Myth: Inflation Is A Bad Thing

As I pointed out in the comments on the first of these articles, Congressman Paul advocates a dual currency system in the short term. This would be nothing like the pre-Depression monetary system. Eventually, he would probably favor either a gold standard with no fractional reserve banking (which this country has never had) or a free banking system similar to what occurred from 1836-1861. No one advocates the pre-Depression currency system (a fiat system that masquerades as a gold standard) and for good reason.

The Fed failed to prevent the Depression, and is blamed by many for making it worse. I know it's a scary word, but it didn't happen in the era before the Fed, the Fed was firmly entrenched at that point. .

Well the arguments can go either way couldn't they?

Milton Friedman, leader of the Chicago School, argued that the Federal Reserve System did not cause the Great Depression, but made it worse by contracting the money supply at the very moment that markets needed liquidity. Since its entire existence was predicated on its mission to prevent events like the Great Depression, it had failed in what the 1913 bill tried to enact.[36] This is also the current conventional wisdom on the matter, as both Ben Bernanke and other economists such as the late John Kenneth Galbraith--the latter being an ardent Keynesian--have upheld this reasoning.

Ben Bernanke, the current Chairman of the Board of Governors, apparently agrees with Friedman's assessment, saying in a 2002 speech: "I would like to say to Milton [Friedman] and Anna [J. Schwartz]: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."[39] [40]

The argument that they caused it or made it worse is not trivially dismissed if Ben Bernanke accepts it.

Except by your own quote, both Friedman and Bernanke appear to agree that the Fed did not cause the Depression:

Milton Friedman, leader of the Chicago School, argued that the Federal Reserve System did not cause the Great Depression

So maybe it can be dismissed that the Fed caused it, although we can argue over their attempts to mitigate its effects once underway.

Sorry, I didn't link my quote there: http://en.wikipedia.org/wiki/Federal_reserve#Historical_criticisms.

Further snippet:

At one end of the spectrum are economists from the Austrian School and the Chicago School who want the Federal Reserve System abolished.[35] They criticize the Federal Reserve System's expansionary monetary policy in the 1920s, arguing that the policy allowed misallocations of capital resources and supported a massive stock price bubble.

Milton Friedman, leader of the Chicago School, argued that the Federal Reserve System did not cause the Great Depression, but made it worse by contracting the money supply at the very moment that markets needed liquidity.

This is an extremely key point. Were it not for then Treasury Secretary James Baker's interventions into currency supply in the wake of the 1987 stock market crash we would have had a very, very rough go in the marketplace. The ability to supply tactical as well as strategic liquidity in currencies is key. Put simply, sometimes a little inflation is just what you need to prevent a collapse. A little.

Put simply, sometimes a little inflation is just what you need to prevent a collapse.

Only if you start with the premise that an inflationary bubble is good policy. You're focusing on what to do once imbalances have been created, not how to prevent the imbalances in the first place.

Entelechy,

In a market system, inbalences are part of life. being able to deal with them effectivly is the key to continuing beyond them.

It is still a problem Handshake.

Yes... people do not lose their jobs as much, but then you end up with poorer workers.

Poor workers do not make productive workers. less production leads to less profit, and on down... so companies who use worker wages as a central point to save money will suffer in the end.

I'm not saying that cutting real wages is the answer for companies in trouble, just that the alternative is often worse. I fully agree with you.

Wait, what does this have to do with the Fed? It's a thoughtful statement, but I'm not sure how it's relevant.

I was supporting Killfile's debunking the notion that "inflation is a bad thing", the title of this article, though I think I am coming at it from a different angle than he is. Then again, perhaps that's not entirely true:

Inflation deters hording and encourages the rapid deployment of that capital. As inflationary pressures increase, so also does the velocity of money which itself relates directly to the propensity of an economy to both consume and invest. The converse is also true, as inflationary pressures approach zero individuals are more likely to horde capital than they are to invest it. This results in deflationary pressures which themselves reinforce the impetus to horde.

Now, I never thought about inflation before, so my thoughts are pretty rough. I'll admit that my points about externalities of perpetual title transactions may not apply to money, which I think is really just an IOU rather than a finite real resource, and require some more thought and debate. I'm not sure yet.

I think what vas is saying is that basing a currency on an accrued fixed wealth such as gold isn't as important as proving the value of your economy in a competitive marketplace.

