:
- It is a process that begins with the artificial expansion of credit (central banks or fractional reserve).
- Generates distortion of relative prices (not all prices rise at the same time or in the same proportion —Cantillon effect).
- Causes misallocation of resources (bad investments in projects that do not respond to real saving/consumption preferences).
- Culminates in the economic cycle: artificial boom → adjustment crisis.
Concrete example with a Pizzeria
1 Let's start with a base example, a country X that:
- has 100 citizens
- produces 100 units of "goods and services" (Food, electricity, automobiles, etc.)
- has 100 units of banknotes issued in circulation
2 The government intervenes in the economy.
Then the president in turn issues (prints and puts into circulation) another 100 units of banknotes for various political justifications, for example:
- They could be given as a gift to a certain part of the population (a social plan) so that they vote for him and thus be reelected.
- It could be necessary to increase the size of the state with some other ministry (social justice).
- To raise salaries for state personnel (decent wages).
3 Immediate consequence: increase in demand
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Artificial increase in demand :
- People who generally did not buy pizzas, now that they have money instead of making them at home, order them for delivery
- This demand is artificial , it is not that there are more citizens who need pizzas, but now there is more money (paper) to acquire goods.
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Consequences for the pizza maker :
- The pizza maker was selling about 50 pizzas a week, now sells 50 more pizzas, sells 100 per week.
- Now the pizza maker needs double the mozzarella, flour, and other ingredients, which he has to order from the supplier.
4 Consequences in the process: saturated suppliers
- Suppliers suddenly need to produce double, but since the country only produces 100 units (remember at the beginning), they cannot supply the pizzerias.
- Out of nowhere, 50 more units of mozzarella, flour, and other ingredients cannot be created.
- Suppliers begin to show that they have no products and the pizzerias begin to pressure: sell to me first, before the other.
- In this situation, the supplier raises the price of the inputs, which then the pizzerias end up raising and thus the inflationary cycle begins
Considerations to keep in mind
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Cantillon Effect:
- The first to obtain the money from the government obtain the goods and services at a cheaper price.
- As time passes, prices rise and the last to receive money, (generally the worker), ends up paying the most expensive prices.
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In normal conditions (an open economy) suppliers could buy abroad and thus supply the pizzerias (with slightly higher prices due to the transportation of the merchandise from another country), which would greatly alleviate the inflationary process.
- However, in countries whose government protects its National Industry, they generally close imports or make them more expensive, with which the effect on inflation IS WORSE.
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Real cause vs consequence of the price increase:
- Consequence: At first glance, it would seem that the one raising the price is the supplier. This is the Marxist view that accuses "the capitalist" of raising prices.
- Real cause: If money had not been issued, none of this would have happened, cutting the evil at the root.
5 Consequences in the economy: Distortion of relative prices
- No one knows the real price of things, you don't know if something is expensive or cheap, everything is always in a continuous increase in price.
- Inflation hits the poorest the hardest, the middle class substitutes products, the upper class can end up consuming less, the poor who receive the money last (Cantillon Effect) are the most harmed.
6 Consequences in the economy: Misallocation of resources
- Because people spend artificially injected money, entrepreneurs read false data from the market, and make long-term investments
- With our Pizzerias example, the owner of a Pizzeria would open another, given the high demand.
- However, when inflation is unsustainable, the government at some point must stop issuing and/or reduce spending and reality sets in, where the country produces 100 units and people require 100 units.
- Here is where demand drops, and bankruptcies and recessions begin, and the pizza maker must close the locations he opened earlier and lay off his employees.
Conclusion
- Inflation occurs because money grows faster than production. It is an excess of means of payment in the face of a scarcity of objects to buy.
- Inflation is also a political phenomenon: governments use it (consciously or unconsciously) as a hidden tax (seigniorage) and as a way to socialize debts.
On this page we focus on the concept of inflation, there are several related topics that we do not explain and that are necessary to better understand the topic, for example:
- For prices to fall, a measure that the government could take is to encourage the increase in the production of goods and services, for example: lowering taxes. If supply increases, with equal demand, prices fall.
This article is part of the Basic Liberalism Course -> Module 5: Notions of Austrian Economics
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Last updated: 2026-05-01
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