Your Basic Free Market Economics Quiz (Part 2-Inflation)

Here's part two of your basic economics quiz. The five questions below deal with inflation and deflation. When you come out on the other end, you might find that your definitions of these terms have changed.

1. True or False: Inflation is a general rise in prices?

Answer: Not exactly.

Inflation is only that general rise in prices that is caused by an increase in the money supply without a corresponding increase in productivity (goods and services). Any other rise in prices--caused by a reduction in productivity caused by ravages of war, natural calamity, etc.--does not constitute inflation. Non-inflationary rises in prices are much more likely to correct themselves (i.e. when the crisis is past). It is much less likely that inflation will occur if a country is on a commodity standard, such as gold. Higher prices that people generally describe as "inflation" are actually a consequence of the actual inflation, or increase of the money supply. In today's America, this is the fault of our central economic planning bureaucracy, known as the Federal Reserve.

2. True or False: The American economy has always experienced inflation?

Answer: False

Due to a relatively constant money supply at the time, coupled with ever increasing productivity, something that cost $100 in 1820 cost only $63.02 in 1913. But this is where the wheels began to fall off the American economy. What happened in 1913? We have experienced inflation for almost all of the time since 1913, when the Federal Reserve was created. The tendency of living Americans to claim that America has always had inflation is similar to the claim of living, former Soviet citizens that Russia had always lived under Communism. If what you know is all you have ever known, it's hard to imagine anything else. However, there really was a time when you could put away something for your future and expect it to not have been ravaged by central economic planning by the time you needed it.

3. True or False: Central Planning encourages saving and investment?

Answer: False

Central planners, having the hubris that they can manage all by themselves something as large as an economy, invariably cause more problems. Some of this is intentional, as the central planners usually benefit from their mismanagement (they get first crack at the inflated money supply before prices generally start to rise). Very seldom has central planning not corresponded to inflation. During inflationary times, people are much less likely to save and invest, because the value of their money declines over time as it is destroyed by the negative effects (inflation) of an inept central planning bureaucracy.

4. True or False: It is possible for a well-functioning economy to experience zero inflation?

Answer: True, but not entirely probable.

Economies are apt to function much better if they are not controlled by central economic planners. Human foibles being what they are, it's not likely that we'll live without any inflation, though, because it's hard to correctly quantify the goods and services in an economy on a continual basis. However, inflation would be much less in an economy that is (a) on a commodity standard, and (b) not controlled by a behemoth such as the Federal Reserve. However, if the money supply were to remain relatively constant, the effect in a healthy economy would be falling prices.

5. True or False: Deflation is a decline in consumer prices? Falling prices are a bad thing?

Answer: Not exactly and not necessarily.

Just as most people are apt to mis-define inflation, they are apt to give the wrong definition to deflation. Deflation is only that decline in consumer prices that results from a decrease in the money supply. Prices also go down as a result of efficiencies of production, or as a result of overproduction (supply exceeds demand). This is not deflation. This is a good thing. When inflation (increase in money supply) is mixed with efficiencies of production, prices do not go down as much as they would have. Imagine, for example, what the cost of a personal computer would be if there hadn't been nearly 100% inflation of our currency since PCs came out in the early 1980's.

. . .

Life without the Federal Reserve would likely have been so much sweeter. Without the inflation that the Fed has caused, you would still be living on a much lower salary, but your home would have a cost not much higher, unlike today. Without our "friend", The Fed, you'd be paying about 27 cents for a gallon of gas, 10 cents for a loaf of bread, and $200 for college tuition. Instead it seems that the cost of living goes up each year more than the increase in our salaries. It kind of makes you feel like a rat in a cage, doesn't it?

You know what? You are.