Free Capitalist Network - Community Archive
Mises Community Archive
An online community for fans of Austrian economics and libertarianism, featuring forums, user blogs, and more.

Monetarist myth that 2-3% inflation is good for the economy? The Austrian view?

rated by 0 users
Answered (Not Verified) This post has 0 verified answers | 23 Replies | 2 Followers

Not Ranked
49 Posts
Points 680
liberation posted on Mon, Oct 15 2012 11:40 AM

I couldn't find an answer for this. I don't know if it is from Milton Friedman himself or is it a general theory that 2-3% is "good for the economy." There are many parties in an econnomy so the question it is good for whom exactly?

What is the thesis and antithesis of this theory?

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/

All Replies

Top 25 Contributor
Male
3,113 Posts
Points 60,515
Esuric replied on Mon, Oct 15 2012 10:33 PM

It's a general monetarist rule that the money supply should increase by the same rate as output (relies on the classic monetarist assumption that velocity is either constant or stable). Output, in the U.S. at least, tends to grow at around 2-3%. The anti-thesis can be found in Hayek's Monetary Theory and the Trade Cycle (yields relative price inflation and therefore relative structural imbalances which must be liquidated. Also reduces the money rate of interest in relative terms, though it may remain constant in absolute terms). 

"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."

  • | Post Points: 20
Not Ranked
2,258 Posts
Points 34,610
Anenome replied on Mon, Oct 15 2012 10:34 PM
 
 

It has to do with Keynesian theories of how to 'tame' the business cycle through controlling interest rates and the supply of money variously, to either pump the economy with low interest rates and free money during recessions and tame the economic engine by ramping these down during boom times.

In actual practice, inflation has the effect of being a tax, allowing the government to spend whatever % inflation is that year, stolen from everyone in diluted value.

The reason the gov likes doing this is not just because they profit off it personally, but because government debt is measured in fixed quantities of dollars while the value of the dollar is allowed to slide downwards, meaning the money they owe in real terms decreases. This is politically popular not just because of the largesse gotten out of it by various groups, but because of all the debtors whose home loans become cheaper and cheaper as the value of the dollar slides.

So for various and sundry reasons, an inflationary policy is popular by those with political power.

In a free marketed you'd actually get continual deflation. How long has it been since we saw that :P

 

 
Autarchy: rule of the self by the self; the act of self ruling.
  • | Post Points: 20
Not Ranked
452 Posts
Points 7,620

In a proper Austrian/free market economy, how should the money supply grow? Would it match the real demand for money? Does it even need to grow?

http://thephoenixsaga.com/
  • | Post Points: 20
Not Ranked
2,258 Posts
Points 34,610
Answered (Not Verified) Anenome replied on Tue, Oct 16 2012 12:49 AM
Suggested by shackleford

shackleford:

In a proper Austrian/free market economy, how should the money supply grow? Would it match the real demand for money? Does it even need to grow?

I'll answer this is terms of gold and bitcoin.

There is, in the universe and on our planet, a finite supply of gold.

Yet the value of gold will continue to fluctuate because the demand for gold will always change, and price is a function of both supply and demand together.

Same is true of bitcoin. In this respect they're both similar, with a finite supply. Also, in both cases, more is continually mined over time, but there is an ultimate limit.

Now, in a free market, with good money (gold / bitcoin) what we'd expect to see, and what we actually did see before fiat currencies came to dominate the world, was continual deflation, whereby money was constantly rising in value. The entire 19th century, for instance, experience deflation continually. People took pay cuts year after year and didn't complain, because their purchasing power either remained the same or improved despite the paycut, because of continual deflation. Money was becoming more value.

It becomes more valuable because each year people work. And by working their produce wealth. And thus real wealth increases every year by some value, yet the supply of gold/bitcoin remains the same. Also, more people enter the workforce continually.

So, demand for money continues to increase, and the amount of wealth in the world increases by trillions of dollars every year.

There's literally no reason why you'd want the money supply to remain at zero % inflation or deflation. You do not need to increase the money supply at all for an economy to function. The money supply is inflated currently purely because it's political advantageous to do so. End of story. It's not economically advantageous except to debtors--of which the US government is the largest! Oops. But that doesn't help the citizens.

What would happen in a free society is that demand for money grows and the money deflates, prices continually drop, and we cut money into smaller and smaller segments to cope with this deflation. Gold is essentially infinitely divisible, and bitcoin is too.

You could eventually have the equivalent of quadrillions of today's dollars one day packed into bitcoin, or gold, based on simply wealth production and demand for money.

tl;dr: we'd all be better off if money were left in the hands of the market.

 

Autarchy: rule of the self by the self; the act of self ruling.
  • | Post Points: 35
Not Ranked
49 Posts
Points 680

> yields relative price inflation and therefore relative structural imbalances which must be liquidated.

