In a couple of blog posts this week, Paul Krugman has heaped praise upon that phenomenon known as inflation, claiming, among other things, that the euro could be successful only if it is inflated enough. Since Austrians say that inflation is bad, period, there obviously is a huge disconnect between the two camps.
Before going further, however, I need to clarify the difference in how Austrians and Keynesians define inflation (and even there, I am sure that I will leave out lots of nuances that could invoke lots of discussion among Austrian-oriented grad students). Keynesians see inflation as an increase in the government-created "price level," period. Inflation is defined as a visible and general rise in prices and nothing else.
Thus, according to Krugman and the Keynesians, a large increase in the monetary base itself (excess reserves held by U.S. banks) is not in itself inflationary, especially if the reserves just sit there and are not loaned out. (Obviously, if they are loaned into the system and the new loans reflect the amount of money in that base, then even the Keynesians agree that price levels will increase -- which is exactly what they want to happen.)
Austrians, on the other hand, hold that the actual increase in the amount of money in circulation is inflation in and of itself, even if the monetary increase is not reflected in an increasing price level. The reason for this position is that increasing the amount of money in circulation is going to affect the relationships among assets, changing relative prices.
Furthermore, increasing the amount of money in circulation also keeps prices higher than they would have been otherwise. Furthermore, Austrians argue that even if the official government price level index is relatively flat, nonetheless, the increase in the amount of money in circulation is going to have a negative effect upon the relative value of both higher-order and lower-order goods.
As I see it, Krugman's praise of inflation is based upon an assumption that inflation will provide the cut in real wages, making labor relatively cheaper (and boosting employment), and the fact that money is losing its value brings people to spend rather than save. (Don't forget that the vaunted Keynesian "multiplier" is the number 1 over the rate of savings. So a higher rate, say 20 percent, produces a "multiplier" of 5, while a 0.01 percent rate of savings gives us a multiplier of 100. So, the less we save, the wealthier we will be.)
Krugman also has praised inflation as a tool for "deleveraging," which is a nice way of saying that we can inflate away debt by debasing the dollar and paying the debt service in cheaper money. (One is reminded of people paying their "debts" in Weimar in 1923 by dumping bags of worthless money onto the desks of creditors.)
This is part of what Krugman claims is a "free lunch." But it clearly is not, as the borrower might be gaining a temporary advantage, but as inflation increases, lenders protect themselves by changing the terms of the loan payments to reflect the increase in inflation.
What Krugman and other inflationists never seem to understand is that inflation is not a static thing. Over time, it draws resources from productive to unproductive uses, destroys savings (which is necessary for capital development), and it encourages malinvestments. Inflation is NOT a mechanical thing, but an insidious development in which the "good" effects are felt first (the brisk spending and the fall in unemployment). The bad effects -- malinvestments and, yes, increasing unemployment AND wildly-increasing prices -- are on the back end.
Notice that Alan Greenspan's Fed aggressively increased monetary reserves in the late 1990s, and we had a boom in which some people claimed we were in a "New Economy" in which the business cycle was a thing of the past. After the 2001 bust (when the stock bubble collapsed), the next recovery, featuring the housing boom, was not quite as robust as what had been the case in the late 1990s, and now we are in a non-recovery stage, a depression.
In 2001, the Bush administration resorted to a "hair of the dog" program for economic recovery. Following the last recession, it seems that Krugman and the Obama administration want the dog to get drunk, too. The government can throw spending and the Fed new money at the economy, but the economy is not going to respond as though it were 1998.
Krugman's call for the Fed to purchase U.S. paper directly also needs to be seen as a destructive scheme. First, the "benefits" are not spread directly. Instead, the new money will fall into the hands of those who either are government employees or are politically-connected. Second, these groups will be able to purchase goods at the OLD prices with NEW money, but as the money is spread through the economy, one can see how the insidious wealth transfers develop. Those who are NOT in the direct money pipeline will see their incomes rising very slowly and consumer price increases will outpace their ability to pay.
In other words, Krugman, for all of his talk about "income inequality," simply wants to change the terms of income inequality. He now wants huge transfers of wealth to groups that are politically-connected to the White House and, more specifically, to the Democratic Party. This has nothing to do with improving the economy as a whole; it is a scheme to benefit some groups at the expense of others -- and I should add that it won't be the "rich," but rather others who are middle class earners who don't have the same Democratic political connections.
