I recently came across the following. It seems that the “optimum” inflation rate is 2-3%. Can that be right?
"However, as noted earlier, Edmund S. Phelps (1972, 1973) made clear that, by standard cost-benefit criteria, the optimum rate of inflation might actually be positive. Phelps’s reasoning relies in good part on the idea that inflation is a “tax”. In other words, the reduction in consumer surplus in Figure 3 is actually transferred to the government. What the government decides to do with this extra “revenue” must be included as an item of any subsequent welfare analysis. It can easily be the case that the Chicago Rule is not the “optimal” monetary policy in this case - as was shown by Phelps.
As is evident from the admirable survey of Stanley Fischer and Franco Modigliani (1975), the only substantive cost of (modest) inflation is largely the manner in which it distorts taxation. Consequently, as Phelps (1973) argued in a famous article, optimal inflation ought to be treated as a public finance problem, effectively an “optimal taxation” issue. However, note that “optimal inflation” arguments usually yield steady, modest inflation (2-3% or so); higher rates have a tendency to become highly variable and/or spiral into hyperinflations, which brings on considerably more dangerous complications. Nonetheless, the implications are clear: as catalogued by Fischer and Modigliani (1975), the real costs of mild inflation are surprisingly few - certainly, not enough to justify the huge sacrifices disinflation requires."
Yes, it is indeed a tax, meaning a way of taking purchasing power away from everyone with dollars in their wallets and giving that purchasing power to the govt. Or, more accurately, to the Fed and friends, whoever they are. We are not allowed to know who gets the money from this tax. Is it Goldman Sachs? Is it the bank of England? Rest assured, it’s not you and me.
Note that it is a tax that hits hardest on people with fixed incomes. It is a tax that does not distinguish between rich and poor. It is a tax not voted for or approved by anyone, the kind that caused the Revolutionary War. No taxation without representation.
His talking about “the huge sacrifices disinflation requires” is utter nonsense. Henry Hazlitt wrote two books about inflation, available free in pfd form, explaining this.
I think 2-3% is just the number that governments think they can get away with. Any more and people would start noticing the price increases. But if the government just prints enough to negate increases in productivity plus 2-3%, we never notice our purchasing power gone. People start to believe that prices just naturally increase a bit each year.
Well, maybe the government just pays the bills with it. Unemployment insurance and whatnot. In that sense social democratic states are really kind of fake welfare states, because they take the purchasing power away from people in the first place, only to give it back in return for votes.
The BOE aim for 2-3% but I find it is more like 5% in real price inflation. But when i moan about inflation to socialists they always come back with the argument that deflation is worse. Because if you are producer that just produced a table for $100 and then there is deflation in the economy they could potentially have to sell the table at less than $100. I did not have a good answer for that and I have been still trying to work it out. I guess although the produce sells the table for $90 in real terms that $90 could be worth more in value than the original $100 that it costs him to produce the table. But balance sheet wise it might look like a loss. Which i guess would be bad for taxation from the central bank/government perspective. Which might be why they think inflation is preferable (or even acceptable) compared to stability or deflation or even a moderate fluctuation of inflation/deflation.
The comment “the huge sacrifices disinflation requires” was in reference to 1979-82 when money supply targetting in the USA and the UK worked to bring down inflation, but also caused severe recessions. As a consequence, both countries abandoned this approach.
Saying that money supply tightening caused severe recessions in 1979-82 is a very bold statement. What is the causal connection between the two? .[The phrase “post hoc” springs to mind].
And why does this causal connection fail to exist when one studies 17 countries for a period of 100 years?
As for the Austrian look at that wondeful event, deflation. just google “site:mises.org deflation” [without the quotes]. Plenty of info right there. Also Hazlitt’s free book “Inflation”, is very informative.
I find it informative that socialists will argue in favor of the producer when defending inflationary policy. They conveniently forget the moral question of stealing from the poor and fixed income demographic, yet they are happy to use them to promote redistribution of wealth. They can’t be accused of consistency.
As a grain producer I benefit in the short term from inflationary effects on commodities. In the long term, however, I will pay higher input costs and likely find myself in a higher tax bracket. I cannot even begin to quantify the potential problems that inflation driven social unrest may bring to my markets. Particularly if price controls or nationalization of agriculture are in our future.
