Nowadays, most people use the term inflation to mean an increase in the prices of consumer goods. When gasoline, food, tuition, housing, and medical services tend to get more expensive, year after year, people call that “inflation.”
However, this was not always the case. Historically, economists often used the term inflation to mean an increase in the quantity of money (and perhaps credit). In this usage, when the government or the banks inflated the money supply, it meant that there were more dollars in the economy.
We can see how the two usages are related. Monetary inflation, other things equal, leads to price inflation, because there is more money chasing the same amount of goods.
To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call “inflation” the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying “catch the thief.” The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices.
Monetary inflation by the authorities reduces the purchasing power of the dollar; money doesn’t “go as far” at the store as it used to. However, the Austrian economists recognized that monetary inflation is more destructive than merely “watering down” the value of the currency. To fully understand the operation of our modern financial system, one must understand the basics of fractional reserve banking and its relationship to the business cycle. After studying these topics, one understands that monetary inflation through the banking system ends up causing the wild booms and painful busts that most people erroneously attribute to “free market capitalism.”