Look to Expansion of Money Supply & Devaluation of Dollar to Assess Inflation; Product Price Stability Fools Us.

Featured Article: The Definition of Inflation

Put very simply, inflation is defined by the expansion of the money supply. In the United States the money supply is controlled by the Federal Reserve Bank, therefore the Federal Reserve Bank is the source of any inflation that creeps into the system.

The Federal Reserve Bank has many ways in which it can increase the money supply but one of the most well known ways in which it does this is simply by reducing interest rates. By reducing rates, the cost of borrowing from the Fed becomes cheaper, and therefore more borrowing is triggered.

When the Fed does increase the money supply, they use many terms to try to disguise what they are doing. Some of the terms used include: monetary easing, increasing liquidity, quantitative easing, increasing the monetary base, among others. However, when the Fed uses any of these terms what the Fed is saying, in essence, is that they are increasing the money supply and therefore creating inflation.

One of the misconceptions of inflation is that inflation is an upward price movement of goods and services in an economy. However this definition is wrong, and demonstrates the lack of understanding about what inflation really is. Upward price movements of goods and services are a symptom of inflation but not inflation itself.

In fact, when the Federal Reserve Bank increases the money supply and therefore creates inflation it doesn't always result in an immediate increase in the price of goods and services. The money printing by the Fed can result in asset bubbles in other sectors of the economy well before an upward movement of prices is seen in goods and services.

This was demonstrated in the past decade by the numerous asset bubbles that were created as a result of loose monetary policy of the fed over the past decade or so. These asset bubbles included the NASDAQ bubble, the real estate bubble, and most recently the bond bubble.

However there are a finite number of asset classes that can be inflated before inflation ultimately reeks havoc on the prices of goods and services within an inflationary economy. This is the most dangerous consequence of inflation, and if inflation is not kept under control, spiraling costs of food and energy and the hyper-devaluation of a currency can be the most disruptive consequences of inflationary policies.

InflationNationWebsite, Featured Article (author not identified).  08/14/11