Inflationomics

Why Inflationomics is So Popular

Inflationomics, the notion that inflation is good/necessary, is a new term that has its roots in what Ludwig von Mises called inflationism; i.e., the political programs aiming at inflation and deflation in the sense of big cash-induced changes in purchasing power.1 That refers to every-day monetary policy in today’s world; i.e., the manipulation of world currency prices through the expansion and contraction of money supplies and credit. This policy has evolved, in part, due to the confusion surrounding the word “inflation.”

In recent times, use of the term inflation has changed in meaning from "an increase in the money supply" to "an increase in prices." By changing the use of the word, many people are misled into believing that price increases, rather than money supply and credit expansion, are the source of the problem. Some people have even suggested that it is greedy businesspeople who raise their prices and cause "inflation." In the long run, it is this faulty thinking that leads to price and wage controls.

This misleading use of the word “inflation” is based on the mistaken assumption that money is supposed to maintain a constant value relative to the goods it is used to purchase. In reality, money, like everything else, is subject to the laws of supply and demand. Thus, its price is constantly fluctuating. This is reflected in the prices paid with the money, and is most clearly seen when one looks at the foreign currency markets. It is quite clear that all monies (currencies) are constantly fluctuating relative to one another. (For a history of the relative prices of the Euro and U.S. Dollar, click here) These currencies are also fluctuating relative to the prices of goods purchased with them. For a chart showing how much the U.S. dollar has changed relative to goods prices, click here.

On the other hand, if we realize and hold steadfast to the idea that inflation is the expansion of the money supply and credit, we can also realize that it is primarily the governments, who expand the money supply and credit, who are creating "inflation." Governments benefit from their increase of the money supply and credit in several ways:

  1. Government debtors, such as Zimbabwe and the United States, benefit from the expansion of their money supplies. By inflating the money supply, thus making each dollar worth less, they pay off their debts with cheaper money. This is especially true for the U.S. because much of the world uses the dollar as a reserve currency. This gives the U.S. a much broader base of demand, thus allowing it to export much of its inflation.
  2. As prices rise, incomes rise, and if these governments have progressive tax systems (especially if they also have an alternative minimum tax) in place, they receive more in tax revenue as a result of incomes creeping into higher tax brackets.
  3. Because inflation is a gradual phenomenon (at first), those who spend newly created money first benefit the most. Those who are farther down the line, receive cheaper money. Governments obviously get the first crack at spending the money they print and so they get the highest possible value for their money.

It’s not just governments, however, who benefit from inflation. Debtors of all kinds benefit. This is especially true for debtors with fixed payments. In fact, the longer one is able to lock in a fixed payment, the longer he/she benefits from the effects of inflation. Thus, people who are able to lock in longer term payback periods, have a greater incentive to keep silent while governments pursue an inflationary policy.

After a period of minimal inflation, with minimal harm perceived, it becomes an ingrained notion that inflation is good. People not only compensate for the minimal inflation, but they also grow to expect it. Businesses learn to deal with rising wages and employees grow to expect them. Unions push for ever higher wages, benefits, and fewer work hours. Even sub-prime debtors are able to borrow money.

Eventually, more people are dependent upon a continuing rise in prices than there are people who oppose inflationary policies. When a large percentage of people in a country benefit from inflationary policies, you no longer have economists talking about the evils of inflation, you only find economists and political scientists arguing about the "best" rate of inflation.

In the long run, if inflation accelerates, people flee from using their fiat currencies and look for safe havens. Only then will the appeal of inflationomics and the wisdom of its policies be questioned.

Robert Jackson Smith

Notes:

1 Mises, Ludwig von. Human Action: A Treatise on Economics, p. 423. The Foundation for Economic Education, Inc.: Irvington-on-Hudson, New York. 1996.
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