Best of the Week
Most Popular
1. TESLA! Cathy Wood ARK Funds Bubble BURSTS! - 12th May 21
2.Stock Market Entering Early Summer Correction Trend Forecast - 10th May 21
3.GOLD GDX, HUI Stocks - Will Paradise Turn into a Dystopia? - 11th May 21
4.Crypto Bubble Bursts! Nicehash Suspends Coinbase Withdrawals, Bitcoin, Ethereum Bear Market Begins - 16th May 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.Cathy Wood Ark Invest Funds Bubble BURSTS! ARKK, ARKG, Tesla Entering Severe Bear Market - 13th May 21
7.Stock Market - Should You Be In Cash Right Now? - 17th May 21
8.Gold to Benefit from Mounting US Debt Pile - 14th May 21
9.Coronavius Covid-19 in Italy in August 2019! - 13th May 21
10.How to Invest in HIGH RISK Tech Stocks for 2021 and Beyond - Part 2 of 2 - 18th May 21
Last 7 days
Junior Gold Miners: New Yearly Lows! Will We See a Further Drop? - 23rd Jul 21
Best Forex Strategy for Consistent Profits - 23rd Jul 21
Popular Forex Brokers That You Might Want to Check Out - 22nd Jul 21
Bitcoin Black Swan - Will Crypto Currencies Get Banned? - 22nd Jul 21
Bitcoin Price Enters Stage #4 Excess Phase Peak Breakdown – Where To Next? - 22nd Jul 21
Powell Gave Congress Dovish Signs. Will It Help Gold Price? - 22nd Jul 21
What’s Next For Gold Is Always About The US Dollar - 22nd Jul 21
URGENT! ALL Windows 10 Users Must Do this NOW! Windows Image Backup Before it is Too Late! - 22nd Jul 21
Bitcoin Price CRASH, How to SELL BTC at $40k! Real Analysis vs Shill Coin Pumper's and Clueless Newbs - 21st Jul 21
Emotional Stock Traders React To Recent Market Rotation – Are You Ready For What’s Next? - 21st Jul 21
Killing Driveway Weeds FAST with a Pressure Washer - 8 months Later - Did it work?- Block Paving Weeds - 21st Jul 21
Post-Covid Stimulus Payouts & The US Fed Push Global Investors Deeper Into US Value Bubble - 21st Jul 21
What is Social Trading - 21st Jul 21
Would Transparency Help Crypto? - 21st Jul 21
AI Predicts US Tech Stocks Price Valuations Three Years Ahead (ASVF) - 20th Jul 21
Gold Asks: Has Inflation Already Peaked? - 20th Jul 21
FREE PASS to Analysis and Trend forecasts of 50+ Global Markets by Elliott Wave International - 20th Jul 21
Nissan to Create 1000s of jobs with electric vehicle investment in UK - 20th Jul 21
Bitcoin Halvings Price Forecast and Stock to Flow Analysis - 18th Jul 21
Dell S3220DGF Unboxing and Stand Assembly - 32 Inch 165hz Curved Gaming Monitor Amazon Discount - 18th Jul 21
What Does The Fed Mean By “Transitory Inflation” And Why Is It Important To Understand? - 18th Jul 21
Will the US stock market’s worsening breadth matter? - 18th Jul 21
Bitcoin Halving's Price Projection Forecasts Trend Trajectory - 18th Jul 21
Dell S3220DGF Price CRASH to £305! 32 Inch 165hz Curved Gaming Monitor Amazon Bargain - 16th Jul 21
Google, Amazon and Netflix are Scrambling For This Rare Gas - 16th Jul 21
Sheffield Millhouses Park New Children's Play Area July 2021 Vs Old Play Area - Better or Worse? - 16th Jul 21
Inflation Soars, Powell Remains Unmoved. What about Gold? - 16th Jul 21
Goldrunner: Gold Could Jump To $1,900-$2,100 In Next 30 days – Here’s Why - 15th Jul 21
Tips For Finding The Right Influencers - 15th Jul 21
ECB Changed Monetary Strategy. Will It Alter Gold’s Course? - 15th Jul 21
NASA And Big Tech Are Facing Off Over This Rare Gas - 15th Jul 21
Will the U.S. Dollar Lose Momentum In the Second Half of 2021? - 15th Jul 21
Bitcoin Stock to Flow Model Forecasts Infinity and Beyond! - 14th Jul 21
Proteomics: The Next Truly Massive Investing Opportunity - 14th Jul 21
Massive Solar Storm to Hit Earth 2025, Coronal Mass Ejection (CME) Danger and Protection Solutions - 14th Jul 21
Is This The Best Way To Play The Coming Helium Boom? - 14th Jul 21
Meet SuperMania and its Ever-Present Sidekick, SuperMeltdown - 14th Jul 21
How NFTs Are Shaking Up Arts Trading - 14th Jul 21
Gold: High Time to Move Out of the Penthouse - 13th Jul 21
Climb Aboard! Silver Should Run Up To $38 In Next 30 Days - 13th Jul 21
How Will Remote Work Impact the U.K. economy? - 13th Jul 21
Why Helium Stocks Are Set To Soar in 2021 - 13th Jul 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Good Inflation

