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What the most common myths about inflation??

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bling4money Posted: Fri, May 2 2008 10:35 PM

Hey everybody! I'm putting together a list of common myths about inflation. Does anyone know about a list or article such propaganda?

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Ego replied on Fri, May 2 2008 11:37 PM

The most common: inflation is a rise in prices.

Don't allow leftists to play games with definitions! Some of the libertarian-leaning leftists at this forum will try to redefine "left-wing" back to its original defition (Third Estate, limited government, free-markets, laissez-faire reforms, etc.). Fine! We non-leftists can't stop them from using their own personal definitions; they can use whatever labels they want to describe any concept they want.

However, they have the audacity to then use their personal definition of "left-wing" (remember, the original definition, which is no longer valid) to prove that modern leftists are more libertarian than modern rightists! They will say that libertarianism is "inherently leftist" (again, using the original, no longer valid definition), and use that to insist that we should prefer and side with modern leftists over modern rightists.

Question their motives.

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maxpot46 replied on Sat, May 3 2008 12:14 AM

That inflation affects "the country", i.e. all people equally and concurrently.  In fact, it takes effect over time, and it benefits those individuals who receive the money first (government, banks, military contractors) at the expense of those individuals who get the money last (working folks).

 

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donmc replied on Sat, May 3 2008 2:08 AM

 

Ego:

The most common: inflation is a rise in prices.

There are multiple commonly accepted definitions of inflation.  Some define it as an in prices.  Others define it as an increase in the money supply.  I don't like either explanation.

Even with a stable money supply there can be particular goods/services in the economy that can experience rapid and persistent price increases.  Changes in supply and/or demand can profoundly affect a given market.  Many will call this "inflation" as in "agricultural inflation" or "oil inflation."  I don't like adding the tag to a particular market because inflation involves an across-the-board increase in prices.  That is not to say that prices of individual goods can't decline; but i am saying that prices in aggregate need to be increasing for their to be inflation. 

I know ego (and many others) don't agree that inflation being an increase in prices, but i'll explain why i don't like inflation as an increase in the money supply definition.

Just as increasing prices in a particular market segment does not constitute inflation, an increase in the money supply also isn't necessarily inflation.  Consider for a moment that your entire economy considers of one producer and two consumers.  Say the producer manufactured two ice cream bars, and that government puts 2 dollars into circulation.  Assume for a moment that no one saves.  In this case the GDP of the economy (the total value of goods and services) is 2 ice cream bars.  The total supply of money is 2 dollars.  If the invdividuals do not save and the only goods/services are the two icecream bars, then the the people will pay exactly 1 dollar a piece for each of the icecream bars.  2D/2ICB = 1D/ICB.  Thus we can express GDP in dollar terms of 2 dollars.

Say the next year the icecream producer makes 4 icecream bars.  This represents an increase in the GDP of 100%.  Since there are still only 2 dollars in circulation (and again assuming there is no savings), the price of the icecream bars will fall to 50 cents each to reach equillibrium pricing.  2D/4ICBIn = .5D/ICB.  In this case there was 50% deflation in the economy. 

Now consider the contrary.  Assume that in year two the icecream producer makes the same 2 ice cream bars, but that government increased the money supply by adding 2 more dollars to the economy.  Now we have 4 dollars in circulation, and only 2 ice cream bars to purchase and thus the prices of treats will be bid up to 2 dollars each.  4D/2ICB = 2D/ICB.  Again since the consumers aren't savers and there are no other goods or services to purchase, they have no incentive to hold onto those dollars.  As as result those "extra" dollars will be chasing the same number of goods which causes prices to rise.  Here the government inlfated the money supply by 100%, and with 0% growth in GDP we end up with 100% inflation.

But there's a third example:  suppose for a moment that the ice cream producer makes twice as many goodies in year two (4 vs 2 for the first year), AND that government increased the money supply during that same period by 100% (I.E. they increased the money supply from 2 to 4 dollars total).  In this instance GDP rose by 100% and the money supply also increased by 100%.  Those who define inflation as an "increase in the money supply" don't end up with the evils of inflation in this scenario.  Although the money supply did indeed increase by 100%, GDP rose by the same amount.  In the first year there were 2 dollars and 2 ice cream bars resulting in a price of 1 dollar per ice cream bar.  There are now 4 ice cream bars but there are also 4 dollars in circulation.  4D/4ICB = 1D/ICB.  With no savings, the prices of ice cream bars remains stable as there are just as many ice cream bars as dollars in the economy.