Inflation is not a "solution." It is something that only will make things worse. Yes, I guess Paul Krugman would consider me to be an "enemy of the people" for not believing that all of the answers lie in debasing the dollar, but as I see it, the enemy consists of those who tell us the Big Lie that we can inflate our way out of this mess.
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20 comments:
I'm an amateur Austrian, but I can see a limited case for inflation.
The root of our current problem is debt. There is way too much debt at every level from the consumer to the sovereigns. It is unsustainable. So it must be either defaulted or inflated away.
Pick your poison. I think a serious one-time step devaluation, followed by a return to the gold standard, might be the least painful way out of the mess that the Keynesians and Fed central planners have gotten us into.
More thoughts here.
And by contrast the cultist Austrian anarcho-capitalist wants:
(1) to return us to a world of sluggish economic growth, by creating a 100% reserve banking system, which would choke off the endogenous money supply that povides credit for the needs of trade, commerce and industry, and which has always charcaterised real world capitalism
(2) cause relentless deflation, which would be a penalising deflation tax on the producers and productive debtors in society who borrow money to increase output; debt deflation would be relentless.
(3) There would be powerful disincentives to capital goods investment. By holding money idle, you have a guaranteed return in endless deflation.
(4) The relentless deflation would after some years - say, a 100 years or so - see an astonishingly unequal and high disparity of wealth.
(4) The relentless deflation would after some years - say, a 100 years or so - see an astonishingly unequal and high disparity of wealth.
As opposed to where Keyesianism and Fed credit bubbles have brought us today?
Lord Keynes hates old people!
He want's them to slave away and die at their desks because the money they saved for retirement buys less and less each year.
Oh noes! not deflation...
We wouldn't want computers to get exponentially better AND cheaper every 18 months.
"In a couple of blog posts this week, Paul Krugman has heaped praise upon that phenomenon known as inflation, claiming, among other things, that the euro could be successful only if it is inflated enough."
The real question is successful for whom?
"Krugman also has praised inflation as a tool for "deleveraging," which is a nice way of saying that we can inflate away debt by debasing the dollar and paying the debt service in cheaper money" HENCE BERNANKE'S POLICY PREFERENCES THAT DEBASES THE DOLLAR.
All Keynesian's I know are for a weak dollar. Little do they realize that 1) we import more than we export, and 2) as dollar loses value, commodity prices (including oil) rise as they are priced in dollars.
Hey, LK, how's that crippling Weimar deflation working out for you?
Basically, reverse everything this buffoon says, and then it may make some sense.
The fact that lenders can protect themselves from inflation is a argument in favor of it. Debtors don't have the same protections from deflation that lenders have from inflation.
And yes inflation makes mal-investments more likely because it makes all investments more likely.
Why loan money out at 0 or 1% and would any entrepreneur accept even that low interest rate if price deflation is severe enough.
I'm not saying 10-12% inflation is good but more along the lines of 2% is an open question.
Also what W.C. said. We're overextended as a nation. What can't be paid back won't be paid back. Some inflation may be the least bad way of accomplishing a needed default.
LK:
where do you get your opinion that Austrians want endless deflation? There is a difference between running, say, a normal 1-2% inflation a year versus real price deflation.
Disclosure: once again, though I am a believer in neoclassical economist, I feel more at home with the Chicago School than the Austrian (though there is not a huge unbridgeable difference) so I am not trying to blindly defend the Austrians.
To me, Keynesianism is welfare economics in its foundation (you know, the Keynesian Welfare Model). As someone interested in history of economic thought, I learned a long time ago that Keynes was nothing more than a closet socialist; maybe even a Marxist - a smart one, however, who realized early on that socialism would fail to take hold unless capitalism (crony one at that) was used to facilitate it. Therefore, Keynesian economics is a tool for hardcore collectivists of all types (as well as useful idiots, which I suspect you are a part of) to undermine free market capitalism.
I guess Best Buy's business model is faulty. They specialize in products that go through price deflation.
And I guess no one is willing to buy a flat screen TV, because the price is going to be lower tomorrow. I'm amazed that the TV manufactures can stay in business.
LK:
(1) to return us to a world of sluggish economic growth, by creating a 100% reserve banking system, which would choke off the endogenous money supply that povides credit for the needs of trade, commerce and industry, and which has always charcaterised real world capitalism
100% reserve banking does not cause "sluggish growth". It facilitates practically infinite real growth. As usual, you're ignoring prices.
(2) cause relentless deflation, which would be a penalising deflation tax on the producers and productive debtors in society who borrow money to increase output; debt deflation would be relentless.