Economics / Inflation Nov 20, 2009 - 04:43 AM GMT

By: Joseph_T_Salerno

Economics Best Financial Markets Analysis Article

Last week a student in my MBA-level intermediate-macro seminar raised a provocative question. We were discussing the various kinds of (price) deflation and which kinds, according to Austrians, are benign and accommodate consumer preferences, and which are malignant and conflict with consumer preferences.


In view of the Austrian emphasis on inflationary monetary policy as the primary cause of the business cycle and the current financial crisis in particular, the student asked if Austrians considered any kind of inflation as "good" for the economy. I gave a short response in the affirmative and then thought about it more over the weekend. Here is the note on the subject that I wrote up for discussion in class tomorrow. (The last two paragraphs on free banking were not part of the original note.)

One kind of "good" inflation typically results when innovations and changes occur that permit people to economize on the amount of money they need to hold in their cash balances. For example, the introduction and increasing availability of credit cards bring about a decrease in the demand for money, which, all other things being equal, causes a general rise in prices. Credit cards operate as an alternative means of payment for many transactions and therefore reduce the amount of money people need to hold in currency and bank deposits in order to finance their anticipated exchanges at the prevailing level of prices.

These "excess" cash balances produce an increase in the demands for goods, the supplies of which have not increased. The result is that overall prices rise. But inflation here performs an important function: it reduces the buying power of the dollar to the point where money no longer is in excess supply, because people are now content to hold the total supply of money in existence in order to finance planned transactions at the new, higher level of prices. Another way of putting this is that the "real" money supply, that is, its total purchasing power in terms of goods, has been reduced to exactly the level desired by consumers.

What we might call "cash-economizing" inflation tends to occur as a result of any financial innovation, including the invention of money-market mutual funds, ATM machines, PayPal accounts, and so on. It may also result from organizational or technical innovations in business that promote vertical integration of operations, where capital goods previously exchanged between two independent firms are now produced and employed within the same firm.

Note that cash-economizing inflation is benign precisely because it is an outcome of individuals striving to optimize their property holdings through the voluntary exchange process. It is also noteworthy that this kind of inflation involves a one-shot increase in prices: once the new payment method or invention becomes broadly adopted, the decline in the demand for money ceases and prices stop rising. Lastly, inflation caused by people responding to opportunities to economize on their money holdings has no systematic effect on credit markets and the interest rate and therefore does not precipitate the business cycle.

"Note that cash-economizing inflation is benign precisely because it is an outcome of individuals striving to optimize their property holdings through the voluntary exchange process."

A second type of good inflation is one that occurs as a result of a reduction in the supplies of goods and services caused by natural disasters, the depletion of natural resources, or increases in people's preferences for leisure (causing a decline in labor-force participation) or for present consumer goods (causing the nonreplacement or "consumption" of capital goods). All of these events bring about, sooner or later, a greater scarcity of exchangeable goods in the economy.

The reduction in the supplies of goods in the market, all other things being constant, including the stock of money, causes an excess demand for goods to emerge. Overall prices will naturally rise to restore equilibrium in goods' markets. This rise in prices both indicates the greater scarcity of available goods and ensures that they are allocated to the uses most highly valued by consumers.