The key here is that although the money supply was inflated by 100%, this didn't produce any increase in prices, and infact we retained price stability.  Hence, across-the-board price increases will only result if the growth in the money supply exceeds GDP.  This is why i don't like "an increase in the money supply" definition for inflation either.  As a result i define inflation as "an increase in the money supply that exceeds growth in GDP and results in broad-based price increases in the economy."  I think that the most common defintions are both partially right, but none of them fully capture inflation what it is and what it does.

In my view price stability is the best outcome for aggregate pricing.  Economists often complain about the evils of deflation, and somehow conclude that low, positive inflation is somehow good for consumers (often expressed as 2 or 3 percent per annum).  Both are bad in my opinion as they distort information.  For example if you make $100,000 a year and your boss says "congratulations you are getting a $2,400 pay raise next year!" are you really better off?  Of course in most modern economies this isn't enough information because you need to know what the inflation rate is to calculate your real net earning increase.  If inflation is 2.4% or lower, then yes you are indeed better off as you gained purchasing power (assuming you don't get bumped into a higher marginal tax bracket as a result).  If, however, inflation is greater than 2.4% then you were really given a pay cut by your employer as you are losing purchasing power (and still have the potential double-whamy from increased taxation to worry about!).

Of course the greater the rate of inflation or deflation, the greater the distortion is when trying to compare pricing.  The 1% you are being paid for keeping your money in a savings account is a worthless metric until you adjust that percentage against the change in prices.  These problems in valuations permeate financial decisions.  If you bought a house in 1965 for $10,000 and the realtor says you can sell it today for $400,000 did your house appreciate during that time?  Again without adjusting the price for inflation it's impossible to tell whether you are better off, the same, or worse off.  Moreover, inflation makes it harder to tell the effects of things such as technology on prices.  Sure the ipod might have gone down 10% in nominal dollars, but once again you have to adjust those dollars for inflation to correctly determine what the true price decrease really is.  Again, the goal should be price stability as it makes all of the above examples much clearer to the consumer as to their true state of financial affairs.

~don

 

 

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donmc:

But there's a third example:  suppose for a moment that the ice cream producer makes twice as many goodies in year two (4 vs 2 for the first year), AND that government increased the money supply during that same period by 100% (I.E. they increased the money supply from 2 to 4 dollars total).  In this instance GDP rose by 100% and the money supply also increased by 100%.  Those who define inflation as an "increase in the money supply" don't end up with the evils of inflation in this scenario.  Although the money supply did indeed increase by 100%, GDP rose by the same amount.  In the first year there were 2 dollars and 2 ice cream bars resulting in a price of 1 dollar per ice cream bar.  There are now 4 ice cream bars but there are also 4 dollars in circulation.  4D/4ICB = 1D/ICB.  With no savings, the prices of ice cream bars remains stable as there are just as many ice cream bars as dollars in the economy. The key here is that although the money supply was inflated by 100%, this didn't produce any increase in prices, and infact we retained price stability

This is the neo-classical view, neatly encapsulated in the equation P=Ms/Md (Price Level equals Money Supply divided by Money Demand).  It seems to make sense.  It is also wrong.

What happens if 1 person doubles his money supply?  Sure, he'd be willing to pay a bit more for an ice cream bar, but double?  Of course not -- he would not gain.  He would pay as much more as necessary to get what he wants, and keep the rest.  Furthermore, marginal utility dictates that one values his second dollar less than his first dollar.  On these two grounds, we can say with apodictic certainty that one will not double his price level when he doubles his money supply.  Yet the P=Ms/Md equation says the price level should double.  Since the aggregate is just the sum of individuals, we can right away see that the equation must be wrong.

