Inflation is the relatively equal proportional rise in prices of products and labor and the attending decrease in the value of money because of it.⁽¹⁾ It makes a fixed sum of money easier to get, because it is worth less compared to your products and labor, but it makes the money you already have, and the fixed sums you have contracted for before the inflationary period, worth less in purchasing power than what you traded it for. Other things being equal, in a true inflationary period, your labor at the end of the period is worth the same as it was at the very beginning compared to other people's labor (i.e., the products and services you can trade your product or service for); it is just not worth the same amount of money. So that any labor converted into (i.e., traded for) money at the beginning of the period, is labor that was wasted in proportion to the amount of inflation. And any contracts that involve fixed or unchanging amounts of money to be paid out for a product or service over the period which turns out to be inflationary, make the contract worth proportionally more for the person who ends up with the good or service and less for the person who is being paid the money.

Contrary to recent terminology, however, inflation is not the general rise in prices of one or a few sectors of the economy, though such price increases might be part of an overall proportional rise in prices as the other sectors "catch up". It is not really inflation one is talking about when one says "Over the past decade, inflation in health care costs (or, say, in construction costs) have increased 63% more than the average rate of inflation." In such cases, houses or health care cost not only more in money, but more in the amount of contemporary labor that one would have to do to trade for them. That is not inflation, but is simply a rise in prices in health care or housing. It can represent any (or a combination) of seven factors: (1) one gets more from a doctor or a contractor, so that the increase in cost represents a proportional increase in what one receives -- this happens when one buys a bigger house (or one with more features) or when one gets medical treatment that might not have been available in the past; (2) people are willing to pay a higher proportion of their earnings for the same housing or medical care they paid less for earlier. This constitutes an increase in the relative value to people of housing or health care; it is a reflection of the fact that health and housing are more important to people -- as when people are more likely to be interested in, say, cosmetic surgery than they were previously, --or that it is scarcer, as in housing in a booming urban area. (3) There are greater costs involved, not because of higher cost prices to the contractor or the physician, but because he has to pay more people to be able to offer the same amount of service himself. This does not increase the amount of home or health care one gets, but increases the number of people one is supporting by buying homes or medical treatment. This happens when malpractice insurance increases or when construction licenses and taxes or inspection time increases. (4) People have greater "disposable" income --can get more luxuries and conveniences for their labor (money) as more products and services are available at cheaper costs-- so that they are willing to spend more on housing or health care without having to give up other necessities. (5) Greater income becomes concentrated among a smaller proportion of people, who are then willing to spend more on homes and health care and other things they want because they have greater income, though the general population does not. Their income may be sufficient and there may be enough such people that they drive up health care costs and essentially make adequate or better health care available to fewer people. In this way recession and inflation can co-exist. (6) Gouging: contractors and doctors find out that they can get almost anything they want for their services because enough people will figure out how to pay it (medical insurance arises, home mortgages are available). This may occur through oligopolistic practices or through physician shortages (whether intentionally controlled or unavoidable) in a free-market. (7) The same amount of medical care supports more people, such as those involved in health insurance, management, etc. as delivery and payment becomes more complicated. If a society has to support not only physicians and nurses for medical care, but health insurance company employees as well, it will likely spend more money overall on health costs even though not all of the money is going to those who provide the medical part of the care. This would, of course, not be true if insurance companies were able to take their wages out of money they actually saved for clients by reducing physician and hospital charges, but that is an unlikely circumstance. Health insurance cannot reduce overall costs of the system because it adds many more people to the system who live off it even though they provide no medical care themselves of any sort. None of these things, separately or in combination, is inflation. 