I don't quite understand this grammatical structure. I'm not a native speaker. Thanks!

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 5
Not Ranked
49 Posts
Points 680

Sorry. This quotation system seems not work for me.

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 20
Not Ranked
49 Posts
Points 680

Anenome,

Your explanation is clean and clear.

> There's literally no reason why you'd want the money supply to remain at zero % inflation or deflation.

I only don't get this sentence and how it connects to the rest of your post.

If there is a constant deflation in the economy (wage cuts every year, previous year's money worths more than this year's) then doesn't it imply that people will work less and less? At least who have savings.

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 20
Not Ranked
2,258 Posts
Points 34,610
Anenome replied on Tue, Oct 16 2012 11:56 AM
 
 

liberation:

> There's literally no reason why you'd want the money supply to remain at zero % inflation or deflation.

I only don't get this sentence and how it connects to the rest of your post.

If there is a constant deflation in the economy (wage cuts every year, previous year's money worths more than this year's) then doesn't it imply that people will work less and less? At least who have savings.

Perhaps you're right, but this would actually be a positive outcome. It would mean that those with existing wealth would tend to gain more wealth over time just by sitting back and doing nothing. Which means that there would be a benefit to being rich and saving capital, making more productive capital available to society generally.

Since the amount of capital available is tied to how prosperous and wealthy a society can become, this would be a good thing.

In an inflationary environment, going into debt is encouraged by inflation, since your debt will be worth much less the longer you wait. Deflation encourages savings. Which is more productive for an economy, debt or savings? Clearly savings. Because if everyone had savings, of any amount, there is no problem at all. Every person could have a billion dollars in the bank and the economy would be just fine.

But give everyone a billion dollars in debt and we have a serious problem on the order of 1929.

So, to answer your question about zero % inflation. Those who control the money supply in most countries initially tried to reach 0% inflation or deflation, to create money as demand grew. So let's say demand for money grew by say 3% a year and that was what I'll call 'natural deflation.' It's what would happen if the government didn't interfere and create extra money.

Prices would be able to remain exactly the same, loans wouldn't be affected, etc., by 0% inflation. That seems like a benefit, but really it's not such a benefit that we should care about it. Because the market is capable of taking inflation or deflation into account as it happens and adjust contracts to it. It's more damaging for the rate of inflation/deflation to fluctuate wildly than anything else.

You can construct contracts that take inflation into account and adjust the value of loan principal according to inflation, etc.

So, you don't need zero % inflation, and that's why a government inflation to keep zero % inflation is not needed, and why using gold or bitcoin as a money--moneys that would naturally be deflationary--is the way to go.

So, would people stop working eventually?

Hah, now that's the libertarian dream. You see, what we want in an economy, the actual overall goal, is not full employment, it's full consumption. If we could not work and yet consume the same amount, would we? Hell yes.

Save enough productive capital and we can replace ourselves as workers with machines and other tools and continue to prouduse without working. It's the long term goal that we will eventually get to, turning earth into something like a paradise, where the only work people do is that which they choose to do from interest and fun.

(Ironically this sounds something like the socialist's vision for utopia, a worker's paradise, but their vision can never be achieved as they imagine it being achieved, whereas the one I cast here for you is already in operation and needs only to expand considerably.)

Deflation would incentivize savings, would reward it, and the result would be more capital for investing. One major difference between a first world country and a third world country is the amount of productive capital invested in it.

In a libertarian society, we would seek to make capital investment so rewarding and profitable that it becomes first world not only quickly, but continues to excel far beyond what first world looks like today, to the point that we create a new standard of living, let's call it 0.5-world, which makes first-world look shabby and trite :P

 
Autarchy: rule of the self by the self; the act of self ruling.
  • | Post Points: 20
Not Ranked
Male
444 Posts
Points 6,230

liberation:

Sorry. This quotation system seems not work for me.

Please read the Newbie Thread:

https://mises.org/Community/forums/t/23624.aspx

My long term project to get every PDF into EPUB: Mises Books

EPUB requests/News: (Semi-)Official Mises.org EPUB Release Topic

  • | Post Points: 5
Not Ranked
49 Posts
Points 680

Thanks for your detailed answer Anenome!

Actually where can I read more /see more of your deflation theory? A short video presentation os preferable to a long book. :) Thanks!

The common wisdom says deflation is the worst thing that can happen to an economy:

People will not buy stuff, they put their purchases later when prices will be even cheaper. Companies can't sell, there will be layoffs, unemplyment...

OK, maybe it's not correct arguemnt.

