Money and inflation.

Inflation is by definition a monetary phenomenon, a decline in the commodity value of the monetary unit of account, the dollar in the United States. Deflation too is monetary, a rise in the commodity value and commodity cost of a unit of money. (From 1.9 9 to 1.9!!, for e"ample, pricess fell at, on avera#e, $.% percent per year.& 'o understand inflation and deflation, therefore, it is necesary to revie( the role of money in economic life. )n economy (here #oods and services are al(ays bartered directly for each other (ould be spared inflation or deflation. It (ould also be terribly inefficient. *erhaps the villa#e cobbler can trade shoes for the farmer+s e##s, and even promise shoes tomorro( for e##s today. ,ut ima#ine the difficulties if steel plants had to pay their (or-s in steel in#ots, or else trade the in#ots for e##s and other #oods more to their employees+ tastes. .ithout money, much time and effort (ould be spent see-in# and e"ecutin# mutually advanta#eous trades, and much capital (ould be tied up in inventories. 'o escape these inefficiencies the people of even primitive societies have a#reed amon# themselves on a common tradin# commodity, a money. 'he money of a society serves as a commonly accepted medium of e"chan#e and as a unit of account and calculation. /oods and services can be traded for money rather than directly for other #oods ands services. 'he cobbler can sell shoes for money and use the money later to buy e##s, as (ell as leather, nails, and the services of an apprentice. 'he steel plant can shell in#ots for money and pay employees in money, and the (or-ers can find and buy (hat they individually (ant. *rices can be 0uoted and values calculated in units of money. Ima#ine the difficulty of -eepin# trac- of barter prices for all possible pairs of commodities. 'hese are money+s functions. ,ut (hat is money1 It is (athever the society collectively fi"es upon, by convention and tradition and in modern nations by la(. 'he substances chosen have differed (idely, includin# #attle, land, roc-s, silver, #old and en#raved paper. Some, so2called fiat moneys, have had no value e"cept that conveyed by their status as money. 3thers have been commodities (ith intrinsic value in consumption (such as ci#arettes amon# prisioners of (ar& or production. 4ven commodity moneys have had, than-s to their monetary desi#nation, more value in terms of other #oods and services than they (ould have had on their o(n. Some thin#s ma-e more convenient moneys than others, but the vast advanta#es of money to the society are #ained by a#reein# on a common medium of e"chan#e and account, (athever it is. In this respect, money is a social institution comparable to lan#ua#e. In both cases, the immense contribution to social cooperation and communication depends on the #eneral currency of (athever medium is chosen. Money is also a store of value, in (ich individuals can save and hold (ealth for future use. 3ther(ise, it (ould be useless as a medium of e"chan#e. 'he farmer parts (ith e##s for the cobbler+s money only because the farmers e"pects the money (ill later beb acceptable payment for shoes or seed or fence (ire, tomorro( or ne"t (ee- or ne"t year. 4veryone (ho accepts fiat money 5or

commodity money such as ci#arettes or silver in e"cess of consumption needs2 is countin# on its future acceptability to others. ,ut money is not, of course, the only store of value available to savers and (ealth o(ners, or even the principal form of (ealth. 4ven in primitive societies land, livestoc-, and other cormmodities are more important vehicles of (ealth. 'his remains true in modern economies, (here ultimate o(nership of real properties is often indirect, e"pressed throu#h a net(or- of financial claims. In a modem national economy, many assets and debts are denominated in the monetary unit of account. Some of these are media of e"chan#e, but most are not. In the United States, for e"ample, the basic physical manifestation of the dollar is the fiat issue of currency 2paper bills and coin2 by the federal #overnment. 'he federal #overnment also has outstandin# obli#ations to pay specified amounts of these dollars, some on demand (notably the deposits of commercial ban-s in Federal 6eserve ban-s&, some on stated future dates ('reasury bills, notes, and bonds&. 7urrency and demand deposits do not bear interest8 time obli#ations do. In addition, non2federal debtors have issued an immense volume and variety of dollar2denominated obli#ations, some payable on demand, others at future dates. 'he debtors include ban-s, savin#s institutions, state and local #overnments, business firms, individuals (homeo(ners, car buyers, department store customers, students, etc.&, and forei#ners. Most of these I3Us bear interest, but demmand obli#ations (e.#., ban- chec-in# accounts& #enerally do not. In addition to currency itself, some promises to pay currency on demand are #enerally or fre0uently acceptable instruments of payment. 'hese include not only chec-able deposits in ban-s and savin#s institutions but also the obli#ations of credit card and travelers9 chec- companies and of some mutual funds. .hen inflation or deflation alters the value of the dollar, it affects the real values of all dollar2denominated obli#ations, (hether private or public, (hether demand or time, (hether media of payment or not. For this reason, both the causes and conse0uences of chan#in# values of the dollar 0ua unit of account e"tend far beyond #overnment issues of basic dollar currency and beyond the dollar means of payment supplied by ban-s. 'hrou#hout history, the value of monetary stores of value has been variable and unpredictable. 7onsiderin# the nature of money, this is not surprisin#. 'he notion that price stability or predictability is natural and normal, (hile inflation and deflation are patholo#ical aberrations, is an abstraction (ith little realistic foundation. *eople save for future consumption, for their old a#e, or for their children. ,ut (hatever form of (ealth they accumulate, they can never be sure (hat vallue it (ill have (hen they or their heirs need it. Since they cannot store precisely the commodities they (ill (ant to consume, they are al(ays dependent on (hat other people (ill be prepared to pay for their assets. 'his is true of land,

houses, personal s-ills (human capital&, machines and tools, and common stoc-s. It is certainly true of money, the value of (hich depends not on its intrinsic utility in consumption or production, but al(ays on (bat others e"pect its value (ill be to them. Investors are al(ays speculatin# about the relative values of #oods and titles to them, on the one hand, and money and titles to money, on the other. Fluctuations in the value of money are costs societies have to pay for the efficiency that monetary institutions contribute in trade and division of labor. 'he problem is to -eep the fluctuations from bein# so violent that they ne#ate those positive contributions. /reen(ald 4ncyclopedia of 4conomics *p :11 2 :1!