Confusing Inflation and Prices

I read this article, at Social Europe, yesterday, and wanted to briefly respond to the fundamental confusion contained in it.

Many ordinary people confuse, inflation, manifest as a change in prices, with prices themselves. These are two quite different things. If prices are at an index level of 100, for example, and there is inflation of 100% p.a., then, after a year, prices will be at an index level of 200. If, in the subsequent year, inflation disappears, i.e. no increase in the level of prices, at the end of the year, the index level of prices will still be at 200, it will not have gone back to 100! It is understandable that ordinary citizens might get confused about this, and, as reported, frequently, hear that inflation is falling, and take it as meaning that prices themselves are falling. That economists make that mistake is not understandable. Yet, that apparently is what Ronald Janssen has done, in this article.

He writes,

“Inflation is instead driven by the supply side. Pandemic-linked disruptions—bottlenecks in global supply chains, the invasion of Ukraine, production shifting from services based on human interaction to consumer goods and back—are in the process of reversing. Global supply chains are being repaired and workers moving into sectors where labour is in higher demand. Inflation is thus coming down of its own accord, without much need to push unemployment up by squeezing demand.”

In other words, Janssen confuses a change in prices for the level of prices itself. If, as he claims, the “inflation” is a result of an imbalance of aggregate demand an supply, with aggregate supply having been curtailed as a result of the various supply-side shocks he lists, then, likewise, as those supply constraints disappear, not only should that “inflation” disappear, but it should be followed by an equal counteracting “deflation”, to reduce the price level to its former equilibrium level. If we take the price of ice-cream on a hot day, rising demand that exceeds supply may cause the price to rise from say £1 to £2, a 100% “inflation”, in Janssen's terms. When the weather cools, and demand subsides, to at least its previous level, prices would fall back to £1, a 50% “deflation”. But, does anyone seriously expect to see the same thing with the general level of prices? Of course not! Even if “inflation” falls to zero, rather than the 2% target of most central banks, we will not see prices, overall, falling back to where they were in 2020, or indeed falling at all.

According to Janssen, inflation arises from one of the two above situations.  Either I, aggregate demand rises, or II, aggregate supply falls.  He claims, currently, its due to II, not I.  But, in either case, this is not the cause of inflation.  If as Janssen claims, the inflation is a result of supply-side constraints (a shift of the supply curve to the Left from S`S` to SS), then the removal of those constraints, bringing a shift of the supply curve back to the Right, S`S`, would not only result in inflation disappearing, but in prices as a whole falling!

A simple supply and demand chart illustrates the problem with Janssen's argument, which fails to take into account that prices are measured by something, i.e. a standard of prices, whose own value affects that index. Suppose, on this chart of demand and supply, both are in balanced equilibrium at 1 million units, and a price of 10. (Say, in II, the intersection of S`S` and DD).  We have to ask the question 10 what? If we define this standard of price as £'s, its obvious that, if, instead, we used $'s, with an exchange-rate of $1.20 per £, then the equilibrium price would move to 12, even though there is no change in the level of aggregate demand and supply, no imbalance arising between them. Indeed, if we simply used UK pennies as the standard of price, the equilibrium price would rise to 1000!

But, similarly, as Marx describes, just because the nominal standard of price remains constant, at say £1, does not mean that this £1 has the same value. If that £1 actually only has a value of £0.80, compared to a year earlier, as a result of an excess of these £1's being thrown into circulation, it would be the same as if prices were measured in $'s rather than £'s, or as Marx also demonstrates, silver being used as the basis of the currency rather than gold. Without any change in the level of aggregated demand and supply whatsoever, no imbalance of one with the other, prices would rise from 10 to 12.

Janssen confuses form and content, and is transfixed simply by the impress on the standard of prices, much as Marx describes was the case with Proudhon.

“Philip I was not a maker of gold and silver, as M. Proudhon says; he was a maker of names for coins. Pass off your French cashmeres as Asiatic cashmeres, and you may deceive a buyer or two; but once the fraud becomes known, your so-called Asiatic cashmeres will drop to the price of French cashmeres. When he put a false label on gold and silver, King Philip could deceive only so long as the fraud was not known. Like any other shopkeeper, he deceived his customers by a false description of his wares, which could not last for long. He was bound sooner or later to suffer the rigour of commercial laws. Is this what M. Proudhon wanted to prove? No. According to him, it is from the sovereign and not from commerce that money gets its value. And what has he really proved? That commerce is more sovereign than the sovereign. Let the sovereign decree that one mark shall in future be two marks, commerce will keep on saying that these two marks are worth no more than one mark was formerly.”

(The Poverty of Philosophy, p 80-81)