You're confusing good deflation (falling prices based on higher productivity, which does not reduce profitability) and bad deflation (falling prices based on a decrease in money supply and volume of spending which does reduce profitability).
(3) There would be powerful disincentives to capital goods investment. By holding money idle, you have a guaranteed return in endless deflation.
Nobody can hold 100% of their incomes idle. They have to spend at least a positive amount of money. The money they do spend, will be able to buy up every capital good and consumer good and labor hour that is offered.
A gradual rate of price deflation may result in a rise in money for holding, but it won't result in a continuously growing money for holding. Instead of people holding 25% of their wealth in cash with 5% inflation, say, they would hold 35% of their wealth in cash with -5% deflation, say.
Gradual inflation doesn't result in continuously falling demand for money holding, and gradual deflation doesn't result in continuously rising demand for money holding.
Gradual price deflation will not eliminate the need to consume, or the need to produce.
Yes, holding money will mean you get a small positive return. But you will get a LARGER return by investment. The reason why investors don't invest everything they have in "risk free" government bonds at low rates, but rather only a portion of their portfolios and the rest is private market investments, is the same reason why investors won't "invest" everything they have in "risk free" cash balances, but rather only a portion of their portfolios. Exactly what they do now with inflation.
Inflation in this context does not stimulate investment. In this context, it just raises the prices of everything.
(4) The relentless deflation would after some years - say, a 100 years or so - see an astonishingly unequal and high disparity of wealth.
Relentless deflation = relentless growing real incomes. Oh no!
Inflation is what exacerbates wealth disparity, not a free market money. This is because inflation typically enters the economy at the same points all the time (government, banking). That transfers wealth away from everyone else, to the government and banks.
With a free market money, the average person's income is protected from the ravages of inflation, because their income grows in real terms through production, and their real wealth is not transferred to those who receive inflation first.
4 garbage assertions, 4 long ago refuted economic fallacies, 4 monetary crank claims, 4 textbook displays of economic illiteracy, 4 easy as pie refutations based on economic science.
What the critics forget is that deflation cannot be "endless," as prices in money terms cannot fall below that which is supported by the existing stock of money. Furthermore, when deflation occurs, the factors gain their economic balance with one another.
Inflation, on the other hand, not only distorts the value relationship between the factors, but it also has an endpoint: when the value of the inflated currency falls to zero.
What the MMTers want us to believe that money gains its value from the state, so as long as the state declares money is valuable, that is proof that it is valuable. In the end, they will support whatever violence the state imposes in order to force people to use its inflated money.
1. I'll say it again. The statists do not comprehend the real world of human exchange and economic calculation and the "economy" isn't a machine that lacks, needs or gains "traction".
2. But wouldn't sluggish economic growth pursuant to the Austrian cult cure Global Warming? Don't government freeways, funny money loans and housing subsidies cause SPRAWL? Oh wait. Government officials are benevolent and omniscient. Just ask LK. They can carefully moderate the stimulated growth while simultaneously tamping down such growth with their inciteful, I mean insightful regulations. What would we do without government officials?
My argument is that all schools of economics should be in favour of price stability. The reason being that money is intrinsically useful as a mechanism to facilitate trade, and as a mechanism to assist in economic calculation (although money serves the same ultimate purpose as barter, money is just a lot more convenient and easier to work with).
When you have substantial price instability, this actually makes money more difficult to use, and thus intrinsically detracts from the value of money, and at the same time discourages trade all round.
I'm not suggesting price fixing as such, merely that whoever issues the money (e.g. the Fed) should primarily focus on keeping prices stable and thus avoiding both inflation and deflation. In particular, sharp periods of high inflation or high deflation are the worst.
From this perspective, the credit bubble that inflated housing prices was a bad thing (caused by years of overly low interest rates), and also the rapid deflation of that bubble was a bad thing (caused by crappy lending standards).
To some extent, the QE tried to fill in the hole as debt deflation and crashing mortgages dragged the system down. As a temporary response to an already bad situation, QE did make some sense, although when massive price fluctuations are happening to people's major assets (their houses) keeping the price of motor vehicles and iPods stable is perhaps a bit pointless, but better than nothing I guess.
Kicking off another round of inflation from here seems kind of crazy to me, yes I agree that 1% or 2% would be harmless enough, but so easily this gets out of hand as everyone comes to expect the inflation and tries to get a step ahead of it. Then you need another 1% or 2% and another, and off it goes.