The reason that I think inflation seems so wrong for a person who believes absolutely in private property and the notion that once you've earned and own something, no one has the right to ever take that away from you, and inflation is effectively the taking away of your property. I'm essentially deflating the underlying assumptions of that argument, excuse the pun.

Though, as I've said, my thoughts may not apply to money as obviously as they do to land, for example. If I worked 40 hours and get a piece of paper in return, I do think it a reasonable expectation that it shouldn't matter whether I wait one day or one decade before I use that piece of paper to get someone to work for me, all other things being equal.

hmm... that is an interesting way to look at inheritance and wealth Vas... If you do not give a chunk of it now to feed the society, those who are at a permanent disadvantage later on will simply take it at the tip of a bloody knife.

Or the wealthy could spend even more money on private armies and make large donations to religions that keep the masses docile.

Agreed, some inflation is necessary to ensure that people with capital continue to reinvest in an economy rather than to sit on their nest eggs. But a system that accepts inflation must also accept that people who lived on lower or fixed incomes may not be given the opportunity to keep up with inflation. So if you're going to have an economy with some modest and desirable inflation you have to resign yourself to systems that ensure both social mobility and social security in order to maintain a stable society.

How to handle deflation Killfile?

Do what Bush did in 2002.... give everyone 100 dollars and tell them to do their patriotic duty and spend it!

jblossom,

Then every senior should transition their savings and retirement to gold backed bank accounts. Then their money at retirement which they will have to pull on at a fixed rate will maintain its economic value.

No need to mess with the economy at large.

BMS, is there any such system? Pensions do not pay out in gold doubloons last time I checked.

Then every senior should transition their savings and retirement to gold backed bank accounts.

BMS, is there any such system?

Couldn't they just buy gold or gold certificates?

The issue is that they receive fixed amount payments in dollars. As inflation goes on, those fixed payments are worth less and less gold (or other real goods, like food or gas) every time. You can't inflation proof the payments after they've already been issued in dollars.

Social Security works around this by constantly raising the amount due to cost of living. Minimum wage doesn't deal with this at all.

But if gold retains its value relative to other real goods (Isn't that the basis of arguments for a gold standard?), it doesn't matter what the dollar value is as long as you only use dollars as an intermediate exchange medium. If an ounce of gold pays for a month of rent today, it should still pay for a month of rent 50 years from now, even if instead of $650 its $6,500 &mdash again, assuming the pro-gold standard advocates beliefs about gold.

Brian... I am saying that those on a fixed income prior to retirement put all those funds into a gold backed account. They do not need to pay out in doubloons, just be backed by the commodity and then you can make a withdrawal of say (as vas mentioned) an ounce of glad in dollars... since the gold standard folk claim it is a robust inflation resistant medium for monetary systems, then this micro system for maintaining fixed fund accounts should keep our seniors from suffering inflation pains.

vas - the fixed incomes I'm talking about are paid out in a fixed number of dollars. Was this unclear? If so I apologize. Fixed incomes decline every year in purchasing power due to inflation. That means every year you could buy less and less gold every month. People on fixed incomes also generally use those incomes to pay rent, buy food, etc - not to put into holding accounts.

BMS - yes that would be fine, but as far as I know there are exactly zero gold based pension plans in the US. Pension plans are paid out by the retirees company (not under the retirees control) month to month, using reserves they've put away, or funds currently pulled from current workers salary, or company profits. The reserve part of that could be put in gold backed resources, but the other two components cannot easily be divorced from the nation's currency.

Brian,

Ahhh... I see the disconnect. You're talking about people locked into existing dollar-based pensions while BMS and I are talking about there not being a reason to switch everything to a gold-based standard because anyone who wants that can simply put their savings in gold rather than in dollars. You're talking existing realities while we're talking monetary theory. BTW, didn't we have this same disconnect on another thread?

Looks like we've switched roles. Typically in my debates with Libertarians, I feel they are talking in abstract ideals and I focus more on existing realities. :)

So... allow inflation to occur, devaluing the dollar every year, but automatically adjust retirement benefits and minimum wages to the constantly devalued dollar to arrive at - a situation very similar to having no inflation in the first place.

What am I missing that makes this not some kind of perpetual motion machine? Are you actually allowing inflation to occur if you auto-hike people's income? Or does that show an inherent tendency to want to fight the effects of inflation?

