Would you rather have the government ...

Economics Economics Questions
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21

Guys,

I fully agree with what you say. It is true that spending taxed money will create malinvestments and I said so myself. But again, do give me a praxeolgiclay valid answer to this:

You spend the money: you will create malinvetsments, at least partial, but there will be little if any redistribution of wealth (as compared to the other scenraio).

You destoy the money: there will be no malinvetsments, but there will be redistribution of wealth due to deflation. If you think that only inflation can create malinvetsments, that is true. But it must be said that deflation too, giving us an artificial rise in the interest rates, will force people to consume capital. So, if you destroy money, you redistribute wealth and make people consume the capital base.

Now tell me, and I want a praxeologicaly valid answer: can we say which of these actions is the best in any and all occasions?

22

In my mind, and I won’t go so far as to say this is a praxeologically consistent answer as I am speculating. But the destruction of the currency does not necessarily cause the consumption of natural resources as the spending route does. Deflation would occur as you stated.

The more money pulled out of the system however the more and more people will start bartering or experimenting with alternative mediums of exchange.

As citizen’s become aware that their money stock is being depleted(Not their natural resources) it is more likely that they would switch units of exchange. People would hold onto their units of steel, as eventually it will be more abundant than their money.

I think that in the current scenario where we have mal-investment people are over spendy. People are generally too hasty to invest. I think in the scenario where the money stock is destroyed the opposite would occur. People would be unnecessarily conservative, and economic growth would be unnecessarily slow.

You don’t see people abandon their unit of exchange on the spending side however, the inflation side, as consumers are tricked into thinking their cash holding is rising, and as such they think their wealth is also rising.

23

But look at what happens when you destroy existing fiat money: deflation sets in.

Now, in the real world those who depend on the government’s infusionf of money are banks. So it will be banks who shall feel deflation first: they’ll see their income lowered, and their costs unchanged. They will cut credit to avoid going bankrupt. The ensuing rise of interest rates though will be artificial (in part) because the banks’ income “should” have changed at all, as real resources in the economy are just the same: prices should have fallen when money was destroyed.

But an artificially higher interest rate induces people to consume real capital. So, even with deflation real resources, not just money, are squandered: that capital wood have served better if invested. Now we consumed part of it.

So, both scenarios entail loses for the economy (and it should be so: I don’t see how stolen funds could be helpful). In practice it would boil down to a judgment call by whoever controls the state at the time. Each of us must decide for himself which course of action would look like being the lesser evil. There is no precise and universal answer. I myself think that spending would be the third best option, after giving the money back to the taxpayers and just giving them to state employees as a bonus (both options we do not have in this thread). Destriogn tehm would be the last best option. But than again, it just me.

24

I understand that deflation is also redistribution and unecessarily slows down growth but I don’t see why spending the money is better than destroying it. As far as I know, spending the money does nothing to alleviate the redistribution caused by the reduction in the money supply. It only misallocates resources further. I am not sure if taxing the money and spending it is twice as bad as taxing then destroying ot if it is equally as bad though.

25

We are asusming that taxation has ceased, and all we have to do is decide what to do with the funds collected out of past taxation.

Spending the money would prevent deflation at all, as it is precisely the destruction of that sum which brings deflation.

But I do not claim that spending is better than not spending: there is no way to know. I just “feel inclined” to opt for spending. It somehow feels like the lesser evil to me. But its just a feeling, as we cannot know praxeologicaly.

26

I’m confused here. Why does higher interest rates necessarily force people to consume real capital beyond what they already would normally do? That is what low interest rates normally do. If anything I would assume people would be more conservative, not consume more, but less. In my mind I see the situations problem is that capital becomes idle, but not consumed.

27

Deflation will cause interest rates to fall. The future value of the currency will be higher than today. Commodities or assets will therefore cost less in terms of future currency value. People will trade their commodities or assets today for currency to obtain gains from future currency appreciation. People who have debt, priced in terms of yesterday’s currency, will need to produce more commodities or goods/services in the future to repay their debt priced in units of yesterday’s less valued currency. Therefore, in deflation, interest rates will be lower due lower demand for debt today - because of higher burden to repay that debt in the future.

