Wednesday, February 24, 2010

Is Inflation the Cure for our Economy?

About 30 years ago, I read The Biggest Con by Irwin Schiff (Peter's dad), and he made an important point about Keynesian "economics" which I have never forgotten: Inflation is the only arrow in the Keynesian quiver.

That comes to mind as I read Paul Krugman's recent outburst in his blog about inflation: We don't have any:

You might think it would be hard to be an inflation hawk, demanding monetary tightening now now now, in the current environment. For one thing, there’s no inflation. And there’s also mass unemployment. Based on historic Fed behavior, the combination of these two factors should mean a Fed funds rate of around -6 percent; since the Fed can’t do that, it ought at least to keep rates near zero for a long time, probably at least the next two years.

But these guys are made of sterner stuff than that. Irwin Kellner explains that the overall level of prices is rising, as long as you don’t count the goods whose prices are falling.

Being that Krugman wrote in his Depression Economics book that many, if not most, economic problems can by solved simply by "printing money." Do we have troubles now? No problem. Get the Fed to create a lot of funny money, throw it into the economy, and watch the magic begin.

If the economy were simply an amorphous mass of homogeneous assets, and simply stirring money into the pot were all that was needed to make the mixture viable, I guess he might have a point. However, assets are heterogeneous, and inflation only prolongs the fundamental imbalances that have been plaguing us for the last several years.

True, prices for some things have been falling, such as housing prices. That should not be surprising, given the massive malinvestments in housing during the boom, malinvestments that could not and cannot be sustained by simply printing money and lowering mortgage rates.

True, much of the newly-created money is sitting in the banks and has not been loaned in the general economy, seeking demands from the government that banks start lending -- or else. However, don't forget that loans are made on the assumption that the borrower will pay back the money. In the Keynesian view, that is no problem; the new money will automatically "stimulate" economic activity to the point where borrowers will have the money in the future to repay their loans.

However, in the Austrian view, the situation is much more complex. If the economic fundamentals are out of balance, then government action make those imbalances worse, so pouring new money via the banking system will stimulate nothing but further bankruptcies.

Krugman is betting on the former; Austrians see the latter. That is why we are and always will be so-called inflation hawks. Contra Krugman, there are no overall economic benefits that accrue from inflation. None.

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