Economics Questions

Re: Inflation - how should inflation be defined?

DD5 — Fri, 10 Dec 2010 23:00:11 GMT

Jonathan M. F. Catalán:
I think by defining inflation as simply an "increase in money supply" detaches the word from the original purpose

As Mises will explain to you later in the course of your reading, the original purpose always served a pseudo-economic purpose. Mises then rejects the entire concept and declares that it serves no purpose in economic analysis. I tend to agree with him on that.

Jonathan M. F. Catalán:
I know this is an "eternal" debate between......

There is no "eternal" debate in my opinion. That some "free bankers" (and I won't name names) reduce the argument over what does or does not distort prices to one over the definition of inflation shows that they do not understand the causal effects as well as they think they do.

It's only a definition.

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Fri, 10 Dec 2010 22:32:10 GMT

DD5,

If you want to define inflation as an "increase in money" then OK. I don't know if that is what Mises really meant. It's possible that you are right. I would have to read that book in context (whatever book that quote is taken from).

I think, though, that one has to remember that the Austrian definition of inflation is still relevant to a change in prices. However, Austrians detached themselves from the mainstream definition (or, perhaps more accurately, never accepted the re-definition) because the original definition maintained causality. Changes in prices from changes in the quantity of money in circulation were separated from changes in prices due to a change in preferece (or distribution of a fixed amount of money in circulation). I think by defining inflation as simply an "increase in money supply" detaches the word from the original purpose, which was to maintain causality between changes in money and changes in prices. True, increases in the amount of money may lead directly to an increase in the quantity of money in circulation, but the latter is the most relevant part related to the consequence change in [relative] prices.

I know this is an "eternal" debate between more Rothbardian (and I don't mean to regard them as "non-Misesian"; neither side is "non-Misesian") scholars and "Hayekian" scholars (free bankers, namely), and I obviously do not have sufficient command of all of Mises's writings to really speak authoritatively .

Re: Inflation - how should inflation be defined?

DD5 — Fri, 10 Dec 2010 22:21:16 GMT

Jonathan M. F. Catalán:

DD5,

What, bank deposits need not be in circulation?

I never said they weren't. They aren't de facto in circulation, but they can be if the money in these deposits are being spent electronically (or funds are being withdrawn and spent, et cetera).

By the way, from Human Action (1998),

The endeavours to expand the quantity of money in circulation either in order to increase the government's capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation. (p. 225).

My point is that Mises in that previous quote doesn't necessarily refer to "inflation" as just an increase in circulating money, but an increase in the money supply in general. Anyway, it's only a definition. The affects of "inflation" can be accounted for only once your terms have been defined. People seem to think that the debate over how prices are affected is a debate over the definition of "inflation".

What is the purpose of the quote you just posted now? You'll have to explain to me. Obviously, money cannot affect relative prices magically without ever commanding on goods.

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Fri, 10 Dec 2010 22:10:03 GMT

DD5,

What, bank deposits need not be in circulation?

I never said they weren't. They aren't de facto in circulation, but they can be if the money in these deposits are being spent electronically (or funds are being withdrawn and spent, et cetera).

By the way, from Human Action (1998),

The endeavours to expand the quantity of money in circulation either in order to increase the government's capacity to spend or in order to bring about a temporary lowering of the rate of interest disintegrate all currency matters and derange economic calculation. (p. 225).

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Fri, 10 Dec 2010 22:01:54 GMT

I totally disagree. It costs very little to mint a coin. It's not the minting process, or the coins in circulation that gives a gold coin value, it's the gold itself.

No, gold does not have objective value. Gold for the value of gold is relevant when talking about non-monetary gold products, but has nothing to do with its monetary value. Gold's monetary value depends entirely on its exchange ratio with relevant economic goods, and therefore has everything to do with the quantity of gold in circulation. This is why if the quantity of gold in circulation falls nominal expenditure falls and thus prices falls, and if the quantity of gold in circulation rises nominal expenditure rises and thus prices rise.

Money that is not in circulation does not affect prices, or the purchasing power of the monetary unit.

It's also important to remember that money is a means of purchasing goods. These goods are either goods which immediately satiate certain desires (consumption goods) or goods which themselves are means by which to satiate future desires (i.e. capital goods).

If you made a few coins out of clay would they be super valuable because only a few were in existence?

How is this relevant? Clay's value is subjective. There's no reason why someone else should accept clay coins as money. The introduction of money into the market took several generations. I would suggest reading Menger's Principles of Economics, Mises's The Theory of Money and Credit and/or Human Action on the topic.