But my understanding of ABCT is that manipulations of the supply of money and credit lead to boom-bust cycles. I would have thought that the experience of 1979-82 validates that theory. No?
The phrase “manipulations of the supply of money and credit lead to boom-bust cycles” has to be nailed down.
Which manipulation leads to what?
Where does each phase of the boom bust cycle comes from?
What is a boom and what is a bust?
The gist of ABCT is that inflation [=increasing the money supply] leads to the boom. The boom means plenty of money invested in the wrong places [=wasting resources]. The boom itself then leads to the bust. The bust means when all that money being thrown away and the scarcity of resources it produced starts affecting the economy. So if there is a recession in 1979-82, ABCT would look for a boom before that, and for money printing on a grand scale before the boom.
Tightening money and credit is not going to lead to a boom, certainly, for there is no money to waste.
Will it damage the economy in an of itself, independent of an ABC? Murray Rothbard and Mises in his later works say no.
BTW, I just saw Murray Rothbard describing the events of 1979 as an inflationary recession, not a period of deflation. Don’t think I’m quoting him as holy writ, but it does make me want to know what evidence there is that it was a period of deflation.
"The Federal Reserve announced several times during the 1970s that it intended to bring inflation under control, but various attempts were unsuccessful. Then, on October 6, 1979, the Fed, under Paul Volcker’s chairmanship, announced and put into effect a new attempt involving drastically revised operating procedures that had some prominent features in common with monetarist recommendations. In particular, the Fed would try to hit specified monthly targets for the growth rate of M1, with operating procedures that emphasized control over a narrow and controllable monetary aggregate, nonborrowed reserves (i.e., bank reserves minus borrowings from the Fed). The M1 targets were intended to bring inflation down from double-digit levels to unspecified but much lower values.
In retrospect, the events that occurred from October 1979 to September 1982 are widely viewed as the crucial beginning of a necessary and successful attack on inflation that led, eventually, to the worldwide low-inflation environment of the 1990s. At the time, however, the “experiment” seemed anything but successful to many Americans. Short-term interest rates jumped dramatically in late 1979 under the tightened conditions, and 1980 witnessed a major fall in output in one quarter followed by a major jump in the next, due primarily to the imposition, and then removal, of credit controls. Finally, in 1981 and into the middle of 1982, a sustained period of monetary stringency brought about the deepest recession since the Great Depression of the 1930s and began to bring inflation down, more rapidly than many economists anticipated, toward acceptable values."
In table 1 of the article it shows CPI at 13.3% in 1979 falling to 3.8% in 1982. The unemployment rate went from 5.8% in 1979 to 9.7% in 1982. During that period, the Fed Funds Rate was in double-digits.
Again, this looks compelling evidence to me that tight monetary controls can cause a recession, just as loose monetary controls can cause a boom.
OK, first the unimportant point. The author of that article is clearly not an Austrian. This is very clear from his various titles and from his theory about what causes inflation.
He says inflation is caused by “shocks”. Which is clearly not an Austrian position, and is furthermore an absurdity. If the amount of dollars in the country remains the same, all the shocks in the world will not make people able to spend more money than they have, So that if people spend more on item A because its price went up due to some shock or other, they will have to spend less on items B,C,D, etc. They just don’t have the money. By the law of supply and demand, the prices of B,C,D etc will go down.
He paints a picture that the decrease in the money supply caused the recession. But of course he offers no theory that explains WHY a decrease in the money supply causes a recession, because there is none.
An Austrian would say that this is what was happening: Everyone admits that there was high inflation before 1979. That article itself mentions it. As explained in an earlier post, this led to a reccession waiting to happen. Now the govt can delay unemployment by printing money and spending it. Like Bush did from 2001 to 2008. But that cannot last forever. In 1979, Volcker decided enough is enough, we are ruining the country with all this inflation, so let’s stop printing so much money. This EXPOSED, [not caused] the weakness in the economy that was until then being papered over by all that money printing. A recession, whose roots lay in the money printing of the 70’s, began.