Moreover, using methodological individualism we can see why it's wrong.  In your example you keep saying "the government increased the money supply" and "the money supply also increased by".  There is no "government", there are only individuals banding together in an organization which we call the government.  When the government creates new money, they do so by putting it in the hands of selected individuals.  These individuals, gifted with fresh money and an unchanged price structure, get to exercise increased buying power.  Those things they buy increase in price (though not proportionately, as I previously showed), but also the things they don't buy don't increase in price.  Unlike the equation that implies that increases in the price level happen uniformly and instantaneously, using methodological individualism we see that inflation affects different sectors with different intensity, and unfolds over time resulting in a transfer of wealth to the first to recieve the money from the last to receive the money (since the latter have to pay higher prices for a long time before getting the fresh money).

What conclusion can we draw?  That there is no such thing as price stability...  it only exists in the ERE.  Chasing it is a fool's errand, a chimera.  It only justifies government intervention in the money.  Gold is the best money, but even under gold there is no price stability (usually a slight deflation with occasional inflations when huge reserves are discovered, e.g. California in 1849 and (especially) South Africa in 1883).  Even gold starts in the hands of individual miners, who cause price increases only in the things they spend it on.

 

 

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I honestly have no idea why do people find price stability such a good thing. Natural, based on higher product output deflation increases the purchasing power of your money. What could be cooler then that?

 

oh, and don, by defining inflation by increase of money supply we find it obvious, that observed price stability can be, and usually is, inflation. The prices would be (ceteris paribus) lower with a comodity money supply, wouldn't they?

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Don, ceteris paribus, an increase in the money supply will erode the purchasing power of a currency. What you're saying is that, if the productivity grows, that an expansion of the money supply will not be inflationary. Perhaps not - but should it be the case that productivity did not rise correspondingly or that demand for money (an important and neglected factor) remained constant whilst the supply of money grew, you will have inflationary effects. As for increases in productivity, these are not deflationary; they lower prices, yes, but that is not deflation in and of itself.

-Jon

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donmc replied on Sat, May 3 2008 7:27 AM

Mr. Karla:

I honestly have no idea why do people find price stability such a good thing.

why? because it removes information asymmetries.  That's why inflation works as such a great tax.  The rising prices cloud the true value of goods, services, savings, and investment and thus makes it difficult for the layman to discern whether he's better or worse off.  Very few  complained about the 20% per annum increases in housing prices in recent years because they believed (wrongly so) that they were becoming wealthier when infact they were not.

Mr. Karla:

oh, and don, by defining inflation by increase of money supply we find it obvious, that observed price stability can be, and usually is, inflation.

emphasis mine.  simply because it can be doesn't make it so.

Mr. Karla:

The prices would be (ceteris paribus) lower with a comodity money supply, wouldn't they?

not necessarily.  If the rate of new gold entering the market was slower than GDP then yes aggregate prices would decline.  It's not some universal fact, however, that a backed currency guarantees deflation because it does not.  If someone discovered an economical way to cull gold from the world's oceans i can assure you that prices would rise even if the dollar were backed and reserved 100% by gold.  Moreover, the nominal price is unimportant.  It matters not if a TV costs $400 US dollars, 300 wampum, or 15 grams of gold.  I'm referring to the change in prices over time, not how many units of exchange is required for a transation at a given point in time. 

 

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donmc replied on Sat, May 3 2008 7:32 AM

Jon Irenicus:

Don, ceteris paribus, an increase in the money supply will erode the purchasing power of a currency.

 

Yes, and it matters not whether it's the federal government printing more dollars, or someone at the local river panning for gold.  In both the fiat currency and the gold-backed one, an increase in the money supply lowers the purchasing power of the currency already in circulation.  This does not happen in isolation however.  An increase in GDP with no change in the money supply will cause an increase in the purchasing power of the currency.  If the growth in the money supply equals the growth in GDP then the purchasing power in aggregate is unchanged.

 

 

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I'm not even drawing that difference - in terms of practicality, a gold-backed currency is much harder to inflate than a fiat one, but aside from that yes, both are governed by the laws of demand and supply. My point is simply that, inflation results from expansions of the money supply in excess of the demand for money. And that is what Austrians mean as well - they do not assert unqualifiedly that money supply increases result in inflation. Prices increases are symptoms of this monetary phenomenon.