Re: Inflation - how should inflation be defined?

cr113 — Fri, 10 Dec 2010 21:32:28 GMT

cr113: "I think if we were on a strict gold standard the monetary base (M0) would be the physical amount of gold whether it was in currency form or not."

Jonathon: "But, what does this matter? What matters is the money that is actually in circulation, being bid towards goods. "

I totally disagree. It costs very little to mint a coin. It's not the minting process, or the coins in circulation that gives a gold coin value, it's the gold itself.

If you made a few coins out of clay would they be super valuable because only a few were in existence?

Re: Inflation - how should inflation be defined?

gocrew — Fri, 10 Dec 2010 19:53:01 GMT

JH2011:

I constantly hear people refer to the CPI as the best measure for inflation. However, this does not make sense to me because the way I understand the CPI, it represents the price level of a market basket of consumer goods and services.

Inflation is an increase in the supply of money. Price inflation is a rise in prices. The fire at the oil production facility is irrelevant... if the price goes up, the price goes up. To the extent that this disruption in the supply of oil slows production in other dependent fields, prices may rise elsewhere too.

The CPI, if done well (it's not) attempts a general look at price inflation across an economy. In reality, we each have our own Price Inflation Indexes based on what we buy. If the price of oysters goes up, but you don't buy oysters, your personal PII is unaffected. However, if you buy tube socks and the price of tube socks goes up, your personal PII goes up. The CPI, if done well, can try to give you an idea of what people across the country are feeling, as an average.

Re: Inflation - how should inflation be defined?

DD5 — Fri, 10 Dec 2010 19:36:24 GMT

Jonathan M. F. Catalán:

"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check."- Mises

Bolding is mine. Increases in the quantity of money in circulation. I rather not start a debate (although, others can partake in one if they'd like), but an increase in demand for money will withdraw money from circulation.

The last part of Mises' quote above is in contradiction with your interpretation of it. What, bank deposits need not be in circulation? Increase in the money supply in the broader sense is probably where Mises is going with this. Bank notes (money substitutes) by definition must be in circulation for them to exist at all.

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Fri, 10 Dec 2010 19:26:17 GMT

I think if we were on a strict gold standard the monetary base (M0) would be the physical amount of gold whether it was in currency form or not.

But, what does this matter? What matters is the money that is actually in circulation, being bid towards goods. I also explained how in a commodity standard it's not unlikely that the outside money actually reduce in size as its replaced by inside money (or, as inside money circulates at a much greater rate than commodity money).

I think it's the scarcity that matters here. Not what form it's in.

I don't know what you mean by this, or how it's relevant.

If a mine suddenly "struck gold" and doubled the entire amount of gold in existence I would expect prices to double in terms of gold all things being equal.

As long as that gold entered circulation as money.

Re: Inflation - how should inflation be defined?

cr113 — Fri, 10 Dec 2010 17:11:04 GMT

Jonathon: "I said commodity money is sitting in reserve, never circulating, then it's more economical to melt it and sell it for other uses. It's also economical to do so if the non-money uses garner you greater value than its money uses. Coin melting was not uncommon. In Europe, gold import from South America actually did adversely affect prices, and the change was not permanent because the new bullion circulated from areas of high concentration to areas of relatively lower concentration (where it would garner a higher utility), so this is also a means by which the supply of commodity money fluctuates."

I think if we were on a strict gold standard the monetary base (M0) would be the physical amount of gold whether it was in currency form or not. I think it's the scarcity that matters here. Not what form it's in. I also think the physical amount of gold would be far and away the most powerful force determining prices in the long run. If a mine suddenly "struck gold" and doubled the entire amount of gold in existence I would expect prices to double in terms of gold all things being equal.

The tricky part for me is defining the monetary base with a fiat system.

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Fri, 10 Dec 2010 01:21:13 GMT

When I say printed money I include anything that can also be converted into cash. Suppose we were on a strict gold standard. To me the monetary base or M0 is the physical amount of gold (Am I correct?). That to me is the true money supply. Not M1, M2 or M3.

The supply of money which affects prices is the supply of money in circulation, whether that be outside money, inside money, or fiduciary media. By the way, "base money" is not just commodity money. In our current fiat standard, some of that fiat currency is base money.

I think where we disagree is where you say it's easy to destroy money. Someone owns that money. I don't see how you can destroy it. If my bank account electrons suddenly disappeared I'd be pissed off.