Gouging involves making an ethically unfair profit for a genuine (as opposed to fraudulent) service or product. As far as free market economics is concerned, technically there is no such thing as an unfair profit, an outrageous price, or therefore gouging. In the free market, a price is only too high, if no one will accept it. Anyone willing to accept a high price is doing what they want out of choice. And any price you can get for your services is a fair price. Gouging is an ethical, not a business or market concept. But then so is our disapproval of contract killing, fraud, counterfeiting, baby selling, etc. All of these things could have a place in the market if we did not try to prevent them by non-market means. Gouging occurs when one takes advantage of another's needs. It seems particularly odious, the more "basic" or important those needs are. Charging $12,000,000 for, say, a work of art does not seem reprehensible (from a purely transactional standpoint --as opposed to an opportunity cost (how that money might be better used) standpoint-- because anyone who is willing to pay that is doing so out of their own free choice; but charging someone extreme prices to make extreme profits to relieve their suffering, seems cruelly unfair. Their choice, though in some sense free, is not exactly voluntary or totally free. This does not have to be just health related -- for example a mechanic in a small town might charge a stranded motorist an exorbitant price to help him get somewhere that is important to him on time. 

Insurance, particularly insurance for which a great many payoffs are made in a scarce or oligopolistic market, has a curious way of probably driving prices in insured fields higher, as long as fees are able to be collected over and above the insured amount. It does so by passing certain costs on to people who are not buying the service being charged for. The concept of insurance is an important one in that insurance helps spread out among many people the financial (labor) part of the burden of relatively costly but unlikely disasters that basically strike unpredictably, unavoidably, and randomly. Everyone involved pays a little bit in order to avoid a large loss if they are the one who accidentally incurs the problem insured against. So far, that is a reasonable and fair idea. The process gets perverted, however, when all the following happen: a) insurers pay "the average" or "the going" rate charged for the work insured against or they pay some lesser percentage of that rate -- call either of these payments "the base" rate or benefit; (b) the vendor doing the work is allowed to charge the client whatever additional fee, over and above the base rate the client is willing to pay for, especially when the excess amount is purely profit; (c) this drives up the going rate or average cost for the service, and the insurance company then raises its base rate to compensate for that (in part to be competitively more attractive to its potential clients); and (b) and (c) then continue to "loop" or repeat. Step (b) is able to occur because psychologically a customer tends not to mind paying an additional relatively small amount for what is in total a rather expensive product or service. If your insurance company pays $100 for an eye examination, you may not object to having to pay an additional $10 out of your own pocket -- it seems at the time like getting a $110 service for only $10, because one does not count the premiums one has been paying. Similarly if your car is damaged and the insurance company pays $1200 but the body shop charges an additional $100. The problem is that this process can quickly spiral out of hand as base rates climb to catch up with the co-payments or additional charges.. 

When operated this way, insurance goes from being simply a protective plan to its becoming a collective pre-payment plan for continually more gougingly expensive services that some people may not ever use, or that they pay more for over time than they would have had they simply saved their money. A group of people not using a service at any one time is now paying (some or all of the costs) for the services being used by others when they need it. Somehow psychologically this seems acceptable to us when it concerns necessary services; it would seem preposterous for conveniences or luxuries. "You never know when you might need a business photograph to be made, so if each of you will pay me $2 per month, I will do a picture of you when you need it for your company for only $6 instead of the normal fee I charge." This is different from a pre-paid bank "Christmas Club" type of plan, because only some people will get the benefit of everyone's pre-need contributions.

It seems highly probable to me that if physicians, for example, were not allowed to charge additional fees, or if insurance companies told customers the maximum additional fee --in the form then of a co-pay-- they could be allowed to pay, or if insurance companies paid the actual amounts medical bills show (which they do not) and did not raise their benefits for purely profit price increases by physicians and hospitals, medical costs would not be so high or rise so rapidly.

In periods of rising inflation, changes may occur that causes some businesses to fail before a new non-inflationary equilibrium is reached, because the prices of all products and services will not likely all rise at once and because the equilibrium quantity of money needed to proportionally match all prices and costs at a new time for the same available products and services at a previous time will not have been reached. Necessities can often rise in price without much loss of demand, but conveniences and luxuries cannot. And mechanisms for increasing the amount of money in circulation to pay for equally rising costs need time to adjust. There is also the problem of "fixed income" or of incomes and prices determined by fixed amounts of money, rather than by what the money would purchase. Loans repayments, retirement income, etc. if made at fixed rates, buy less over time than the value of products and labor they represented earlier. In some cases that may be unfair to the people receiving the money - unfair in that it no longer serves as adequate or commensurate recompense for the contribution they made to earn it.

