While reading "The Case for Legalizing Capitalism" by Kel Kelly, I stumbled upon a claim, which I interpret as "it's impossible for all prices in an economy to grow without monetary base growing".
I've re-read pages around page 130 several times, but I still do not see any sound explanation of this.
Is this a known theorem that price inflation cannot happen without monetary inflation (assuming no catastrophes or other decreases in overall productivity)?
I am not familiar with such a theory, but i can imagine situations in which rising prices occur without monetary expantion.
Imagine an economy in which has a stable monetary base, but the government increases regulations on all enterprises significantly. This will lead to cross the board rises in prices without an expantionary monetay policy as the culprit.
but the government increases regulations on all enterprises
< INSERT : therefore the government decreases productivity and .... <INSERT >
This will lead to cross the board rises in prices without an expantionary monetay policy as the culprit.
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Sure. Simultaneous reduction in the amount all commodities except for whatever commodity is used as "money". Let's say one day the economy consists of 100 oz. of silver, 100 apples, 10 apple trees, 100 oranges, and 10 orange trees. Then the next day, there's 100 oz. of silver, 10 apples, 1 apple tree, 10 oranges, and 1 orange tree. Price inflation without monetary expansion.
Actually, a crop failure like that wouldn't work, because the land itself would decrease in price.
Thank you all for your input. I probably need to clarify my question.
Imagine an economy with a very stable (constant): technology, natural conditions, capital goods, human preferences, and monetary base.
Is then price of every good/service in the economy strictly determined by these conditions? Or there may be multiple possible worlds, differing only by price levels? Further, is it possible for prices in one of the world to dominate corresponding prices in another world?
As a quick example of what I am talking about:
Let's say the whole economy consists of Crusoe and Friday (I know, 2 persons do not need money, but I believe this argument scales up to any number of participants).
Crusoe can sell a goat to Friday for 10 coins, then Friday can sell 10 apples to Crusoe for 10 coins.
What precludes replacing 10 coins in the previous sentence with either 5 or 20 coins? The coins are just an exchange medium, so as long as there are enough coins for any transaction, prices can be arbitrary scaled, no?
The assertion is correct. The overall price level cannot change without alterations in the supply of money. For example, if there is an increase in the demand for final consumer goods/services, as a class, then the price of consumer goods will rise, but only at the expense of producer/future goods (also known as an elevated time preference). If, on the other hand, the demand for a single economic good rises, then its price will rise at the expense of another economic good, or multiple economic goods.
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Essentially, you're asking if inflation can occur without monetary expansion? The obvious answer is no, as inflation is defined by monetary expansion.
Can all prices simultaneously increase at equal rates/degrees without monetary expansion? Yes, but I can only think of this happening during a crisis of some sort or population explosion. Since you've ruled out natural crisis, I can only think of a situation where all couples spontaneously decided to have 500% or some arbitrarily large amount of children than normal for that population center. So long as those progeny are children and non-productive, then all prices would rise proportionatly.
It seems like you're making a self-fullfilling condition. Can inflation happen without inflation? Can generalized price increases occur in a system where all influences factors stay equivalent and keep prices stable and productivity cannot decrease? I think you need to revise your question.
1. The general idea is that the price of everything cannot go up, because there is not enough money to go round. Say there are thousand dollars in the economy as a whole, and a thousand objects, each of which costs a dollar. If the price of frisbees goes up to two bucks [say there are twenty of them] because a craze for frisbees starts for some reason, then after the frisbees are bought, there is 960 bucks left for 980 objects. Obviously somebody is going to have lower prices to get his stuff sold.
2. One can have many alternate universes with different prices, even thought the exact same money supply and objects exist in each one. In Universe A, people love apples, and will pay a lot of money for them, but arent willing to pay much for oranges. In Universe B it's the opposite. You get the idea. As AE teaches, prices are determined by personal preferences [among other things], which show up in the concept called "demand".
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If you base your money on Gold then your basing your money on a commodity.
There is nothing magical that makes a Gold standard free from any price fluctuations like any other commodity.
Think about it.
And like anything else the relative value of Gold as a commodity can rise and fall when compared to everything else.
Its just that Gold makes a rather decent base for money since its easily divided, it's a fundamental element so it cannot be artificially created and since it does not really rust or degrade it's nearly infinitely re-usable, and there is a actual fairly level demand for it's use in items like jewelry, decorations, electronics, etc etc. The amount of gold in the world does not very much. The gold we use today, for the most part, is the same gold that has been floating around in circulation for centuries.
So it's very easy to see that if you had a sudden rise in the amount of Gold relative to other commodities then you'd see inflation.. your gold is worth less and it takes more gold to buy the same stuff as it did before. And conversely if you see a decline in the amount of gold then you'll get deflation and your gold will be worth more. :-)
If, for example, we suddenly discovered that underneath the Canadian Shield (massive expanse of bedrock dating back to the beginning of the Earth) was a entire mountain of solid gold then all of a sudden people that horded massive amounts of gold thinking that this hording ment they were building real wealth then they would be a world of hurt!!
For most people, however, it would be a temporary pain (even though it would be terrible for a while) as people would simply move to using some other commodity.
@Esuric: with all respect, merely repeating a statement is not proving it.
@Bohemian: "inflation is defined by monetary expansion" - I was careful to distinguish between monetary inflation and price inflation.
@Smiling Dave: "then after the frisbees are bought, there is 960 bucks left for 980 objects." - I think there are still 1000 bucks in the economy, so the rest of the explanation does not work for me.
@nate-m: "if you had a sudden rise in the amount of Gold relative to other commodities then you'd see inflation" - I am not arguing about impossibility of price inflation in presense of monetary inflation, rather whether it is possible to have price inflation without monetary inflation.
Thanks to all of you for replying, and sorry if I confused you.
Smiling Dave:
As AE teaches, prices are determined by personal preferences [among other things], which show up in the concept called "demand".
Almost forgot to address this. In my question I postulated constant (not changing across possible worlds) preferences.
Basically, I feel intuitively that prices are somehow determined by the complex of existing capital, natural resources, technology, and preferences, but I do not see a clear way to demonstrate it (yet).
Are you looking for a mathematical proof or what? Money always stays in circulation, and prices are a ratio of exchange between consumer/producer goods, on the one hand, and money on the other. Thus the overall price level cannot change unless there is a change in either the total quantity of goods or total quantity of money in circulation (we may speak about changes in the demand for money affecting the overall price level, but it does so only because the demand for money, in large part, determines, the supply of money).
Are you looking for a mathematical proof or what?
A convincing demonstration should be enough. So far, all I've seen was along the lines: "there is only that much money chasing that much goods, so all the prices cannot rise". Come on, money is not consumed during trade, the same dollar (or oz) can be used over and over, so even if entire amount of money in economy is spent to buy just half of the goods needed per period of time, it has not gone - it is still there (although distributed differently), and can be used to buy the remaining half of goods. Ah, I remembered, this is called velocity of money. What is the AE view of velocity of money?