How Inflation Happens

Bart Fuller tells an instructive story at

Items for sale included various candy bars, treats and toys, with a couple of gift cards to ice cream shops and bookstores to make it interesting. Everyone who took part started out with the same amount of play money. There was no more to be had; it was a limited supply. Since the supply was limited, all the participants had to look ahead and plan their purchases and bidding accordingly. There was no ability to pull out a credit card and charge more for an item than they actually had on hand. Play cash was king. […]

Once people started winning some of their bids though, there was a change. Invariably, someone would win an item or two and then have only a few play dollars left. So few, that the amount they had left was now worthless for any further use in the auction. Once this point was reached the person would decide they had better things to do. Before leaving however, they would offer their small amount of leftover money to someone else. This started a secondary auction — the new auction being one in which the remaining active bidders vied for the unwanted play money of the people leaving.

Engagement in this second auction occurred each time someone left the primary auction with the departing player giving the money to whomever they liked. The winners of this new money suddenly had more purchasing power than those who were not as fortunate, leaving the less fortunate in the lurch as they were consistently outbid for the remaining items by the new-money bidders. For the sake of argument, let’s say these winners received a “liquidity infusion.”

As time went on, this process only got worse. There was a greater and greater disparity between those who had money and those who did not. In fact, it was possible for those who had all of their original money and had been saving it for a certain item, to lose their bid to someone else who had spent the original money, but also received a “liquidity infusion.” Those with new money were able to bid up the prices of the remaining items and crowd out the people who had not received a new liquidity infusion.

This is a perfect example of inflation in action. Those with augmented resources raised the prices of items with their extra money. Thus the usual definition of “inflation,” a general rise in prices, resulted from the actual definition of “inflation,” an increase in the money supply.


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