To piggyback on nfreiling’s post, Krugman’s article makes several oversights which only muddy his analysis. First, he relies on the mainstream definition of inflation—a rise in prices. However, a more accurate definition for inflation would be “an increase in the supply of money”—something that has happened at a historically unprecedented rate if the following chart is any indication:
“The semantic revolution which is one of the characteristic features of our day has also changed the traditional connotation of the terms inflation and deflation. What many people today call inflation or deflation is no longer the great increase or decrease in the supply of money, but its inexorable consequences, the general tendency toward a rise or a fall in commodity prices and wage rates. This innovation is by no means harmless. It plays an important role in fomenting the popular tendencies toward inflationism. First of all there is no longer any term available to signify what inflation used to signify. It is impossible to fight a policy which you cannot name” (1949, pg. 423).
A key insight of Austrian economics is that money is not neutral. In other words, an increase in the money supply does not simply cause a general increase in prices. It will also change the patterns of profitable production. It is a fallacy to believe that inflation is harmless because an increase in prices will be offset by an increase in wages. While this may be true for some individuals, others will find their real incomes reduced. An increase in the money supply ripples through the economy, increasing prices as it goes. And as these prices rise, the early receivers of the new money benefit at the expense of the latter ones.
It is impossible to know a priori what the overall price level “should” be. Thus, it is shortsighted analysis to conclude that because prices aren’t higher than they are to then conclude that there has been no price inflation. In a society free from the ills of credit expansion and an ever-increasing money supply, the general trend of prices will be a steady decline. As the number of goods increases against a stable supply of money, prices will decrease. On the other hand, a stable price level under a system which does not adhere to sound money might be evidence that price inflation is indeed occurring—without it, prices might be even lower.
Krugman’s surface analysis also ignores that economic theory does not predict price inflation until banks begin to extend loans, while drawing down their excess reserves. Currently, banks are holding over 100% in excess reserves. Only when a significant portion of these reserves begin to “leak out” should we expect price inflation.
Lastly, Krugman ignores the myriad problems associated with measuring inflation. The go-to metric is the Consumer Price Index. However, this is an arbitrary basket of goods which are assigned relatively arbitrary weights. The CPI excludes the prices of “volatile” goods such as food and energy—items that often comprise a large part of the average individual’s budget. The CPI also only measures the prices of goods bought and sold, while ignoring stock prices. It is just as likely that much of the new money will flow into the stock market, and not into the physical marketplace.
Given these weaknesses, Krugman’s argument should be more carefully considered before anyone concludes that he has “debunked Austrian theory.”