Currently traditional measures of money

Inflation is usually misdefined as a period of generally rising prices. Inflation, properly defined, is an expansion of the money supply. The problem is what we mean by “money supply.” Traditional definitions such as M1, M2, etc. have become less useful as a result of technology and financial innovations. Currently traditional measures of money are increasing while private sector debt is contracting and government debt is increasing. On balance, I believe total debt has actually increased, although there appears to be substantial contraction to come in the banking system as a result of overstated assets.

Rising prices is one of the effects produced by the “cheapening” of money. No index is capable of properly measuring these effects. All indices are subject to measurement errors. More importantly, all indices suffer from weighting and inclusion decisions. The Consumer Price Index (CPI) is published by the BLS and assumed to be a proxy for the effects of inflation. It purports to measure the rate of price changes for a typical consumer. It does so imperfectly, even with honest and accurate measurements. Inflation effects are not limited to consumer goods. Often they are felt in financial assets and capital goods (housing, capital investments by business, etc.) long before they show up at the consumer level.
Despite all the fear regarding deflation, it is possible that we are experiencing inflation right now, despite the fact that its effects do not show up in the CPI. Edwin Harrison discusses an article by Caroline Baum that deals with this issue:

Quote of the day: William White and inflation

Caroline Baum had a good column today at Bloomberg in which she suggests central banks consider asset prices in monetary policy going forward. In the piece she quoted William White, a former economist from the Bank for International Settlements. He said:

“The most calamitous downturns were not preceded by any degree of inflation. There was no inflation in 1873-74, in the 1920s, in the 1980s in Japan and in the 1990s in Southeast Asia.”

This is a very important historical point because central banks have been fixated on consumer price inflation for years as a result of runaway consumer prices in the 1970s. However, consumer price inflation and inflation are not the same thing. Inflation comes from increasing the money supply and increased credit.
During the 1990s and this past decade, there were a number of factors which suppressed consumer price inflation, the fall of the Iron Curtain and the integration of China into the global economy being the most important. As a result, increased money and credit found its way, not into consumer prices but into asset prices fueling several destabilizing bubbles along the way.
If central banks want to be more successful going forward they will need to heed Caroline Baum’s advice and start to consider asset prices as well.