http://blogs.forbes.com/johntharvey/2011/05/14/money-growth-does-not-cause-inflation/
He starts with Mv=Py, where M is money supply, v is velocity of money, P is average price, y is quantity of production.
He then says that increasing M may not increase P, for several reasons.
1. It may increase y instead. "Take for example y. One need only look out the window to see that it is not currently at the full-employment and therefore maximum level...there is no reason that this [=increase in M] could not lead to the rise in y... as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand...This is, of course, the goal of the government deficit spending that so many economically-ignorant people are trying to stop right now."
2. There may be a corresponding decrease in v. "As one would expect, it [=v] tends to decline in recessions when people do, in fact, want to hold more cash".
3. He then argues that it is impossible to increase M, ever! He assumes, with Milton Friedman, that increase in M means an increase of the supply of money over the demand for money. [Esuric. I think you agree with that also]. But how can you supply more money unless someone demands it, i.e. is willing to trade it for something. In his own words:
But perhaps the real nail in the coffin of the “money growth==>inflation” view is this: the phenomenon that Milton Friedman identifies as key to the whole process, i.e., the excess of the money supply over money demand, cannot happen in real life. ..How is it that the Federal Reserve increases the money supply? Remember that Friedman used a helicopter–indeed, he had to, for there was no other way to make the example work. This wasn’t just a simplifying device, it was critical, for it allowed the central bank to raise the money supply despite the wishes of the public.
However, that can’t happen in the real world because the actual mechanisms available are Fed purchases of government debt from the public, Fed loans to banks through the discount window, or Fed adjustment of reserve requirements so that the banks can make more loans from the same volume of deposits.
All of these can raise M, but, not a single solitary one of them can occur without the conscious and voluntary cooperation of a private sector agent. You cannot force anyone to sell a Treasury Bill in exchange for new cash; you cannot force a private bank to accept a loan from the Fed; and private banks cannot force their customers to accept loans.
Supplying money is like supplying haircuts: you can’t do it unless a corresponding demand exists.
Would appreciate any comments on any or all of those 3 points.
My humble blog
It's easy to refute an argument if you first misrepresent it. William Keizer
1. prices do not equal inflation, his argument that rises in prices can be offset by production doesn't disprove inflation. There can be serious inflation, i.e. an increase in money accompinied by serious deflation, i.e. a decrease in prices. These events aren't mutually exclusive.
2. Velocity will drop as demand for cash is higher.
3. This point is so stupid, as if credit isn't over demanded. Lower interest rates create demand, they signal investors to take risks. As if people are going to say no to a glut of money. Was this asshat in a cave during the housing bubble? Does he not see the over consumption from an overabundance of money that was available? He is essentially saying that individuals only take what the want and they take exactly what they need. If this were true, we wouldn't need a market for anything, no prices needed as people would just take the proper amount from an unlimited supply .
He then argues that it is impossible to increase M, ever! He assumes, with Milton Friedman, that increase in M means an increase of the supply of money over the demand for money. [Esuric. I think you agree with that also].
?
It may increase y instead. "Take for example y. One need only look out the window to see that it is not currently at the full-employment and therefore maximum level...there is no reason that this [=increase in M] could not lead to the rise in y... as those spending their “excess money balances” actually cause entrepreneurs to raise output to meet the new demand...This is, of course, the goal of the government deficit spending that so many economically-ignorant people are trying to stop right now."
At this point you should already understand the differences between general price inflation on the one hand, and relative price inflation on the other. Increasing the supply of money never necessarily yields the former but must cause the latter (alters relative prices in a disproportionate way). It is true that increasing the supply of money may, and frequently does increase Y/Q, but only because relative price distortions (and artificially lowered interest rates, which go hand-in-hand with monetary injections) yield malinvestments. The creation and accumulation of malinvestment will in fact increase output and reduce unemployment, but only temporarily. It is met with an inevitable correction, i.e. recession.
The rest of the argument is pure nonsense. It's true that no 1 can force the private sector to buy government bonds, but so what? If Bernanke wanted to, he could write me a check for 10 trillion dollars, which he would create out of thin air (would just credit my bank account). And finally, this person does not understand Milton Friedman, who never claimed that monetary expansion always leads to general price inflation.
"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."
Esuric,
Thank you for the detailed reply. Some questions.
1. Increasing the supply of money never necessarily yields the former
Is that statement contreversial, or do all Austrians agree?
2. What is the Q in Y/Q?
3. If Bernanke wanted to, he could write me a check for 10 trillion dollars, which he would create out of thin air (would just credit my bank account).
Yes, he could, indeed. But I don't see how that addresses Harvey's point, that it's never done that way, but always in exchange for something. Which he says means the demand always equals the supply.
What I'm asking is, is his reasoning wrong, and if so what is the flaw?
Possible answers:
The supply of money increasing may cause price inflation even if there is a corresponding increase in demand.
The situations he describes [Fed buying treasuries etc.] are not increases in demand. Demand for money means hoarding it.
Which of those possible answers are right, if any, and why?
What is the Q in Y/Q?
Q = Output, Y = Income. Y = Q
The demand for what always equals the supply of what? When the FED engages in open market operations, it purchases financial assets, usually treasury bonds/bills/notes, with money that it creates out of thin air. It's not the case that you're exchanging money for money; you're exchanging a note for money that the FED just created, therefore expanding the supply of money.
Again, Bernanke could write me a check for 10 trillion dollars (created out of thin air) in exchange for my 1998 Volvo. This too would be an exchange, and it would also expand the supply of money by 10 trillion dollars.
This. A higher demand for government bonds (which is not real demand; it's demand that the FED artificially creates) does not equal a higher demand for money. They are two different things.
"increasing M may not increase P, " .
How about :"increasing M may, or may not not increase P", "
If we forget the rest of the fol de rol [i.e his reasoning, because maybe he's right but for the wrong reasons! ], would you say that you either agree, or disagree, with his claim ? Just curious. Regards, onebornfree
For more information about onebornfree, please see profile.[ i.e. click on forum name "onebornfree"].
I think it will, always. But it might take a year or two.
Smiling Dave: I think it will, always. But it might take a year or two.
So you posted the article because even though you "know" that the author's conclusions ["increasing M may not increase P, " ] "must" be "wrong", you were/are unable to refute his reasoning?
regards, onebornfree
onebornfree.
Thou barkest up the wrong tree.
Smiling Dave: onebornfree. Thou barkest up the wrong tree.
Which would be......?
Regards,onebornfree.
Careful reading of my posts will show me innocent of your accusations.
Smiling Dave: Careful reading of my posts will show me innocent of your accusations.
What accusations are you accusing me[ ] of making? Regards,onebornfree.
This one:
Smiling Dave: This one: So you posted the article because even though you "know" that the author's conclusions ["increasing M may not increase P, " ] "must" be "wrong", you were/are unable to refute his reasoning?
That was [and is] a simple question, asked out of genuine curiosity as to your reason for posting,not an accusation of anything. Why do you choose to see it as accusatory? Regards, onebornfree.
The value of money is determined by both the supply of money and the demand for money. Friedman's error is in agreeing with the Keynesians that money supply and demand cannot be analyzed in the same way as supply and demand of any other good. The only difference between fiat money and any other good is that the supply of fiat money can be increased without bidding away resources from other sectors of the economy. Hence, the natural interest rate is not necessarily affected by changes in the fiat money supply. This is explained by Hulsmann here.
Clayton -