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donmc replied on Sat, May 3 2008 7:49 AM

maxpot46:

It only justifies government intervention in the money.

 

That's your conclusion not mine.  At no point did I suggest or assert that government should be empowered to manipulate the money supply to stabilize prices.  I too would much rather see 100% gold backing with a 100% reserve requirement, AND the private sector be able to mint coins instead of the federal goverment. 

My entire point is that an increase in the money supply does not necessarily cause a widespread increase in prices.  That's why i don't like defining inflation as an increase in the money supply because it doesn't clear up what is happening.  If the federal government prints and inserts into the economy exactly 1 us dollar today it will have no discernable impact on prices, yet by the definition it's still inflation.  You might not like that inflation = widespread increase in prices, but the vast majority of people have long ago accepted that definition.  The main problem is that people don't understand why prices are increasing.  They see increasing prices as the cause, not the consequence.  Simply stating that inflation is an increase in the money supply and nothing more doesn't help resolve the situation because it only talks about the cause, and not the effect.  What i was trying to point out is that inflation should include both A) an increase in the money supply and B) the effect of causing prices in aggregate to rise.

Infact, now that i look at dictionary.com they take it even one step further:

Economics. a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency

Even my dusty Webster's Ninth New Collegiate Dictionary defines inflation in the following way:

2: an increase in the volume of money and credit relative to available goods resulting in a substantial and continuing rise in the general price level.

Again, i assert that inflation does not only require an increase in the money supply, but an increase that is at a level greater than the growth of available goods and services (GDP).

If US GDP is 4.0% in a given year and the federal government increases the money supply by only 1 USD you want to call it inflation while at the same time prices will fall.  The seniors on fixed income certainly would not be harmed by that definition of "inflation."

~don

 

 

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donmc replied on Sat, May 3 2008 7:57 AM

 I agree with you on both points Jon. 

Jon Irenicus:

 And that is what Austrians mean as well - they do not assert unqualifiedly that money supply increases result in inflation.

Ok, I thought the assertion was that any increase in the money supply *is* inflation.  You are saying that's not the case.  Fair enough.

thanks,

~don

 

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 Most common myth about inflation:  That the Federal Reserve System can reduce it/control it through monetary intervention.

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donmc replied on Sat, May 3 2008 8:33 AM

Mr. Karla:

I honestly have no idea why do people find price stability such a good thing. Natural, based on higher product output deflation increases the purchasing power of your money. What could be cooler then that?

 

Deflation introduces the same information asymmetry problems as inflation.  Do you own a house?  Deflation means aggregate prices would fall, and this would include this like housing.  What if the dollar value of your home was declining 5% a year each year?  Is that cool?  Of course everyone wants cheaper ipods and cheaper plasma TVs, but they forget that deflation would not only affect prices of things they buy but of things they own and wages as well.  What about your 401k?  Would you be happy if the dollar value of it declined by say 10% a year in your deflationary scenario?

The answer is you need more information.  Deflation just like inflation obscures the true value of good/services not because of a real increase or decrease in price but because of a change in the money supply.  A 5% annual decline in the dollar value of your home might be good or it might be bad but you can only determine that after you factor out the rate of deflation.  This is the same problem you get with inlfation, and that's why aggregate price stability is good because you can much easier determine what is actually increasing/falling in value or price.

Infact one of the reasons to use a currency as a medium of exchange is to remove those information disparities.  Having either inflation or deflation removes one of the reasons for using a currency in the first place.  You can have your deflation, but i would prefer price stability so i can better see what's going on!

don

 

 

 

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I like the idea of having free banking *and* full-reserve banking. If the bills emitted by a bank are promised to be redeemed in gold, then they have to keep their word. However, there could be banks using other strategies, and if for some reason, the supply of money went bizarre, due to some gold meteors falling on earth or whatever, then people could start using some of the fiat currencies... A free market on money, rather than letting some unaccountable central bank screw the entire country.