Once you have had a few doses of this, people will no longer trust the pricing system at all. They barely trust it now. It's a road to disaster. By the way, there are still plenty of unresolved issues in the mortgage industry in terms of foreclosure fraud, and trying to trace dodgy paperwork. These things will continue to sap away at the confidence and trust, and thus prevent healthy free trade, until they are properly cleaned up and resolved.
LK:"And by contrast the cultist Austrian anarcho-capitalist wants:
(1) to return us to a world of sluggish economic growth, by creating a 100% reserve banking system, which would choke off the endogenous money supply that povides credit for the needs of trade, commerce and industry, and which has always charcaterised real world capitalism
(2) cause relentless deflation, which would be a penalising deflation tax on the producers and productive debtors in society who borrow money to increase output; debt deflation would be relentless.
(3) There would be powerful disincentives to capital goods investment. By holding money idle, you have a guaranteed return in endless deflation.
(4) The relentless deflation would after some years - say, a 100 years or so - see an astonishingly unequal and high disparity of wealth."
jason h
"We wouldn't want computers to get exponentially better AND cheaper every 18 months.'
"Pete":
cause relentless deflation, which would be a penalising deflation tax on the producers and productive debtors in society who borrow money to increase output; debt deflation would be relentless.
"You're confusing good deflation (falling prices based on higher productivity, which does not reduce profitability) and bad deflation (falling prices based on a decrease in money supply and volume of spending which does reduce profitability)."
Well said Pete. but then you say:
"Relentless deflation = relentless growing real incomes. Oh no!"
and we're right back where we started from.
When i see threads like these i see two groups of people talking past each other, speaking an entirely different language. i feel like banging my head against a wall and screaming in frustration.
First to LK.
Good deflation lets call it prodflation (productivity plus deflation) is a substantially different animal ENTIRELY than bad deflation. Lets say there's a substantial positive technological shock like superbatteries or commercial cold fusion that surprises the monetary authority and Wall street. productivity grows by 10% in one year. Scrambling to catch up, Wall street frantically begins investing again and the Fed expands money in circulation by 5%. What is the result? the result is the best of both worlds you get falling prices, and rising nominal incomes, and no debt problems whatsoever because the supply of money and credit in circulation has not fallen IT JUST HASNT CAUGHT UP FULLY TO PRODUCTIVITY YET! Its not inflation that helps debtors, its expansion of their nominal incomes. So good deflation is a VERY good thing, Lets have a lot more of it.
To the Austrians
Jason h.
You are doing exactly what Pete has accuses LK of doing, ignoring the difference between good and bad deflation. Its frankly dishonest.
Pete. i don't know what to say. The first comment that I quoted seemed to show you understood the difference between good and bad deflation. But the second comment? Are you so determnined to hate Keynes that you even ignore Milton Friedman who understood the horrific nature of bad deflation. bad deflation destroys profits. it destroys savings. It is, quite frankly a nightmare.
Maybe you see bad deflation as the consequence of a sinful previously inflationary policy by FRB or the Federal reserve. But that leads to a whole discussion about Austrian Business cycle theory, which, if you want to discuss fine, just tell me where and when and I'll show up.
To conclude might I recommend George Selgin, As one of my favorite Austrians , he understands the profound differences between the two deflations
Cheers,
Ed
From Lord Kash Bottles:
"...the cultist Austrian anarcho-capitalist ..."
You use the Web avatar of an international pederast/felon whose economic quackery has brought civilization to the brink, and you accuse students of the Austrian School of cultism? How many on this weblog style themselves Mises, Rothbard, or Bastiat? Take the Keynesian beam out of your eye before you comment.
Humiliate the Statists.
Keynesians have one definition of deflation - a general decrease in prices.
They claim that during deflation people will hoard cash and send the market into a death spiral as no one will spend and "aggregate demand" will plummet.
There is no good/bad deflation to a Keynesian.
My computer example dissolves the notion that continuous falling prices are bad for an economy.
As to "bad" deflation, one can only artificially decrease the money supply after one artificially increases it.
Bad deflation is impossible when a society uses real money.
@ Ed -
when pete said "Relentless deflation = relentless growing real incomes. Oh no!" i took that as relentless GOOD deflation, because the amount of deflation isnt the concern, its how its occurring.
burkll13:
when pete said "Relentless deflation = relentless growing real incomes. Oh no!" i took that as relentless GOOD deflation, because the amount of deflation isnt the concern, its how its occurring.
Bingo.
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