Conversely, it may be said that there is a fall in the "exchange" demand for money, which is constituted by the goods offered for exchange. The decrease in the demand for money in exchange, with the supply of money unchanged, initially produces a surplus of money, because at the low prices prevailing, the supply of money offered exceeds the supplies of goods brought to market. Eventually, the buying power of the dollar adjusts downward, goods' prices are bid up, and all dollars offered are absorbed in exchange for the now-higher-priced goods.

Once again we note that, unlike the ongoing price inflation that is typically caused by central-bank expansion of the money supply, the inflation generated by diminished supplies of goods is a one-shot affair. Prices stop rising as soon as the supplies of goods and services stop decreasing and stabilize at the lower level consistent with the change in the economic data.

"Scarcity" inflation is thus socially beneficial because it facilitates economic calculation and smoothly operating markets in a situation in which people's preferences or their production opportunities have undergone a radical change. History has shown time and again — during wars, revolutions, sieges, and crop failures — that any attempt to repress scarcity inflation via price controls or centralized distribution of necessities results in calculational chaos, widespread poverty, and social disorder.

Our conclusion is, thus, that a rise in general prices driven by the demand for money always improves economic welfare as Austrians understand that term.

In the interest of full disclosure, I note that most modern Austrians who support free banking, while agreeing with me on scarcity inflation, would strongly disagree with me that cash-economizing inflation is benign. Writers such as Larry White, George Selgin, and Steve Horwitz insist that any change in total spending caused by shifts in the demand for money must be promptly undone by a change in the supply of money in the same direction. Thus under our current fiat-money system, if financial innovations occur that induce people to reduce their demand for cash balances and to exchange money more rapidly, then according to "free bankers," the central bank must contract the money supply in order to prevent the increase in prices that corresponds to people's voluntary choices.

"The free bankers claim to be in favor of a freely competitive monetary system, but presume to know in advance what outcome the entrepreneurs operating in this system will bring about."

This is a direct implication of the free bankers' "productivity norm," according to which the central bank must actively suppress "meaningless" changes in prices. Meaningless changes in prices include those caused by shifts in what free bankers characterize — misleadingly in my opinion — as "the velocity of money." Thus, free bankers become cheerleaders for a monetary deflation engineered by the central bank as a means of stifling a pattern of freely chosen exchanges of property that expresses consumer preferences for higher prices.

The position of free bankers is not only erroneous but paradoxical as well. They accuse Austrians of the neo–Currency School, created by Mises and Rothbard, of viewing deflation and inflation asymmetrically, favoring deflation while condemning inflation. But as I tried to demonstrate above, Austrians of the neo–Currency School are perfectly consistent in their attitudes toward rising and falling prices: both "inflation" and "deflation" are benign as long as they are in accord with the voluntarily expressed preferences of consumers. Not so the free bankers, who claim to be in favor of a freely competitive monetary system, but presume to know in advance what outcome the entrepreneurs operating in this system will bring about, namely, complete stability of a particular macroeconomic variable.

Thus, the real point at issue between the free bankers and their neo–Currency opponents is whether the productivity norm should be invoked to encourage the central bank to use its power to manipulate the money supply in order to stabilize "total spending," a meaningless, ex post macroaggregate. The free bankers answer, "Yes." Neo–Currency School Austrians accept Mises's dictum that rising and falling prices per se are meaningless in assessing the soundness of a monetary regime. As Mises wrote,

The notions of inflation and deflation are not praxeological concepts.… They impl[y] the popular fallacy that there is such a thing as neutral money or money of stable purchasing power and that sound money should be neutral and stable in purchasing power.…

However, those applying these terms are not aware of the fact that purchasing power never remains unchanged and that consequently there is always either inflation or deflation.[1]

Joseph Salerno is academic vice president of the Mises Institute, professor of economics at Pace University, and editor of the Quarterly Journal of Austrian Economics. He has been interviewed in the Austrian Economics Newsletter and on Mises.org. Send him mail. See Joseph T. Salerno's article archives. Comment on the blog.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in