Equality before the law and material equality are not only different but are in conflict with each other; and we can achieve either one or the other, but not both at the same time. -- F. A. Hayek in The Constitution of Liberty

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Interesting discussion! But I was looking more for common misconceptions amongst the public and media pundits. I was talking to some people and they were saying that speculators in the oil market were driving up the price of oil, thus causing higher prices thus this is the cause of inflation. What are some other common misconceptions promoted out there?

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maxpot46 replied on Sat, May 3 2008 12:23 PM

donmc:

maxpot46:

It only justifies government intervention in the money.

 

That's your conclusion not mine.

Is it not a fact that all statists, in advocating government intervention in the money, worry loudly about price stability?  So while I may have put words in your mouth (for which I apologize), your argument leads to that implication.  How else to gain price stability then government intervention, when the market's best money (gold) does not lead to it?

donmc:
My entire point is that an increase in the money supply does not necessarily cause a widespread increase in prices.  That's why i don't like defining inflation as an increase in the money supply because it doesn't clear up what is happening.  If the federal government prints and inserts into the economy exactly 1 us dollar today it will have no discernable impact on prices, yet by the definition it's still inflation. 

Yet the government has just managed to coopt $1 worth of US goods/services, because they printed a dollar without earning it.  Yes, the "price level" (which prices again?) might stay the same, but the distribution of goods has been altered in favor of the government.  You say "stable price level, good", I say "government stole goods to keep stable price level instead of letting it drop a little and enhancing the value of my savings, bad".

donmc:
I too would much rather see 100% gold backing with a 100% reserve requirement, AND the private sector be able to mint coins instead of the federal goverment. 

Then why the obsession with price stability?  Because your preferred system won't deliver it.

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"What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation. (Mises, Planning for Freedom, 79)"

 

http://www.mises.org/story/2781

 


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Donmc,

I am afraid you're mistaken. Twice.

In your first mistake, you are asserting that you do not like the official definition of inflation, because it isn't always the result of money supply inflation. Then you also do not like the traditional definition of inflation, because it doesn't always result in price increases. You solidify your view with bringing the "third example" in, where you achieve "price stability".

Note, that in the second example, you point out that without the corresponding and proportional increase in money supply, an increase in total number of goods will result in deflation. There were 4 ICB sold for 0.5 each,resulting in the same 2 dollars of GDP. So, there was no reduction in GDP, and yet, you alledge that the deflation occured. I can only assume one thing, and that is you were referring to deflation in prices, concluding then that it is not the money supply or the economy, but the prices you're still concerned about.

You will probably assert that it is indeed unfair that the computer you type your posts on, was purchased for less than an equal machine would be purchased for say ten years before. That was the deflation in prices resulting from increase in total number of goods manufactured. So, you would suggest that we need to insure the price stability, to make sure prices do not fall?

 

In your second mistake, you assume that having your house price fall in dollar terms annually is a bad thing. How so? What do you care of it's worth in dollar terms, if upon an eventual sale you would still be able to exchange it for the same amount of goods as when you first bought it? Do you like your computer any less because it worth less now then when you first bought it? You wouldn't want to borrow dollars to purchase a house, and that is a good thing, for you should first save, and then buy, not the other way around. But you would want to lend your capital in those conditions, for you will get back much in purchasing ability at repayment. Lender is favored and a borrower is punished, - that is an ultimate fairness to me.

 

Where your mistakes are derived from:

You think of economy in terms of dollars and prices. But this isn't what economy is. Economy is only a descriptive term for an exchange of things we make among us all. And so, if there were only two of us, and we made one thing each a year and exchanged them, then our exchange consisted of only two things a year. As we employ machinery and better ways of production, inventions and saved capital, we could make say ten things each a year and exchange them. Now our yearly exchange is twenty things. So, one thing becomes only worth one/tenth of or year of my work, where it used to be a whole year of my work. So, all that is changing is the unit of exchange we employ, it is being divided further and further. Nothing else changes. Because you produce ten things a year, you're able to buy ten things a year, and the price of ieach in dollars simply signifies the rate of progress as it falls further and further. And what should I care if the price of a gadget that I used to spend a year building, had fell from one whole dollar to just ten cents now that I can make ten of those a year? As long as there is complete fairness, I couldn't care less! The government and their sick cronies still cannot spend anything unless I actually give it to them and that is all that counts for me!

