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inflation and rising prices: which causes which?

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Maurizio Colucci posted on Fri, Sep 10 2010 3:04 AM

How would you respond to someone who claims that it is not monetary inflation that causes prices to rise, but rather vice versa, rising prices cause the central bank to print more money? (Or maybe that the expectation of rising prices causes the central bank to print money ?)

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Answered (Verified) Azure replied on Fri, Sep 10 2010 6:48 AM
Verified by Maurizio Colucci

Until he gives you a good reason why prices would magically rise - which he never will - keep debating his 'increasing price' claims before you talk about the primary subject of discussion.

Really? This is an easy one: Certain events causes time preferences among consumers to heighten in general, lessening the rate of saving and pushing up demand curves across the board, raising prices.

As for how this could lead to an increase in the money supply... Only thing I can think of at the moment requires FRB. Higher prices means businesses will show an increased nominal demand for loans. Combined with the now lowered total reserves due to the lowering of the rate of saving, this means FRBs will have to lower their reserve ratios to meet this new demand, increasing the supply of money. However my reasoning here is academic speculation and I'm sure someone here will tear it to shreds any minute now.

As for the inverted causality it is obvious an increased money supply, all else being equal, causes a rise in prices: The demand curves of those who have received the new money rises while those of everyone else stays the same. Unless your friend has somehow disproven the law of marginal utility he should not be taken very seriously.

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Answered (Verified) WisR replied on Fri, Sep 10 2010 7:04 AM
Verified by Maurizio Colucci

Walk him through it.  Suppose the shop owner successfully raises prices, and the person spends more money buying the same or a little less of the good.  Then what happens?  He doesn't have as much money to spend on other goods, which means if other shop owners want to sell to him, they have to lower prices.

All other things being equal, when the price of some things goes up, the price of everything else must go down.  Ask him to prove why this is not true if he doesn't think so.

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Answered (Verified) xahrx replied on Fri, Sep 10 2010 7:54 AM
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"Really? This is an easy one: Certain events causes time preferences among consumers to heighten in general, lessening the rate of saving and pushing up demand curves across the board, raising prices." - Azure

Wouldn't the heightened time preference mean a flow of money out of investment toward consumer spending?

To the OP, I've been in that argument before and the key question is how can there be a sustained general price increase without an increase in the money supply?  Answer is: there can't.  If the money supply is fixed and general prices rise, some goods and services will simply go unsold as people economize.  The businesses with a surplus can then lower prices and accept a smaller profit margin, and do what they can to innovate and cut costs to get some of that margin back, or adjust production downward to account for the lack of demand.  That's one of the key drivers in pushe's for an 'elastic' money supply, because a fixed one means some producers will ge tthe crap end of the stick when people economize and they simply don't want to deal.

Sean Corrigan gave a nice summary of this in one of his articles.  Put simply if you've got 10 bucks left in this world to your name and you want a burger and two beers, the price of burgers being 5 bucks and beer 2.50 each, you're good.  However, when you get to the restaurant and it turns out there's been a rise in demand for beef let's say, and burgers are now 6 bucks a pop, you have to rearrange your preferences and do with a little less beer or no beef.  And you and millions of other making that similar decision over time dictate who will and will not get the money from those transactions, and how each industry will have to adjust production schedules to account for the new reality.  That is, in the unfucked with economy, if goods/services  A-H are more heavily demanded now for whatever reason, producers of goods/services I-Z will have to accept a lower return either marginally or due to lower production volum unless they can cut costs o convince people to make a different decision.  So when there is fixed supply, or a supply that may as well be fixed due to practical constraints, you can't have a sustained general rise in prices because those goods and services people economize on will simply go unsold.  And since producing goods and services that go unsold is also something that can't be sustained with a fixed supply of money, eventually that behavior has to be changed to match consumer's demands.

"I was just in the bathroom getting ready to leave the house, if you must know, and a sudden wave of admiration for the cotton swab came over me." - Anonymous
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That doesn't even make sense to me how it would be vice versa. I mean, I understand what they're saying, but the logic is completely off. Just to make sure they know what they're talking about, ask them why the prices would rise in the first place. And then debate them about that for a while too. Any way to make them look stupid works out well for you.

"Every normal man must be tempted at times to spit on his hands, hoist the black flag, and begin to slit throats." - H.L. Mencken.

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I haven't asked him why he thinks prices rise as I was too astonished by his claim. However, suppose he replies that prices rise because of the greed of shop owners. What then?