As for consumption and inflation/deflation… If I expect inflation will make goods more expensive next week in units of currency I hold today, I will buy those goods today that I want next week. That would bring forward people’s time preferences to purchase today the things they plan to consume next week. If I expect deflation to make goods more cheaper next week, in units of currency, I may push out my time preference of consuming today in order to get it cheaper next week (with the currency I hold today) and therefore consume it next week. Time preference also impacts interest rates. High demand to consume today using borrowed money will push up demand for debt and therefore interest rates today. If I know that there is a high rate of inflation and things will be more expensive next week I will borrow currency today to buy those goods today that I want next week, and repay the debt next week. It brings forward my time preference to consume today. But when demand for debt rises today, interest rates will rise today. The cost of debt will go up today to make consumption more expensive today based on what the expected price will be next week. Therefore, I don’t think that interest rates adjusts a person’s preference at what time they will consume. It is the expectation of inflation (or deflation) that may adjust a person’s time preference. The interest rate will be a result of that change in time preference.

28

Great post.

29

Scineram, you suggested two of Merlin’s posts. I assume you agree with them?

Merlin,

You’re still wrong, and have not made arguments based in Austrian economics.

Deflation would not cause higher interest rates. Inflation causes higher interest rates.

This tax caused deflation would, not surprisingly, have the opposite effect of bank caused inflation but with some important differences. Uneven taxes on certain industries would cause depression of those industry, instead of inflationary booms. But the difference is that everyone would know why those industries are depressed, unlike credit inflation where its not obvious where the money is going, tax rates are common knowledge. Even though people knew why the industry was depressed, they would still flee. Causing resources to be spent to produce goods desired slightly less than those goods that are taxed. This is where economic waste would set in. But having the government turn around and spend the tax money on goods that are not desired by consumers does nothing to correct this. In fact, it magnifies the problem of resource allocation.

You claim that deflation causes capital to be consumed, but what do you think government consumption causes?

You’re correctly pegged when compared to Keynes, you are appealing to “macro” interest rates without even considering the actual underlying economics.

No after effect is caused by “deflation setting in.” The redistribution is caused when the money leaves the tax payers hand. The market will then adjust price levels to ensure full employment of labor and capital, assuming no second intervention in the form of government spending occurs.

30

Perhaps you are assuming that people know there will be deflation.

But assuming that would mean that everybody knows deflation will occur, hence interest rates would get adjusted in the future, leaving no reason to defer a planed debt today.

Prices too, would be adjusted today to the precise extent of money destruction, leaving again, their real prices unchanged. So, if people really know that there is going to be deflation, deflation can have no real effects (your analysis is correct when people except deflation, but deflation doesn’t happen though).

And again, if people really knew that there would be inflation, and how much inflation would there be, there could never be a boom-bust cycle: all prices as well as the interest rate would be adjusted: money would be “neutral”. So, that assumption in not very realistic.

In the scenario at hand, we have the government that suddenly stops taxing people. It is clear that no one (besides a very few) would except deflation (”the government will destroy its money?! I’m still stunned at its decision to stop taxation!”). And if no one expects deflation, that what happens is that, the government loses money, but prices are still unchanged.

Next, those who normally receive payments from the government lose money, and those would be banks. As banks loose money, they must curtail credit. The chain of those that lose money due to the initial money destruction goes on, until at a given point prices are readjusted downwards. Form then on, those who lose money after such a drop in prices, gain.

Yet banks, by curtailing credit more that they should have (if prices had dropped when bank income fell), artificially increase the interest rate. And a higher interest rate will signal entrepreneurs to shorten the structure of production, investing more resources in industries closer to the consumer: malinvestment.

Basically, its just inflation backwards.

31

My God, is my English really that bad? I’ve been saying from at least the last two post: I TOTALLY AGREE WITH THAT!

Spending tax money does add to the initial misallocation of goods caused by taxation itself. The economy will be moved away from it optimal point. I AGREE.

Yes the market will adjust, just like it does adjust after initial taxation or initial inflation. But the fact that the market can adjust doesn’t mean that no harm will be done in the meantime. Good Lord, by saying that the market “adjusts” you are explicitly saying that there is a situation to be addressed; i.e. there is some misallocation. I do not claim that the misallocation caused by deflation (see my post above for that) is incurable in the market.

Ah, so its because inflation causes artificially higher interest rates that entrepreneurs get the wrong signal and lengthen the structure of production?! And I’m the one not basic his analysis on Austrian economics?

I’m afraid the only parallel I can draw between myself and Keynes is than almost no one isunderstanding a word of what I’m saying!

32

Chillax. [:p]

33

Low federal reserve interest rates cause inflation because of how money creation works in our fractional reserve banking system.

That is different from inflation/deflation fears causing market interest rates to change.

There is a change, that must be accounted for. Price level changes will not fix the misallocation caused by taxation, it will only prevent deflation from causing idle resources.