If said commodity money is sitting in reserve, never circulating, then it's more economical to melt it and sell it for other uses. It's also economical to do so if the non-money uses garner you greater value than its money uses. Coin melting was not uncommon. In Europe, gold import from South America actually did adversely affect prices, and the change was not permanent because the new bullion circulated from areas of high concentration to areas of relatively lower concentration (where it would garner a higher utility), so this is also a means by which the supply of commodity money fluctuates.

As far as Japan goes I was under the impression that Japan only increased M0 by something like 10% over 10 years.

I don't know, but Japan was, broadly speaking, in a "liquidity trap".

Lowering interest rates will cause a temporary boom in prices followed by a bust where prices actually fall below normal. Printing money, or increasing the monetary base will cause a permanent rise in prices.

Interest rates are lowered and raised by changes in the supply of loanable funds. The increase or decrease in the supply of money occurs before the rate of interest changes. New stock of commodity money can also artificially lower the market rate of interest. It is what occured to Spain in during the 17th Century.

Re: Inflation - how should inflation be defined?

JH2011 — Fri, 10 Dec 2010 00:32:35 GMT

"Nominal expenditure is the total amount of monetary expenditure in an economy. We can call it "aggregate demand" (well, technically, "aggregate nominal demand")—in fact, this is the "aggregate demand" most Keynesians refer to when they use the word. Therefore, if there is a general increase in the price level it means that the level of nominal spending has increased, because had the money supply in circulation remained the same then the general (average) price level would have remained the same. Without an increase in money in circulation an increase in price for good A necessarily means that the price of some other goods have fallen (together, by the same amount)."

The above is not intuitively appealing to me, and sounds like different things are being combined which shouldn't be.

Doesn't monetary expenditure (or nominal spending) represent the value of things that are traded in an economy? If it does then the value of things that are trading hands in an economy is something separate from price levels. Thus I would think monetary expenditure can increase or decrease without any preceding change in the money supply.

Unless I am misunderstanding what monetary expenditure is, I don't see how monetary expenditure could have such a direct effect on price levels.

I also don't see why the last sentence necessarily must hold true. Are you saying the price of good A cannot possibly rise without a corresponding drop in the price of good B, assuming no change in money supply? Why would that be the case?

Re: Inflation - how should inflation be defined?

cr113 — Fri, 10 Dec 2010 00:17:19 GMT

Jonathon:

When I say printed money I include anything that can also be converted into cash. Suppose we were on a strict gold standard. To me the monetary base or M0 is the physical amount of gold (Am I correct?). That to me is the true money supply. Not M1, M2 or M3.

I think where we disagree is where you say it's easy to destroy money. Someone owns that money. I don't see how you can destroy it. If my bank account electrons suddenly disappeared I'd be pissed off.

What I think you can do fairly easily is lower the supply of credit by raising interest rates. So you make it harder to get a loan.

In other words I think you can easily reduce the supply of credit or M1,M2,M3 by raising rates. But it's almost impossible to reduce the monetary base or M0.

As far as Japan goes I was under the impression that Japan only increased M0 by something like 10% over 10 years. The US has tripled it's monetary base in the last 2 years.

Here's another way for me to try to explain this. Lowering interest rates will cause a temporary boom in prices followed by a bust where prices actually fall below normal. Printing money, or increasing the monetary base will cause a permanent rise in prices.

P.S. I like this website but I hate this editor.

Re: Inflation - how should inflation be defined?

Tim G. — Thu, 09 Dec 2010 23:39:09 GMT

Esuric wrote:

Inflation is defined by an increase in the supply of money beyond the demand for money (this doesn't necessary yield general price inflation but it will always yield relative price distortions). This is the definition used by Hayek, Mises, Wicksell, and others.

I was about to write something like: "When the money supply increases at a faster rate than the size of the economy generally (as measured by either GDP or your favorite metric)." I think Esuric says it better, though. It gets to the heart of the matter.

Re: Inflation - how should inflation be defined?

Jonathan M. F. Catalán — Thu, 09 Dec 2010 23:33:17 GMT

"Inflation, as this term was always used everywhere and especially in this country, means increasing the quantity of money and bank notes in circulation and the quantity of bank deposits subject to check."- Mises

Bolding is mine. Increases in the quantity of money in circulation. I rather not start a debate (although, others can partake in one if they'd like), but an increase in demand for money will withdraw money from circulation.