You say the economy needs not full employment but full consumption. 2 things about this:

1. How should people survide who are unemployed and have no savings?

2. Maybe it's juts me but 'Im more like Warren Buffett: I mean he is quite well off guy but he lives rather frugally.

So you say gold is ALWAYS a good investment? The conventional visdom says it's rather cyclical: first you are better off investing in the real economy (1980-2000), then in the second part gold catches up (2000-2012). (But what's now? The economy stopped. Gold stopped. That's a good question.)

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 20
Not Ranked
49 Posts
Points 680

Btw. interesting tidbits about gold hoarding (deflation?) by film maker Paul Grignon (in the LETS thread):

http://mises.org/community/forums/p/32043/497878.aspx#497878

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 5
Not Ranked
49 Posts
Points 680

OK. I was thinking about it. Gold simply can't be so much more expensive over time even if it's scarce: it is just one of the commodities, there are others as well: silver, palladium, etc. Sure, the price can go up but I can't imagine it goes up by a magnitude or two.

www.stratfor.com/analysis/love-ones-own-and-importance-place www.stratfor.com/weekly/20100503_global_crisis_legitimacy www.youtube.com/watch?v=p_KKN_jltI8 www.youtube.com/watch?v=sDQX3MybtVA batgap.com/ilona-ciunaite-elena-nezhinsky/
  • | Post Points: 5
Not Ranked
2,258 Posts
Points 34,610
 
 

liberation:

Thanks for your detailed answer Anenome!

Actually where can I read more /see more of your deflation theory? A short video presentation os preferable to a long book. :) Thanks!

You're welcome :)

Inflation in theory is part of any basic econ text. The cause of it is very simple: printing more dollars. The effects of it are subtle, various, and pernicious.

Here's Hazlitt's book intro to econ:

Economics in One Lesson

If you keep delving into libertarianism you're going to need a grounding in Austrian economic theory. It's not as dry as you might think. And once you have your head right in economics, no competing theories of politics trying to justify interventions and state run solutions can tempt you, you'll know they won't result in plusses for people and, more importantly, you'll know why.

Hazlitt also wrote and entire book just on inflation, which I want to read :)

What You Should Know About Inflation

It is not merely that inflation breeds dishonesty in a nation. Inflation is itself a dishonest act on the part of government, and sets the example for private citizens. When modern governments inflate by increasing the paper-money supply, directly or indirectly, they do in principle what kings once did when they clipped coins. Diluting the money supply with paper is the moral equivalent of diluting the milk supply with water. Notwithstanding all the pious pretenses of governments that inflation is some evil visitation from without, inflation is practically always the result of deliberate governmental policy.

But videos? I have no idea. Um, maybe something like this?

http://www.youtube.com/watch?v=9fv1DqIen28

liberation:
The common wisdom says deflation is the worst thing that can happen to an economy:

The worst thing is actually rapid change in the interest rate. If the rate is fairly steady, the economy can adapt. Although, inflation is worse than a deflationary policy for some of the reasons we talked about before. But rapid change paralyzes all business activity. Then your economy stops, or frantically tries to keep up somehow and it's chaos in no time.

liberation:
People will not buy stuff, they put their purchases later when prices will be even cheaper. Companies can't sell, there will be layoffs, unemplyment...

Well, inflation can have the opposite effect. People may want to buy right away to get the most value out of their currency. You see, when there's inflation, prices don't go down, they go up. So, if you're being paid at a job in fiat currency, you try to spend it asap, to get it out of dollar form so the inflation won't affect it anymore.

Anything you buy, say gold, will tend to rise in price along with the inflation and thus serve as a value store.

If you held on to that currency, the amount of anything it could buy would continually fall with the inflation, meaning its purchasing power is decreasing. If you could buy 100 bushels of wheat, with 5% inflation you now can only buy 95 bushels. So you are losing real wealth along with that purchasing power.

The reason companies will contract is because they always contract when there's considerable uncertainty. They put aside long-term plans for wait-and-see, if there's rapid change in the money supply. Also, inflation vs deflation can influence what companies do and how they might invest.

liberation:

You say the economy needs not full employment but full consumption. 2 things about this:

1. How should people survide who are unemployed and have no savings?

What I mean is, in an ideal world your real goal is full consumption.

We are not producing things to produce them! We are producing things in order to consume them! If we could consume them without producing them, we would! Man is a consumer. The only reason he produces at all is because he realizes he'd have much more to consume if he produes it first!

To actually achieve that in real life requires one thing: productive capital.

In real terms, that would mean that we would have to invent strong-artificial intelligence capable of replicating human intelligence. Then the hardware to run it would have to be cheap and ubiquitous. So, we're talking orders of magnitude more productive capital in the world and an invention that may not even prove to be possible ultimately. But if it is, and we build up enough productive capital, then there's no reason why we can't have machines producing everything we need and have human kind sit back and simply consume to their hearts' content.