 

Now, I see your great point of keeping the price stability for the sake of economic calculations. The simplicity and the ease of availability of calculations in such a system has no equals, I agree.

There are other things we could simplify as well. I may suggest posting your annual income, social security number, mother maiden name, address and phone, bank accounts and assets on a publicly accessible website. This would greatly simplify an economic calculations in regards to your creditworthness, for example, without the need to use more sophisticated methods of assessment. Of course, there might be a downside to this, - you could be a victim of identity theft.

But so is the case with inflation of money supply for the sake of ease of calculations. FED doesn't send us all new and additional money, nope, it keeps it all for itself, the government (the destroyers and abusers), and the cronies of the government. So the simplicity in this case comes with abuse and fraud.

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 I don't see anything so terrible about information asymmetry - it's the only thing that gives an incentive to invest!  I think the idea that information asymmetry is bad comes out of a general methodology of equilibrium, a focus on the statics of the economy, without the Austrian interest in dynamics.  It's the same kind of thinking, by the way, which allows companies to have "human resources" departments.

Now, on the original topic.  I think the biggest myth about inflation is that it's tied to a stronger, growing economy, as in "inflation is the price we pay for expansion - we have to balance unemployment vs. inflation" or other such garbage.  The fact that anyone believes such nonsense is the price we pay for not learning economics.  Even neoclassical economics ought to cause one to realize that more economic output cannot cause inflation absent someone increasing the money supply. Closely related is the myth that the Fed exists to prevent - rather than to cause - inflation.

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Sorry this is off topic.

Can you explain what you mean by this:

JAlanKatz:
It's the same kind of thinking, by the way, which allows companies to have "human resources" departments.

I'm certainly no fan of HR departments, but I don't follow the connection to static vs. dynamic thinking.

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tgibson11:
I'm certainly no fan of HR departments, but I don't follow the connection to static vs. dynamic thinking.
 

I'm commenting on the name of the department - the idea that workers are not unique sources of dissipated information, but rather are "resources."  That type of reductionism - treating people as data points, and so on - seems to me to be a hallmark of the "scientism" of the neoclassical methodology.

The tie-in to statics vs. dynamics is that the problem with statics is precisely the fact that it ignores - because it is unquantifiable - the entire discovery process, the idea of the economy as a learning system.  This is precisely the engineering view that allows for the abstract view of human beings as well.

On a side note, I have to wonder why it is that economists working with non-linear dynamics, non-equilibrium concepts, and so forth, such as at the Santa Fe Institute, tend to be so socialist.  Their ideas tie in so well to Austrian ideas, and present such a good Hayekian case for the market, that I'm amazed that 1-they don't realize it and 2-there aren't more Austrians crowding in on their institutes.

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Andrew replied on Sun, May 4 2008 1:53 PM

That inflation happens because "free market capitalism" is under-regulated

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Harksaw replied on Mon, May 5 2008 9:40 AM

mr_anonymous:

 Most common myth about inflation:  That the Federal Reserve System can reduce it/control it through monetary intervention.

Well, they can, they just don't. They certainly have the ability to increase or decrease the money supply.

 

 

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Harksaw:
Well, they can, they just don't.
 

 

Well, a central bank I guess can increase or decrease the money supply, but it does not cure inflation.  What do they do when there is high inflation and high unemployment?  In this situation, the Federal Reserve can do nothing to solve the problem because any action they take will harm the other, a situation that would not arise in the free-market. 

Rothbard said it best when he said that the government (the Fed) is inherently inflationary because controls the production of money.  

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Harksaw:

mr_anonymous:

 Most common myth about inflation:  That the Federal Reserve System can reduce it/control it through monetary intervention.

Well, they can, they just don't. They certainly have the ability to increase or decrease the money supply.

They can control the money supply, but they can't control (or measure) money demand, making it impossible for the Fed to control the "price level".  They imply that they can simply so they keep the power to spend as much as they want (which is the true point of the Fed).

 

"He that struggles with us strengthens our nerves, and sharpens our skill. Our antagonist is our helper." Edmund Burke

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