Inflation and deflation do not necessarily affect monetary items

Inflation and deflation do not necessarily affect monetary items

Inflation and deflation affect only monetary items in the economy. Inflation and deflation have no effect on the real value of non-monetary items.

However, inflation and deflation do not affect all the monetary items in the economy.

Inflation and deflation only affect monetary items not being inflation-adjusted or deflation-adjusted, respectively.

A monetary item that is being inflation-adjusted or deflation-adjusted is not affected by inflation or deflation, respectively.

According to the Banco Central de Chile, 20 to 25 per cent of the broad M3 money supply of Chile is currently inflation-adjusted on a daily basis in terms of the Unidad de Fomento which is a monetized daily indexed unit of account started in Chile in 1967.

Those are monetary items not affected by annual inflation, currently at 4.4 per cent (December 2011) in Chile.

Global inflation-indexed government bonds amount to more than2.680 trillion US Dollars (December 2009) which are all inflation-indexed on a daily basis (these bonds trade daily) in many different countries in the world. They are all monetary items not affected by inflation.

So, inflation in many different countries has no effect on the real value of these monetary items worldwide.

It is thus not correct to state that inflation and deflation affect monetary items. The correct statement is that inflation and deflation affect monetary items not inflation-adjusted and deflation-adjusted, respectively.

Bank notes and coins are the only monetary items that are always affected by inflation and deflation. It is impossible in 2012 to inflation-adjust or deflation-adjust actual physical bank notes and coins.

The entire money supply can be inflation-adjusted excluding bank notes and coins. That would eliminate the total cost of inflation (not actual inflation) from the monetary economy excluding from bank notes and coins which generally make up about seven per cent of the money supply in an advanced economy. This would result in zero cost of inflation in the entire monetary economy excluding bank notes and coins at all levels of inflation .

The same is true under deflation. Under deflation the real value creation effect of deflation in monetary items not deflation-adjusted would be completely eliminated in the monetary economy excluding in bank notes and coins.

Nicolaas Smith

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