US Treasury secretary admits she was wrong about inflation prospects

By Dr Frank Shostak

According to the Financial Times June 1, 2022, Janet Yellen, the US Treasury secretary conceded she was wrong last year about the path inflation would take. Yellen told CNN  “There have been unanticipated and large shocks to the economy that have boosted energy and food prices and supply bottlenecks that have affected our economy badly that I didn’t fully understand, but we recognize that now,” she added. 

To be able to say something meaningful about inflation, it is necessary to establish what inflation is all about. Note that for Yellen inflation is about the growth rate in the consumer price index, which year-on-year stood at 8.3% in April against 4.2% in April the year before. 

We suggest that increases in the prices of goods and services is not inflation but rather the symptoms of inflation. To establish the definition of inflation it is helpful to go back in time to ascertain how it originated. 

Defining what inflation is

The subject matter of inflation is embezzlement. Historically, inflation originated when a country’s ruler such as king would force his citizens to give him all their gold coins under the pretext that a new gold coin was going to replace the old one.  

In the process of minting new coins, the king would lower the amount of gold contained in each coin and return lighter gold coins to citizens.  

Because of the reduced weight of coins that were returned to citizens, the ruler was able to generate extra coins that were employed to pay for his expenses. What was passing as a gold coin of a fixed weight was in fact a lighter gold coin. On this Rothbard wrote, 

More characteristically, the mint melted and re – coined all the coins of the realm, giving the subjects back the same number of “pounds” or “marks”, but of a lighter weight. The leftover ounces of gold or silver were pocketed by the King and used to pay his expenses. 

Note that what we have here is an inflation of coins because of the increase in the not fully backed by gold coins. Alternatively, we can say that we have here an increase in the medium of exchange out of “thin air” because the ruler made the gold coins lighter. The extra gold coins that the ruler was able to generate enabled him the channeling of goods from citizens to himself without any contribution to the production of goods. The ruler is engaged here in an exchange of nothing for something. 

The process of embezzlement was strengthened further when banks started to issue unbacked by gold receipts. For safety reasons instead of holding gold with themselves, individuals were storing their gold possession with their banks. To acknowledge this storage the banks were issuing receipts. 

Over time, these receipts had become accepted as the medium of exchange. Problem however would occur once the banks started to issue receipts not backed by gold. The un-backed by gold receipts were now employed in the economy along with the fully backed by gold receipts.

What we have here is the inflation of receipts i.e. the increase in the number of receipts because of the increase in the receipts out of “thin air”. The issuer of un-backed receipts could now engage in an exchange of nothing for something i.e. diverting goods and services to himself without any contribution to the production of goods and services. 

In the modern world, money, which comprises of coin and notes is not backed any longer by gold. Hence, any increase in money supply here is the increase in money out of “thin air”. Inflation is the increase in the supply of coin and notes. As a result, the increase in the supply of money sets in motion the exchange of nothing for something. 

We can thus infer that inflation is about increases in money supply out of “thin air” that set in motion an exchange of nothing for something.

According to the above definition, inflation is not about general increases in the prices of goods and services as popular thinking maintains. What we are saying is that inflation is increases in the money supply not backed by gold, or money out of “thin air”. These increases set in motion the embezzlement of wealth generators.

Whilst various supply shocks such as the COVID19 response and the Ukraine-Russian war may push the prices of goods and services higher, they are not inflation. Hence, the US Treasury secretary by admitting that she underestimated the strength of inflation because she misjudged the strength of these shocks is running the risk of being wrong again because she regards inflation as increases in prices rather than increases in money supply out of “thin air”. 

Money and Prices

We find it extraordinary that in attempting to explain movements in prices, commentators have nothing to say about the role of money in forming the prices of goods and services. After all a price of something is the amount of money, i.e. dollars paid per unit of something. 

Note that prices are determined by both real and monetary factors. Consequently, it can occur that if the real factors are “pulling things” in an opposite direction to monetary factors, no visible change in prices is going to take place. 

If the growth rate of money is 5% and the growth rate of goods supply is 1% then prices are likely to increase by 4%. If, however, the growth rate in goods supply is also 5% then no increase in prices is likely to take place.  

If one were to hold that inflation is about increases in prices then one would conclude that, despite the increase in money supply by 5%, inflation is 0%. However, if we were to follow the definition that inflation is about increases in the money supply, then we would conclude that inflation is 5%, regardless of any movement in prices. 

Observe that when money is injected it enters a particular market. Once money enters the market, this means that more money is paid for the product in that market. Alternatively, we can say that the price of the good in this market has gone up.   

Once the price of a good increases to the level that is perceived as fully valued the money leaves to another market, which is considered as undervalued. The shift of money from one market to another market implies that once money has risen it is going to have an effect on the average prices after a time lag.   

We suggest that because of past huge increases in money supply currently the yearly growth rate of prices displays a visible strengthening. The yearly growth rate of our measure of adjusted money supply (AMS) climbed to 79% in February 2021 from 6.5% in February 2020. 

Raising interest rates is an erroneous policy for countering inflation

A policy of raising interest rates to counter increases in prices, which is erroneously labelled as inflation, stems from the view that higher interest rates are going to weaken the demand for goods and services. As a result, for a given supply this is going to lower the prices of goods and services. 

Such policy, which distorts market interest rates, makes it harder for businesses to ascertain signals issued to them by consumers’ time preferences. This in turn results in the misallocation of resources and economic impoverishment. 

Furthermore, a higher interest rate policy does not address inflation, which is increases in money supply. Consequently, because of a misleading definition of inflation, rather than closing the loopholes for the increases in money supply the central bank policy is focusing on the symptoms of inflation, which is increases in prices. 

As a result, a tighter interest rate policy of the central bank leaves the inflationary framework intact. This means that once the tighter stance of the central bank is reversed, with the revival in economic activity, the money supply growth i.e. inflation is likely to increase.

To counter inflation and thus the impoverishment of wealth generators what is required is the closure of all the loopholes for increases in money supply. Major loopholes are the Federal Reserve lending to the government and the existence of the fractional reserve banking. 


The US Treasury secretary Janet Yellen has conceded that last year she underestimated the strength of inflation. Note that without a valid definition of inflation she is running the risk of being wrong again. Contrary to popular thinking, inflation is not about general increases in the prices of goods and services but about increases in the money supply out of “thin air”.

On this Mises wrote,

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.

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