How would people survive in this era? There would have to be a cultural shift towards intergenerational wealth transfer. Meaning that everyone would be trust-fund-babies, leaving fortunes to their kids. Everyone. Only the rich do it now, but there's no reason why the middle and poor classes could not as well. You'd just have middle and poor versions of complete unemployment. Maybe the truly rich would be able to jet around the solar system while the poor wouldn't be able to afford even a trip into orbit, meanwhile the middle-class are regularly visiting the moon and Titan. There's no reason why that vision is not one day achievable, as long as we continue to build productive capital.

liberation:
2. Maybe it's juts me but 'Im more like Warren Buffett: I mean he is quite well off guy but he lives rather frugally.

Good, good :) Saving is the mechanism by which productive capital is compounded.

liberation:
So you say gold is ALWAYS a good investment?

No, I'm saying it's always a good value store.

Gold can't, to my mind, be considered an investment. It's a value store. Now, if you expect tons of inflation then maybe the 'investment' terminology makes more sense. But when we talk about the price of gold, we're using the dollar as the "unit of account," that is we're counting the value of gold in terms of dollars.

So what happens if the dollar gets inflated? Well, the price of gold in dollars will continue to rise. But what if the Japanese Yen is not inflated during the same period? The yen will buy the exact same amount of gold it did previously, after the dollar has been inflated. And at no time does the purchasing power of the value that gold represents change.

True investments will actually give you more money, more value, more purchasing power. Gold will only retain it, generally. It's also possible for gold to become more scarce or more demanded, in which case its relative value increases compared to other goods and then its purchasing power really does rise, but we need to separate those two mechanisms in theory to understand what's going on.

liberation:
The conventional visdom says it's rather cyclical: first you are better off investing in the real economy (1980-2000), then in the second part gold catches up (2000-2012). (But what's now? The economy stopped. Gold stopped. That's a good question.)

I think gold rose lately due to increasing demand because people have been fearing inflation. But it's probably over-priced now and could easily bubble-pop.

liberation:
OK. I was thinking about it. Gold simply can't be so much more expensive over time even if it's scarce: it is just one of the commodities, there are others as well: silver, palladium, etc. Sure, the price can go up but I can't imagine it goes up by a magnitude or two.

Well, if money is your unit of account and the government inflates the currency by 100%, then the value of each dollar, in terms of purchasing power, would half at the very least, and the price of gold would double as a result. But its purchasing power would remain the same.

However, to escape inflation people would begin buying gold, and its value would rise in real terms too.

If the gov went crazy and just inflated the dollar wildly, the price of gold in terms of dollars could increase a million percent or more. It happened to the deutchsmark during WWII.

 

 
Autarchy: rule of the self by the self; the act of self ruling.
  • | Post Points: 20
Not Ranked
452 Posts
Points 7,620

Anenome:

shackleford:

In a proper Austrian/free market economy, how should the money supply grow? Would it match the real demand for money? Does it even need to grow?

I'll answer this is terms of gold and bitcoin.

There is, in the universe and on our planet, a finite supply of gold.

Yet the value of gold will continue to fluctuate because the demand for gold will always change, and price is a function of both supply and demand together.

Same is true of bitcoin. In this respect they're both similar, with a finite supply. Also, in both cases, more is continually mined over time, but there is an ultimate limit.

Now, in a free market, with good money (gold / bitcoin) what we'd expect to see, and what we actually did see before fiat currencies came to dominate the world, was continual deflation, whereby money was constantly rising in value. The entire 19th century, for instance, experience deflation continually. People took pay cuts year after year and didn't complain, because their purchasing power either remained the same or improved despite the paycut, because of continual deflation. Money was becoming more value.

It becomes more valuable because each year people work. And by working their produce wealth. And thus real wealth increases every year by some value, yet the supply of gold/bitcoin remains the same. Also, more people enter the workforce continually.

So, demand for money continues to increase, and the amount of wealth in the world increases by trillions of dollars every year.

There's literally no reason why you'd want the money supply to remain at zero % inflation or deflation. You do not need to increase the money supply at all for an economy to function. The money supply is inflated currently purely because it's political advantageous to do so. End of story. It's not economically advantageous except to debtors--of which the US government is the largest! Oops. But that doesn't help the citizens.

What would happen in a free society is that demand for money grows and the money deflates, prices continually drop, and we cut money into smaller and smaller segments to cope with this deflation. Gold is essentially infinitely divisible, and bitcoin is too.

You could eventually have the equivalent of quadrillions of today's dollars one day packed into bitcoin, or gold, based on simply wealth production and demand for money.

tl;dr: we'd all be better off if money were left in the hands of the market.

Technically, gold is not infinitely divisible, but it may be in practical terms. Thanks for the response. All you do is move the decimal place over.

http://thephoenixsaga.com/
  • | Post Points: 5
Page 1 of 2 (24 items) 1 2 Next > | RSS