Understanding Inflation

Inflation is one of the most misunderstood concepts in modern economics. While politicians and pundits often blame “greedy corporations,” “supply chain disruptions,” or “foreign wars,” Austrian economics provides a much clearer—and more accurate—explanation.

Simply put: inflation is caused by an increase in the money supply beyond the real demand for money.

Defining Inflation: A Monetary Phenomenon

Classically, the word inflation referred to the inflation of the money supply itself. The rise in consumer prices, which we now commonly call “inflation,” is merely the consequence of that monetary expansion. As Ludwig von Mises wrote, “Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check.”

When more money chases the same amount of goods and services, prices rise. This is not an arbitrary law—it is basic supply and demand. The value of each individual monetary unit falls, and it takes more of that money to buy the same goods.

Central Banks: The Chief Culprit

In today’s world, inflation is almost always the result of central bank policy. When central banks—like the Federal Reserve—create money out of thin air (whether through direct printing or credit expansion), they distort interest rates and inject new purchasing power into the economy.

But this money is not distributed evenly. It enters the economy at specific points—often the financial sector—causing Cantillon effects: early recipients benefit, while those on fixed incomes or saving in cash see their purchasing power eroded. Inflation, therefore, is not only an economic problem but a moral one—it transfers wealth from the poor to the politically connected.

Fractional Reserve Banking and Credit Expansion

Another major source of inflation is fractional reserve banking. In this system, banks are allowed to lend out many times more than they actually hold in reserves. This artificially expands the money supply and gives the illusion of more savings than actually exist. The result? Booms and busts, malinvestments, and, ultimately, higher prices when the newly created money floods the market.

Government Spending and Deficits

Governments often finance large deficits by borrowing from central banks. This allows them to monetize debt—that is, pay for spending by inflating the currency rather than raising taxes. But the cost is hidden: instead of a visible tax, citizens suffer a stealth tax through rising prices and the erosion of their savings.

Mises warned that inflation is politically tempting because it creates the illusion of prosperity in the short term. But the long-run effects—currency devaluation, savings destruction, capital consumption—are devastating.

Inflation Is Not Caused by Markets

Contrary to popular narratives, businesses do not cause inflation by raising prices. If a business raises prices without real demand, it loses customers. Prices rise generally only when the money supply expands. Supply shocks can raise relative prices temporarily (e.g., gas during a war), but only new money creation can raise all prices systematically.

The Austrian Solution: Sound Money

The only way to prevent inflation is to stop inflating. That means ending central bank money printing, eliminating government deficits, and returning to sound money—like gold or Bitcoin—that cannot be manipulated by politicians.

In conclusion, inflation is not an act of nature. It is a policy choice. If we want honest prices, stable economies, and protection for the poor and middle class, we should encourage honest money.