Tuesday, July 15, 2008


Inflation is in the news and blamed on the rise in oil and food prices. But, inflation is defined as a rise in the general price level, not the rise in the price of particular items. The only way that the rise in oil prices can cause inflation is if the banking system accommodates it by an increase in the money supply. If the money supply is constant, then a price rise for oil means a price drop for other things depending on their relative demand elasticities. The popular misconception of inflation causes us to look at the wrong policy options.


Jeff Deutsch said...

Professor Schmid, you are absolutely correct. Unfortunately, a basic understanding of inflation is so rare these days. People all too often confuse redistribution with aggregate expansion (or contraction), not only in monetary policy but also fiscal policy.


Jeff Deutsch

kievite said...

I would respectfully disagree as oil has a special commodity status. Oil as a scarce non-renewable natural resource now plays the role of global money.

Inflation is a sigh of weakening of the dollar. So it is natural the price of the oil is highly negatively correlated with the value of the dollar and as such can be used a measure of inflation.