Even companies make adjustments for inflation occasionally. The "cost of living" adjustment (maybe more common in times past, I guess).

For retirees on a fixed income isn't perpetual inflation a terrible thing?

If the economy were efficient, I would think there would always be an investment with returns that match the inflation rate. And there is. In fact, retirees, without having to do any more work, actually make money over time. And I'm not even factoring in the appreciation of homes over and above inflation, for those that own.

I was speaking of pensions, which pay out a fixed amount per year, not accounts like IRAs that are investment vehicles. I know, nobody in my generation has them, but they are a significant reality for current retirees. If you're on a pension, I don't believe there is a cost of living increase (unlike social security), and the most common effect of home appreciation on the elderly is to force them out of their homes through higher property taxes that they can't afford to pay.

I was speaking of pensions, which pay out a fixed amount per year, not accounts like IRAs that are investment vehicles. I know, nobody in my generation has them, but they are a significant reality for current retirees.

Thanks, I did not know that. But it seems to me that the culprit here is the pension, not the monetary system. And it looks like people have learned, or the competitive marketplace has come up with "the right solution". I would have no problem with the government subsidizing pension adjustments for people with below a certain level of income, but I think you wouldn't like that because it involves government.

the most common effect of home appreciation on the elderly is to force them out of their homes through higher property taxes that they can't afford to pay

Actually, they can leverage the increased equity to cover the taxes. The market could come up with new "semi-reverse" mortgage products that automatically pay property taxes. If you agree with my points against the concept of perpetual title and the fairness of all property having a time-based cost, then there's no problem here.

I think it depends on the specific pension:

Typical plans in the United States are final average plans where the average salary over the last three or five years of an employees' career determines the pension; in the United Kingdom, benefits are often indexed for inflation.

tell retirees to place their money In a gold backed savings account... problem solved.

So that as gold devalues, their savings is wiped out. Wonderful.

gold should not devalue against the consumer prices in the economy according to the gold standard folk... an ounce of gold in ancient Rome bought a suit...same as an ounce of gold today...

Perhaps you could write an article for those of us who are versed in monetary policy lingo and explain the ups and downs of each of these systems in more detail. I think it would be interesting.

I'm considering doing so, I'll just have to find the time to write it.

It will be of concern to Zimbabwe hows this plays out..

I would suggest that perhaps Herb has never in his life heard of hyperbole either.

Herb... if you claim the US paper money is worthless trash.. then why do you care if wallsteet crooks make millions of those pieces of trash?

I believe you, I just had no idea that prices were so low oustide of very high-cost area that I happen to live in.

My dad told me when I was a child when he was courting my mother they went to the movies 4- 6 nights a week...

How many of those films did they actually see?

I think the point isn't that inflation is nothing to worry about, but rather that inflation is a natural consequence of economic growth - as purchasing power in the economy grows so does competition for goods and services; however, the other side of that coin is that said growth needs to be managed or else inflation can spiral out of control and overtake economic expansion. Which is I believe the concern you raised.

Or I could be exactly wrong. With monetary policy and economics I never really know if what I'm saying makes any sense.

but rather that inflation is a natural consequence of economic growth

Except that the natural consequence of growth is the opposite (prices decline). The more stuff we have, the less valuable any particular unit of it is. Consider how cheap and functional consumer electronics have become.

If you take out the fluctuations caused by boom-bust cycles (caused by fractional lending) in the 19th century, you find that the overall price trend was downward, even though the 19th century saw the most rapid rise in living standards the Western world has ever seen.

Am I wrong in saying that, strictly speaking, economic growth isn't more stuff, it's more dollars?

Could the price trend of the 19th century be attributed to gains in technology and productivity?

I agree Henry... for the worker, it is really bad because most companies have wages as their central money saving strategy so a worker with out a union will lose wages as time goes on even if they get that wonderful 2% raise after their perfect performance evaluation.

Could the price trend of the 19th century be attributed to gains in technology and productivity?

Pretty much entirely. These days we have to take into account "real" vs. "nominal" GDP in order to find the actual increase in production, not just the dollar value. Inflation is not the price of progress. There are some economists who contend that if we had a monetary system of type 2 (see post #8) that we would experience constant low-level deflation.