There is a problem hidden in the heart of economics and government statistics that has been bothering me for some time – The measure of inflation. More specifically, the rationale for excluding Capital assets from inflation figures. I know that sounds crazy as we all know that inflation simply measures increases in the cost of living right? But why? Why are we excluding capital asset prices from inflation measures?

We can see (and have seen) the adverse consequences of this, runaway housing markets, booming stock markets. ‘Ah but it’s all fine’ the central banks and many economists might say. They might advance an argument something like this:  

“The Increases in capital asset values represent increases in the wealth of an economy. Therefore it is beneficial that capital asset values increase, consequently we do not need to monitor it because so long as asset prices are increasing everything is good.Too much or too little cost inflation is harmful to the economy therefore we need to monitor this closely and ensure cost inflation is kept within acceptable parameters.”

However, I disagree with this rationale. Increases in capital asset values are not always representative of increases in the wealth of an economy. To understand this we need to distinguish between different types of inflation. Traditionally inflation has been categorized as:

“Cost-push inflation is inflation caused by an increase in prices of inputs like labor, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods.”


“Demand-pull inflation is asserted to arise when aggregate demand in an economy outpaces aggregate supply

Lets think about the definition of demand pull inflation a little deeper. In the definition of demand pull inflation we have the term “aggregate demand”. What is aggregate demand?

“In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It specifies the amounts of goods and services that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country.”

Apologies for the number of quotations here, I just want to establish some definitions independent from my opinion on what these words mean. Again let us think in more depth about the definition of aggregate demand. Unsurprisingly the word “demand” features quite prominently in the definition. But what is “demand” itself in an economic context?

Demand – “Demand is an economic principle that describes a consumer’s desire and willingness to pay a price for a specific good or service..”

Sorry to keep doing this but bear with me – we now have an important phrase to examine:

“A consumer’s desire and willingness to pay a price for a specific good or service”

Now we can ask ourselves this:

What determines the level of a “consumer’s desire and willingness to pay a price”? My proposal is that this can be broken down into 2 elements:

  1. Psychological – Just how much the consumer (or investor) wants that particular thing.
  2. Availability of money – To make that psychological desire economic reality the consumer must be able to personally procure enough money in order to pay the current market price.

We have all no doubt heard the old trope about there being unlimited demand for Ferrari’s – more precisely we could say there is unlimited psychological demand but this does not translate into economic demand due to the lack of money. Thus both 1) and 2) are required to manifest economic demand.

Given the above analysis we can see the monetarist belief that:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Is demonstrably incorrect. Without the psychological element of economic demand no inflation will result. It is akin to lighting a fire, we need both the fuel (available money) and the spark (psychological desire) to manifest economic inflation. However It would be correct to say that increases in the money supply are an important element, but not the whole, of this type of inflation.

An increase in the money supply is akin to storing a flammable fuel. This is important because we can say it is storing potential energy which can fuel later demand pull inflation. So 1) without 2) we could call “latent demand” and 2) without 1) could be called “stored inflation”.

If we now turn our attention to cost push inflation. What can deeper analysis reveal to us about the roots of this? I will spare you another long-winded step by step process and simply get down to the bare bones. If we conduct something similar for cost push inflation then we come down to a base level where again we can analyse it into two parts:

  1. A psychological element – the same as with demand pull inflation

  2. A “real” element. What I mean by real in this context is that there is some real world factor affecting the supply side of the good. Eg a bad harvest, new technology, labour shortage or whatever.

Again there have to be both elements. If we have a bad tomato harvest (element 2) but nobody in the world likes tomato’s (element 1) then there will be no inflation in tomato prices.

So given all of the above we can now do some useful analysis and comparison of the two types of inflation. Both have one common factor  – psychology – so in the best algebraic tradition I am going to eliminate this factor.

What we are then left with is the critical difference between these two types of inflation:

Cost push inflation

Caused by something “real”. Eg a bad harvest, new technology, labour shortage or whatever.


Demand pull inflation

Caused by the level of availability of money

This could be how monetarists’ arrived at the famous statement I quoted above – it’s a kind of shortcut to the reasoning which I have laid out. But the shortcut is a dead-end because it oversimplifies the cause of inflation, by ignoring the part that psychology plays. If we wish to acknowledge the monetary element of inflation then we must at the same time also acknowledge the other aspect of inflation identified above.

So now we can turn back to my earlier statement that increases in capital assets are not always necessarily representative of increases in wealth within an economy.

My reasoning for this is like so:

The equivalent of “cost push” inflation in capital assets is desirable. The differentiating factor is that the increase in value is represented by something real underlying the asset. Some real increase in wealth has taken place.

However “demand pull” inflation in capital assets is not desirable. The differentiating factor is that it is caused by increases in money supply. Thus we can see that one type of inflation in capital asset prices is desirable while the other is responsible for a bubble (a bubble here meaning a rise in value of an asset not supported by the fundamentals of the asset).

So given this I return to my first question, if asset price inflation is sometimes good and sometimes bad, why is it not included in the general inflation measure?

We can perform the same split on currently measured cost inflation. We can say that there is an element which is affected by increased money supply (eg consumer credit) and an element which is caused by real factors (shortages, tech etc).

So there is no real distinctions between these different types of goods – both are susceptible to inflation which may have benign/positive causes or dangerous/negative causes.

The most important thing about this distinction for me is:

It clearly delineates the measuring of real economic outcomes (cost push inflation) from the outcomes caused by artifices of the economic system (demand pull inflation).

What this means is that it gives us a better theoretical framework to hold politicians to account for their decisions and economists/bankers for theirs. We can have a much better idea of who is to be given credit/blame.

Here are some examples of this:

An increase in cost push inflation on capital asset values would indicate the policies being pursued by politicians are successfully creating wealth e.g. improved infrastructure and health system has increased real estate values in many areas across the nation.

A decrease in demand pull inflation of capital asset prices would indicate that the policies being pursued by the central bank were successfully maintaining the stability of the economy e.g. safely deflating (or preventing) an asset bubble from forming (and vice versa)

An increase in cost push inflation on costs indicates that the policies being pursued by politicians are not successfully creating wealth. e.g. perhaps they have not made it easy for businesses to invest in new machinery and prices of the goods manufactured are thus increasing because demand cannot be met with the old machinery.

An increase in demand pull inflation of cost  prices would indicate that the policies being pursued by the central bank were faulty e.g. rising consumer prices caused by increasing money supply.

Without this split of inflation measures how can we know that the experts charged with the governance of the economy are fulfilling their duties successfully or not? How can we tell what is an asset bubble and what is real wealth growth? How can we tell when living costs are increasing if this is the fault of monetary policy or general government policy?

Therefore I propose the following:

  1. That a new form of measuring inflation needs to be created which can distinguish between these two types of inflation.

  2. That the inflation figures used for guiding economic policy should be split in such a way.

  3. That capital asset prices should be included in inflation measures using these split figures.

I don’t say this is an easy thing to do but economics as a field of study is holding itself out to be expert in these matters. Surely this is something that the professionals should be addressing, how to collect this kind of data. I feel that this neglect must call into question the usefulness of government statistics and economic policy decision-making. It is one of many flaws in the dark underbelly of neo liberal (and indeed other kinds) of economics.

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