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Thursday, 17 April 2014

Difference between inflation and the stable measuring unit assumption

Difference between inflation and the stable measuring unit assumption

Almost no-one understands the difference between the inflation and the stable measuring unit assumption.

DEFINITION

Inflation is a sustained increase in the general price level over time.  

Inflation results in a decrease in the real value of ONLY money and other monetary items over time. Inflation has NO effect on the real value of non-monetary items over time. Inflation can only affect the real value of monetary items - nothing else. 

DEFINITION

Monetary items constitute the money supply.

DEFINITION

Non-monetary items are all items that are not monetary items.

DEFINITION

The stable measuring unit assumption is the ASSUMPTION made by ONLY historical cost accountants that changes in the purchasing power of money are not sufficiently important to require: 

(i) inflation-indexing all monetary items in terms of all changes in the general price level, that is to say, at least daily and 

(2) the measurement of all constant real value non-monetary items in units of constant purchasing power in terms of all changes in the general price level, that is to say, at least daily.  

SUMMARY

Under the stable measuring unit assumption it is ASSUMED  that money is
PERFECTLY STABLE over time at ALL levels of inflation and deflation.

The ASSUMPTION that money is PERFECTLY STABLE over time at ALL levels of inflation and deflation is obviously completely wrong.

So, what is the difference between inflation and the stable measuring unit assumption? 

The difference is that inflation only erodes the real value of monetary items over time and that the constant purchasing power (real value) of constant real value non-monetary items is eroded, not by inflation, but by the stable monetary unit assumption over time during inflation.

Thus, the real value of monetary items is eroded by inflation while the real value of constant real value non-monetary items is eroded by the stable measuring unit assumption, i.e., by the use of the traditional Historical Cost Accounting model. 

Most accountants and economists (as well as people in general) mistakenly believe that inflation erodes the real value of companies´ capital and retained profits while it is actually an impossibility: inflation can only affect the real value of monetary items - nothing else. Inflation has no effect on the real value of non-monetary items. The real value of constant real value non-monetary items is eroded by the use of the stable measuring unit assumption, i.e., by the use of the traditional Historical Cost Accounting model. 

Nicolaas Smith 

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