The argentine economist Fernanda Vallejos, while trying to protect the government because of the inflation, the following:

Inflation is not the result but the cause of monetary emission. As there's inflation (because of other reasons not important here), people need more money and the central bank needs to print more money.

How can you argue against that? As it seems to be the opposite of modern theory on inflation.

Context: This is in Argentina, where it has an important deficit, monetary emission and inflation are around 40%.

  • $\begingroup$ Could you please say who this economist was? Please also note that there is no one single "modern theory of inflation". Which theory, or theories, of inflation do you have in mind? $\endgroup$
    – Mico
    Nov 26, 2014 at 20:06
  • $\begingroup$ @Mico I've added that information. It was Fernando Vallejos, here youtube.com/watch?v=39Oan4NB2UY (in Spanish) $\endgroup$ Nov 27, 2014 at 0:22
  • $\begingroup$ If so, Fernanda Vallejos has given an incredibly erroneous argument, based on verbal ambiguity. (It's the same error as when somebody declares, "Nothing is better than X, and Y is better than nothing, therefore Y is better than X.) $\endgroup$
    – user218
    Nov 27, 2014 at 9:04

3 Answers 3


The problematic part of the statement, is the "because of other reasons not important here" part . In other words: "ignore general equilibrium" -which is an unacceptable statement to make when discussing government policy and actions.

Consider the naive quantity theory of money:

$$PQ = VM \tag{1}$$ $P$ is the price level, $Q$ is output produced (measured in quantity), $M$ is money supply, and $V$ is "velocity of money", an indicator of the "transactions technology" in the economy, how fast money circulates around to settle transactions.

Assume now that we are talking for a "small" country that needs to import basic factors of production like raw materials or energy. "Small" here means "with no market power". Such a country is a price-taker in the international market. More over, substitution possibilities for these factors are usually small to non-existent.

Competitive markets or not, the economy's output will be distributed to factors of production and for our purposes, it doesn't matter whether there will be "capital rents" and "profits", or only capital rents. Use for convenience three factors of production and write

$$PQ = rK + wL + p_fE \tag {2}$$

where $r$ and $w$ are nominal, and $p_fE$ is the nominal cost of imported factors. Denote $s_f$ the foreign exchange rate (units of local currency per one unit of foreign currency), $c_f$ the price of the imported factors in foreign currency, so $p_f = c_fs_f$. Use this and substitute $(2)$ in $(1)$

$$rK + wL +c_fs_fE= VM \tag{3}$$

If something happens to the international market and $c_f$ goes up to $c_f' > c_f$, this will tend to increase the left hand side. This "something" in the international production factors market does not relate to the level of domestic output $Q$, or to domestic money transactions technology, $V$. More over, at least in the short run, factor substitutions will not happen, wages do not move that easily, and firms will maintain their output level while increasing selling prices, to cover the increased production costs. And since the reasons for the increase affect more-or less the whole economy, it is not that likely that competition will stop firms from doing so: they all want to cover their increased costs, they all know that the cost-rise is general and comes from abroad, so they don't need to actually collude in order to sustain a price increase. "Common knowledge" suffices.

So in order to preserve the equality in $(3)$ it appears that we must have

$$rK + wL +c_f's_fE = VM', \;\; M' > M\tag{3}$$

You see? This is the phenomenon called "imported inflation". Whatever the reasons were for the price increase (the "not important" reasons), inflation was not caused by the expansion of the money supply (that's indeed true), and what else the government could do than raise the money supply to service the higher nominal level of output?

Of course what the story above does not say, is that foreign factors of production will want a "money" that they accept, and most likely this won't be the local currency of this small country. And by increasing the money supply the exchange rate $s_f$ will suffer (increase), because $s_f = h(M), \;\; h' >0$, increasing in this way further the costs of imported factors in terms of local currency, and making the increase in the money supply equivalent to "shoot oneself in the foot". And this is only one more step towards the road to general equilibrium.

The essence here is that
a) it is trivial that there are many other factors that may tend to affect prices upwardly, except money supply expansion

b) in the presence of these other influences, increasing the money supply is not necessarily the appropriate government response.

  • $\begingroup$ Exactly. If the local money supply is increased in these circumstance, it would result in rapidly increasing inflation in her small country, because the local currency being less scarce exchanges afterwards for less local output, and yet this solves nothing of the issue with the exchange rates, which is the cause of the initial general price increases. It makes the ERs worse, and if this is replied to with further expansion of the local MS, the process leads to inflationary collapse of the local currency (with dire consequences for production in the country). $\endgroup$
    – user218
    Nov 27, 2014 at 9:15

I think Ms Vallejo's argument is based on (a) a slightly idiosyncratic definition of the term "inflation" and (b) a disregard for the difference between short run and long run phenomena.

She is correct in mentioning that in the short run, various cost shocks -- e.g., a devaluation that leads to imported inflation, or excessive wage demands that are accommodated by employers -- can raise the cost of living. However, such cost shocks are not what Friedman or Tobin would have called "inflation". To wit, if the exchange rate appreciates at some point in the future, the imported inflation will be reversed, and there's thus fluctuations in the exchange rate do not necessarily have a long-term or permanent effect on the price level. Friedman and Tobin were clear that inflation refers to permanent (or at least long-lasting) changes in the price level.

So, what transforms an initial (non-monetary) shock into inflation, in the Friedman-Tobin sense of the word? It's almost invariably the decision by the central bank to try to mitigate the negative effects of the shock on output and employment, viz., by expanding the money supply. While such a decision may be beneficial in the short run, by expanding the money supply the initial shock becomes permanent, i.e., we observe inflation. For the central bank to have the strength not to accommodate cost shocks by creating inflation, it's usually helpful to make it more or less independent of the rest of the government. Without political independence, it's just too tempting for the government to direct the central bank towards undertaking inflationary policies.

Hence, Friedman continues to be right: inflation is a monetary phenomenon.


to give you a straight answer: In the short run she is not contradicting the economic theory. Look to the basic identity in quantitative money theory: $PQ = VM$

The identity does not give you the specific direction on the effect. It may be that the monetary authorities of Argentina does not want to face a drop in Q, and then just decide to supply more money (M). But of course, this can give you a new round of price increase - specially if the economy is indexed - like Argentina is. It can only buy you some time to develop a real plan to contain inflation.

Ignácio Rangel was a brazilian economist that helped to understand this kind of fenomena. There are also structuralist economists who wrote about this, mostly related to the UN´s Economic Commission for Latin America and the Caribbean (CEPAL).

  • $\begingroup$ Thanks for the info. As you said, that's only in the short run though, Argentina has been facing inflation above 20% for the past 8 years or so. $\endgroup$ Jan 26, 2016 at 17:44

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