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Well, I mean, if shop owners are greedy and ask for higher prices, then people will shop elsewhere for a lower price, especially if they can't afford it. Then the greedy shop owner will have to either (1) lower prices or (2) have his business go bankrupt from no customers coming by. That would be how you refute his claim of prices rising before inflation. Then he won't want to look like an idiot, so he'll try to come up with other ways to describe how prices could possibly rise independently.

The other way they could rise is if the government regulates the market. If the government limits the supply, the demand will exceed what is available and all of the competition will be gone. Then people simply can't afford the goods and there's no alternative, which is another reason why government should not intervene.

Until he gives you a good reason why prices would magically rise - which he never will - keep debating his 'increasing price' claims before you talk about the primary subject of discussion.

"Every normal man must be tempted at times to spit on his hands, hoist the black flag, and begin to slit throats." - H.L. Mencken.

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Answered (Verified) Azure replied on Fri, Sep 10 2010 6:48 AM
Verified by Maurizio Colucci

Until he gives you a good reason why prices would magically rise - which he never will - keep debating his 'increasing price' claims before you talk about the primary subject of discussion.

Really? This is an easy one: Certain events causes time preferences among consumers to heighten in general, lessening the rate of saving and pushing up demand curves across the board, raising prices.

As for how this could lead to an increase in the money supply... Only thing I can think of at the moment requires FRB. Higher prices means businesses will show an increased nominal demand for loans. Combined with the now lowered total reserves due to the lowering of the rate of saving, this means FRBs will have to lower their reserve ratios to meet this new demand, increasing the supply of money. However my reasoning here is academic speculation and I'm sure someone here will tear it to shreds any minute now.

As for the inverted causality it is obvious an increased money supply, all else being equal, causes a rise in prices: The demand curves of those who have received the new money rises while those of everyone else stays the same. Unless your friend has somehow disproven the law of marginal utility he should not be taken very seriously.

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Answered (Verified) WisR replied on Fri, Sep 10 2010 7:04 AM
Verified by Maurizio Colucci

Walk him through it.  Suppose the shop owner successfully raises prices, and the person spends more money buying the same or a little less of the good.  Then what happens?  He doesn't have as much money to spend on other goods, which means if other shop owners want to sell to him, they have to lower prices.

All other things being equal, when the price of some things goes up, the price of everything else must go down.  Ask him to prove why this is not true if he doesn't think so.

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Answered (Verified) xahrx replied on Fri, Sep 10 2010 7:54 AM
Verified by Maurizio Colucci

"Really? This is an easy one: Certain events causes time preferences among consumers to heighten in general, lessening the rate of saving and pushing up demand curves across the board, raising prices." - Azure

Wouldn't the heightened time preference mean a flow of money out of investment toward consumer spending?

To the OP, I've been in that argument before and the key question is how can there be a sustained general price increase without an increase in the money supply?  Answer is: there can't.  If the money supply is fixed and general prices rise, some goods and services will simply go unsold as people economize.  The businesses with a surplus can then lower prices and accept a smaller profit margin, and do what they can to innovate and cut costs to get some of that margin back, or adjust production downward to account for the lack of demand.  That's one of the key drivers in pushe's for an 'elastic' money supply, because a fixed one means some producers will ge tthe crap end of the stick when people economize and they simply don't want to deal.

Sean Corrigan gave a nice summary of this in one of his articles.  Put simply if you've got 10 bucks left in this world to your name and you want a burger and two beers, the price of burgers being 5 bucks and beer 2.50 each, you're good.  However, when you get to the restaurant and it turns out there's been a rise in demand for beef let's say, and burgers are now 6 bucks a pop, you have to rearrange your preferences and do with a little less beer or no beef.  And you and millions of other making that similar decision over time dictate who will and will not get the money from those transactions, and how each industry will have to adjust production schedules to account for the new reality.  That is, in the unfucked with economy, if goods/services  A-H are more heavily demanded now for whatever reason, producers of goods/services I-Z will have to accept a lower return either marginally or due to lower production volum unless they can cut costs o convince people to make a different decision.  So when there is fixed supply, or a supply that may as well be fixed due to practical constraints, you can't have a sustained general rise in prices because those goods and services people economize on will simply go unsold.  And since producing goods and services that go unsold is also something that can't be sustained with a fixed supply of money, eventually that behavior has to be changed to match consumer's demands.

"I was just in the bathroom getting ready to leave the house, if you must know, and a sudden wave of admiration for the cotton swab came over me." - Anonymous
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