34

I’m afraid you got that backwards. When the Fed sets “interest rates” it doesn’t stop banks from dealing in any interest rates they like. It is like me proclaiming every morning at 8 am, the “price” of gold form my balcony: no one would give a damn.

What the Fed really means by “we’re cutting the interest rate by such percent” is that they’re cutting the interest rate on the loans they make to banks out of newly-created money. And the influx of this newly-created money lowers interest rates in the economy. So, its inflation that lowers interest rates, not at all the opposite.

True, as I mentioned in my previous post. When people wrongly believe inflation/deflation will ensue, yet no inflation/deflation really happens, the very exalt analysis presented by Bearing applies.

Yet you must see that the market cannot be wrong for too long. After a month of dealing in “expected” interest rates, people would see that there really is no inflation, and rates would go back to normal. The amount of malinvestment promoted by wrong expectations per se cannot be counted at all, that small it is. The Fed can fool the market only if it keeps expanding the supply of money at an exponential rate, always assuring that real inflation is higher than excepted inflation. Well, at least until people begin to except exponential inflation (yes I know, that sounds stupid), in which case we have hyperinflation.

But we must see that “wrong expectations” can never cause a business cycle or malinvestment. At the very least, they have nothing to do with the ABCT.

That is true, the market cannot fully adjust to the negative effects of continuous taxation, but it can well deal, given some time of course, with the effects of taxation after it recedes.

The vary same applies to deflation: the market cannot adjust to the malinvestments caused by continued deflation, but it can, given time, adjust to those caused by deflation after it stops for good.

And that’s the whole point: we are here forced (unrealistically, to be sure) to choose between two sets of measures, each having negative effects. They’ll both be one-time, the market will adjust to both and still both will entail a net loss. There is no way to tell which way is the best. It’s a judgment call. I myself “feel” that spending and causing that kind of malinvestment is a sounder approach, but I surely cannot ‘provee’ it to you. eevryone must make up his own mind on this: praxeology must remain silent.

35

Right.

The available “cheap money” to the banks mean that they can in turn market that money to borrowers. Without these end borrowers, banks will not borrow from the fed and no inflation exists. This is what is described as the Fed “pushing on a string.”

Contrary to a market interest rate where supply of loanable funds determines the rate of interest, the Fed sets a rate of interest then supplies whatever amount of funds is demanded.

But you’re comparing banking system inflation to non-banking deflation. The counterpart to the inflation you speak of would be deflation caused by banks calling in loans. But just because calling in loans means deflation does not mean that deflation always leads to calling in loans. There is no reason for a bank to call in loans just because of taxation, unless to pay some increase in taxes levied on itself.

In fact, deflation would benefit lenders by increasing their real income; just as inflation benefits borrowers by allowing them to pay off their debt in depreciated dollars.

36

You were suggesting that if the government did not respend the tax money that further harm would result, beyond what was caused by the act of taking. That is still incorrect.

No harm is done when the government does not spend.

37

Number 1 for sure. All government spending is consumption of wealth. Throwing paper into the sea only wastes the paper the money was printed on resulting in the least damage to the wealth of society.

38

There you’re going an assumption to far.

Deflation benefits lenders because a higher purchasing power will mean that they will be paid back with higher-valued money; that is correct. But here one is assuming that prices have already fallen, i.e. that the lender is far form the original point of destruction of money.

Whereas in the scenario when the state flow of money to banks ends abruptly (due to those money having been destroyed, not redirected), bank reserves fall immediately while prices remain unchanged. That is, the value of loans being paid back is still the same, but reserves have just taken a hit. So the bank has, at the moment, a very pressing issue of dwindling reserves.

In a world where money would be neutral, the value of loans being paid back would increase just as much as reserves fall, leaving the bank in the very same position. but that is not the case in real life. The bank is facing lower reserves now, and even when, in the future, the value of paybacks will increase, this will only put the bank in the precise same position which it enjoyed prior to deflation: so, the bank loses until prices fall, and than goes back to neutral. A clear net loss.

That’s why a bank will be forced to either stop lending (by increasing interest rates), or call back loans. So interest rates will increase more than they should have. That’s why the market will get the wrong signal to shorten the structure of production. Malinvetsment, just as in inflation.

Of course tat would be a one-time malinvestment, but spending tax money too would be a one-time malinvetsment generator.

39

Of course. if the government does not exist at all, no harm is done by it not spending.

But once tax money have been collected, once the damage has been done, spending them (distorting production), just like destroyign them (deflating and causing an artificial shortening of the structure of production), would bring harm.

40

Throw it away.