Inflation
This article is part of the Basic Course on Libertarianism and the Austrian School of Economics-> Module 5: Austrian Economics and Free Market
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 over a period of time.
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Generalized:
- It is not only that the price of tomatoes rises, but that almost all prices rise.
- It is not an isolated rise in one 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 such as the CPI (Consumer Price Index).
2. The Classical and Austrian Definition (The Cause)
For thinkers such as Mises or the classical economists, the original definition of inflation was not the rise in prices, but the increase in the quantity of money (money stock) above real demand.
- From this point of view, the rise 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 on the market. If you print twice as many tickets but there is the same quantity 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 increase in the real production of goods.
But it goes far beyond “higher prices”:
- It is a process that begins with the artificial expansion of credit (central banks or fractional reserves).
- It generates distortion of relative prices (not all prices rise at the same time or in the same proportion —Cantillon Effect).
- It provokes misallocation of resources (bad investments in projects that do not respond to real saving/consumption preferences).
- It culminates in the business cycle: artificial boom → adjustment crisis.
Concrete example with a Pizzeria
1 Let us start from 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 and in circulation
2 The government intervenes in the economy.
Immediately afterward the president of the day issues (prints and puts into circulation) another 100 units of banknotes for various political justifications, for example:
- They could be delivered as a gift to a certain part of the population (a social plan) so that they vote for him and he is re-elected.
- It could be necessary to increase the size of the state with some other ministry (social justice).
- To raise salaries for state personnel (dignified 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 delivery.
- This demand is artificial; it is not that there are more citizens who need pizzas, but that now there is more money (little pieces of paper) to acquire goods.
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Consequences for the pizza maker:
- The pizza maker sold about 50 pizzas per week; now he sells 50 more pizzas, he sells 100 per week.
- Now the pizza maker needs twice the mozzarella, flour, and other ingredients, which he has to order from the supplier.
4 Consequences in the process: suppliers saturated
- 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 one cannot create 50 more units of mozzarella, flour, and other ingredients.
- Suppliers begin to show that they have no products and the pizzerias begin to press: sell to me first, before the other.
- Faced with this situation the supplier raises the price of inputs, which the pizzerias then raise as well, and thus the inflationary cycle begins.
Considerations to keep in mind
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Cantillon Effect:
- Those who first obtain the government’s money obtain 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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Under normal conditions (an open economy) suppliers could buy abroad and thus supply the pizzerias (at somewhat higher prices because of the transport 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, so 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 for the economy: Distortion of relative prices
- No one knows the real price of things; one does not know whether something is expensive or cheap; everything is always in continuous price increase.
- Inflation hits the poorest hardest; the middle class substitutes products; the upper class may come to consume less; the poor person who receives the money last (Cantillon Effect) is the most harmed.
6 Consequences for the economy: Misallocation of resources
- Because people spend money that entered artificially, entrepreneurs read false market data and make long-term investments.
- With our Pizzeria example, the owner of a Pizzeria would open another, given the great demand.
- However, when inflation is unsustainable, the government at some point must stop issuing and/or cut spending and reality presents itself, where the country produces 100 units and people require 100 units.
- This is where demand falls, bankruptcies and recessions begin, and the pizza maker must close the shops 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 against 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 understand the topic better, for example:
- For prices to fall, a measure the government could take is to foster an increase in the production of goods and services, for example: lowering taxes. If supply increases, with demand equal, prices fall.
This article is part of the Basic Course on Libertarianism and the Austrian School of Economics-> Module 5: Austrian Economics and Free Market
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Last updated: 2026-05-01
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