Buying power

Kevin7D — Fri, 13 Feb 2009 08:32:14 GMT

I've been doing a lot of reading on Austrian economics (Economics in One Lesson, America's Great Depression, etc), but this subject I just can't seem to get my head around. Please correct my logic if I'm wrong somewhere.

The Keynesian business cycle gives us inflation followed by deflation, but the deflation cycle never "corrects" far enough to fully cancel out the currency devaluation caused by the initial inflation. Maybe the money supply never contracts far enough; I don't know. But I make this statement because after almost 100 years of the Federal Reserve being in existence and inflating, the dollar has lost 97% of its value. For example (and these are arbitrary numbers/dates) one dollar is worth one dollar in 1920, the same dollar is worth 70 cents in 1928, then in 1942 that dollar is still only worth 95 cents. On a long enough time line, the dollar slowly and consistently loses value.

So my question is about buying power. Decades ago a store manager could have made $15,000 a year and maybe a house costs $60,000. In 2008, someone in that position could be making $40,000 a year, but they don't have greater buying power, because everything "costs more" (really it's that money is worth less). So that same house could very well cost $160,000 now. In a way the market does find some kind of equilibrium between what people earn and the cost of living. Things cost more, but people make more money, and vice versa.

So government is trying to "stimulate" the economy now and push asset prices back up. Finally, my question; what keeps wages from following suit to find that balance? Is the wage / cost of living balance only restored after a deflation cycle (recession, depression) is complete? A $400,000 house is unaffordable to someone making $40,000 a year...but what if they made $100,000 a year doing the same job?

Maybe I can word this another way as well. A pound of rice decades ago might have cost 10 cents a pound; now it costs $2 a pound. It doesn't really cost more because its cost is relative to what people are earning. So what does it matter if rice costs $100 a pound if average income in $250,000 a year?

I guess what I'm wondering is, if our government is going to print money, instead of focusing on trying to prop up prices, shouldn't they work toward restoring the balance of earnings / cost of living? Is that even possible with inflation? I know you're going to say "no", so why not? Eventually wages do seem to catch up with the overpriced goods, why isn't it possible to speed that along?

I'm a firm believer in Austrian economics; I just can't seem to understand what I'm missing here.

Economics Questions

Buying power