If my model of money is correct - that the amount of money available for products and labor needs to be commensurate with the potential amount of products and labor available, in order to facilitate trade and participation in the economy- then, theoretically, control of interest rates, along with bank reserve requirements, and the sale of bonds will expand or decrease the amount of money available in the economy to accomplish this. However, because there are inequalities inherent in where money is pumped into or out of the system in times of change in the money supply by these methods, although the end result may be the commensurate amount of money and labor is equal overall, it may not be that the money is in the right places to employ labor the most effectively, the most fairly, or the most reasonably. And it may be that prices will not rise proportionately equally, so although there is inflation for the most part, not all people and not all prices or companies are affected equally. Some may prosper while others suffer losses.

Other students may emulate this model and start their own group. That should not affect the trade of the first group then, for all it involves is another group of students dividing and sharing their labor rather than making their own individual lunches. As with the original group, the point is to (1) be more efficient in preparation of lunch, and (2) to benefit from each others' special culinary skills, so that the "profit" is saved time and energy, and more delicious food.

However, suppose some students want to join in with the original group, which is at full employment (but not at full capacity) in the sense of having balanced trade with each other, balanced work, and balanced benefit. An easy solution would be to take over the position of one of the initial group's members, perhaps someone who wants to go back to making his own lunches, or who will graduate from or drop out of school. But suppose no one wants to leave the initial group. Now there are a number of possibilities:

(1) The new person can offer some different benefit, perhaps a ride to and from school for everyone (who, we will say now walks to school) in exchange for lunch. If that is accepted, we still have a balanced trade situation with a new profit -- time and effort saved from walking to school for all the original people, and better lunch for the new guy without his even having to prepare his lunch.

(2) The new person can offer an additional food treat of some sort that everyone might accept in exchange for making one more portion for lunch. Again, we have an increased, but still balanced, trade situation.

(3) The new person can offer to do a portion of the work of one or more of the original members in return for a portion of their lunch. He may make two of the meats for one person in return for an appetizer and a dessert. Or he may make two of the meats for one person and make two drinks for another in return for an appetizer, a dessert, a vegetable, and a fruit. Now the trade situation has become unbalanced in the sense that some of the people are doing more work than others and receiving more benefits for it.

(4) The new person might offer to trade something, such as a ride to school, to one of the people for part of his lunch, so that the new person is not part of the lunch-making group as a group at all. The old group is still balanced as it was, but one member of it has traded his benefit of being in the group for something he considers to be worthwhile.

(5) The new person might offer someone in the group something for them to join a new group or to do something for him/her that prevents his/her still working with the old group. The old group, in order to stay balanced will have to adjust by doing without what that person made and thus making one fewer item to contribute, or by adding a replacement member. 

Suppose a different situation altogether now. Suppose (6) one of the members of the original group only eats half of each of his lunches, and somehow preserves the other half for future use. If he started with the group his freshmen year, he can retire from the group at the beginning of his junior year and live off the half of the food he has saved. This will mean the group will have to adjust as they did in (5) if they want to maintain the status quo.

None of this changes anything in any sort of inflationary way. In fact, it is difficult to imagine anything causing inflation in this trading organization. Suppose we go back to (1) above and the person giving the ride to school wants two items from each person's lunch. To recoup that they can each make one additional item for each other as well as the first item for the driver. Even if the original six people are maxed out making lunch for the others (i.e., are at full capacity) the only cases that would change anything are (1) and this last one, where they would each have to do without one or two items from their lunch and could not replace it, but would receive for those things the ride to school.

Until and unless money is added as a different commodity to be traded for, and unless money has a way of being added or subtracted to the system in some way not related to what is being traded for, there is no way to get inflation into the system, or any system, which trades goods or services for other goods and services.

Suppose (7) that the dessert-maker one day decides he would like larger portions of everything else in return for his desserts, and that the others all like his desserts so much that they agree to make larger portions for him/her. The others then decide that the larger portions look so good that they want them too. And suppose that everyone agrees, including the dessert-maker. At first, all that happened was that the dessert became more valuable then the other foods, but after a while the value of the other foods caught up. Now everyone is doing more work for lunch, but everyone is also getting more lunch. If the dessert-maker holds out to make the same-size portions of dessert, and everyone acquiesces to exempt dessert from the size-increase, everyone but the dessert-maker is doing more work, and getting more; the dessert-maker will be getting more for the same amount of work, so again his/her work will have increased in value, but there will still be no inflation. There can only be inflation (or deflation) when there is something serving as an intermediary for the trading of goods and services and the "value"⁽²⁾ of that thing falls (or rises) in proportion to the value of the goods and services themselves, while the relative value of the goods and services to each other stays essentially constant.

There are a couple of ways the value of money changes: (1) additional quantities of money are added to, or removed from, the system while the quantity of goods and services stays the same or changes more or less than the amount of money. (2) The reverse, where the amount of money remains constant but the quantity of goods and services available changes. (3) The overall amount of money does not change, but the portion of it that is being used for trade among the available goods and services changes. E.g., if someone or some group is hoarding a large proportion of money, keeping it out of circulation, those who are trading for goods and services with the amount of money left in circulation will have to make adjustments in their prices. For inflation to occur with these changes, however, there must also be an equalization of proportional pricing among all the goods and services. 

Until that happens to some great extent, differential rising (or falling) prices will only reflect different values of the goods and services involved. In the 1970's when OPEC raised oil prices, they were able to get and hold the new price while they were united because oil was a necessity for industrialized nations, and those who were able to pay for it, chose to do so. Those who provided other necessities, such as utilities, were able to increase their own prices, in order at least to compensate for the higher energy costs sustained by the companies and by their employees and investors. People who did work for these companies and people were able to then take their fair share of that money, etc. As everyone tried to compensate for the increase in energy and ensuing other costs, they raised their prices where they could. While some people could not, and suffered accordingly, at some point, all those who were able to achieve close to their previous standards of trade essentially completed an inflationary circle. Because of the temporal and piecemeal nature of this process, there is not only inflation that occurs, but also a certain amount of valuation changes, where some people lose and some win, as their goods and services lose or gain relative value to other goods and services in the economy. That could only be prevented, and permit only inflation, if the original price increase in oil were immediately offset by all other prices and contractual payments, and if the right amount of new money needed was added to the economy in all the correct places simultaneously. That would be difficult to compute and to implement. If it were easy to compute and implement, no initial inflationary price hikes would occur if everyone knew they could gain no advantage from it, and would only waste community resources that ended up accommodating the initial change and accounting for it.

Notice that even in a directly controlled, centralized economy, as long as trade is done via money, inflation and deflation can occur because it is not easy to keep a balance between the goods and services available and the amount of money in circulation, particularly the amount of money circulating where it can do the most good or even where it can keep trade simply functioning at the highest levels. None of these things is stable in themselves, let alone as a system. Drought or abundant harvest affect the quantity of available goods; new inventions or applications, new business ideas, organization, etc. effect the quantity and types of goods and services available, as do population changes and changes in the import prices of necessities such as oil.

1. Money can lose value in ways other than inflation. If you are unable to purchase with it what you want or need because the products and services you seek are not available, the money you have to pay for them will not have the value for which you had earned it or held it. If there were no products or services available that you could buy with it, it would obviously have no value. Money can also lose value when currency is outlawed or replaced without substitution. In the U.S. today, Confederate money is not worth anything other than for its antique value.  (Return to text.)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2. "Value" in this sense means "trading value" only, since money has no great value of its own (except as art or a collectible, or as note paper or as coins to flip to choose between two options) other than what it will purchase. In this sense, talking about a rise or fall in the value of money just means that it takes larger or smaller quantities of money to trade for the same goods and services.  (Return to text.)