Inflation question - Input Junkie
If the size of the money supply is increased, are there theories about what make the result more likely to be a boom or general inflation?
A better way to put it is whether the ill results of inflating the money supply are immediate or postponed. If the money goes into investment, then the immediate results appear good; there are more jobs and more production. But since these are the result of cheap money, it goes disproportionately into the areas to which the money is most readily available, eventually resulting in a "correction" (if it's small) or recession (if the effects are more general) when the investments go bad. If the money goes directly into people's hands, either directly from the government or through increases in pay, an increase in prices is likely to follow.
In recent years, we saw an atypical boom-and-bust: Government policies encouraged easy credit to home buyers rather than business investors, resulting in a rise in prices in homes followed by a bust due to bad investment. We've seen a third case at the same time: Much of the increase in the money supply has gone into foreign borrowing. The result is that domestic prices haven't taken off, but the value of the dollar in the eyes of foreign investors is getting steadily shakier. They don't want to blow off their investments, so there hasn't been any major effect yet. But if and when they do, the results could be major.
My question may have been unclear-- what I'm curious about is whether there are factors which cause the economy to have one reaction rather than the other one, or a mixture of the two.
Edited at 2009-09-21 01:05 am (UTC)
It's a matter of conjecture. If the supply of money grows faster than the aggregate demand for it, there will generally be inflation. The demands include consumption, savings, government expenditures, debt service, balance of payments, etc. with different interdependencies.
If the supply does not grow fast enough, there will generally be economic slowdown and rising interest rates.
I don't think it's factors in the economy, so much as how the increased money enters the economy.
|Date:||September 21st, 2009 02:46 am (UTC)|| |
Actually, I would say it was a pretty typical boom and bust. Prosperity led to rising land rents, which led to land prices rising even faster, to reflect expected future rents. Land prices couldn't keep rising by double digits forever, so they finally stopped, and when they stopped rising, they fell, since they were inflated, based on expectations of future increases, rather than value for current use. This has happened many times before.
Increasing the money supply (inflation in the original sense) is likely to give us higher prices (the usual current meaning of inflation), not prosperity. We can have stagflation, contrary to Keynesian orthodoxy. Exactly what the results will be, when, is not something I can predict.
Prosperity by itself doesn't lead to a positive feedback loop in prices. Several aspects of government policy, including the tax shelter of home mortgages and the constant encouragement of marginal loans, promoted the increase.
|Date:||September 22nd, 2009 02:09 am (UTC)|| |
Prosperity by itself doesn't lead to a positive feedback loop in all prices, but it does lead to a positive feedback loop in land prices, given that land is privately owned and not very heavily taxed. The particulars of government policy you mention contributed, as did NIMBY zoning laws in some places that helped send real estate prices sky-high, but they aren't the basic cause.
This isn't standard economic theory, but it explains -- and predicts -- events better than standard economic theory. It was developed in the 19th century by a politicla economist named Henry George, and has been further developed by modern Georgists, notably Professor Mason Gaffney. Try Googling, and you can learn about this stuff.
Easy credit was available to business as well. This contributed to so many companies being leveraged. Indeed, the other problem with the economy is the reward cycle for business was significantly warped. This is also a result of government policy (and common law) curtailing the mechanisms by which business owners (stockholders) could hold those actually managing the business accountable. In particular, the effective elimination by the SEC and the courts of Delaware of the shareholder derivative suit -- by which shareholders could hold officers accountable for wasting corporate assets -- and the rise of common stock with effectively no voting rights, allowed those who controlled the corporation, but did not own it (the officers) to establish lavish salaries and engage in risky behavior.
Tax incentives for corporations likewise have had significant warping effect on corporate spending, often encouraging behavior that had nothing to do with increasing value.
For a long time, the formal economic definition of inflation was "increase in the M1 money supply". Inflation has the effect of making money "cheap", so some new ventures will be undertaken. Too much inflation for too long, and the interest rates go up and money becomes expensive again.
|Date:||September 21st, 2009 04:47 am (UTC)|| |
Modern money didn't start until the power of the Catholic church was broken by the Protestant Reformation. Until that time, the church forbid "usury," or loaning money and charging interest. Without the ability to borrow money, people who didn't already have some couldn't get any, and most people returned to barter until the invention of paper money.
Jews were lending money at interest in Europe by the 1300s-- the Protestant Reformation was two centuries later. I don't know how much lending at interest increased once Christians were allowed to do it, though.
Surely people without money could have sold things or worked, and gotten money that way. This is not to deny the importance of borrowing to start or expand enterprises.
Second link: Your theory about the boom and bust cycle involving raw materials is plausible, but there's a piece I've wondered about-- whether there are only so many good ideas for business expansion around at any given time. Rothbard seemed to assume that there were always enough good ideas, and the only problem was having enough money to finance the ones which take longer to pay off. This isn't obviously true.
Third link: Why didn't the increased money for labor in the dot com boom cause lower prices or wages in other parts of the economy? Does increased productivity from the dot coms come into the picture anywhere?
I'm assuming that economies to slow down when there's less money around because of contracts which were made when the price levels were higher, not because lower prices are bad in themselves.
Edited at 2009-09-21 02:30 pm (UTC)
As others have pointed out, there are several theories. For one thing, Friedman (the father of monetary theory)thought intervention via the central money supply to maintain a steady supply of currency for economic growth was necessary for a smooth running economy. Purportedly figuring out the right equations was what won him the Nobel at which he famously opined (in jest) that the governors of the central monetary funds could be replaced with computers.
The next generation of economists have gone in two directions. Either that it is impossible to predict the outcome of tinkering with the money supply, and that therefore we should void doing so, or that the relationship between money supply and inflation now appears less solid than previously.
More on monetarism here: http://en.wikipedia.org/wiki/Monetarism
For myself, as non-economist tinkering at the edges, it appears to me that the problem of "money supply" is far more complex than what central banks make available. The economy trades in all sorts of instruments deemed to have value converted into dollars (or other currency, but dollars have been the default global currency since WWII). When these lose value, money "vanishes" out of the global money supply. When they rise in value, new money is created without intervention by central banks. Consider the derivatives market as one example of this phenomenon.
I would argue that the link between currency inflation and deficit spending is not in the increase in the money supply, but a reflection of the confidence on lenders that the debtor nation can repay the debt, as the debts of other nations are denominated in U.S. currency. This makes inflation calculation in the U.S. an extremely complicated problem -- because we are also plugged in to some degree to every other economy as the default currency.
Paul Samuelson is hardly the next generation, and he made the obvious point: it depends on how often any given dollar gets spent. This is part of what made booms possible under a hard currency with limited credit; if the same supply goes around twice as fast, there might as well be twice as much of it.
My understanding is that Friedman and his equations assume constant velocity, as the simplest possible case; evidence is limited.
|Date:||September 21st, 2009 05:25 pm (UTC)|| |
Probably just stating the obvious (?) but I've generally gotten the impression that the inflation vs boom issue comes down to whether the increased money supply is linked to an increased total wealth.
If the total wealth (e.g., how valuable, say, the US is) increases without proportionate increase in how much effective money there is, there's deflation. If it's matched by an increase in effective money (by printing debt and issuing money; or by making debt more available and therefore allowing institutions to print their own money, etc), there's a boom. If the amount of effective money rises sharply relative to total wealth, there'll be inflation as money drops in value (and the same if the amount of wealth drops sharply, of course). Oh, and if the same event removes both effective money and wealth, there'll be a bust (but not necessarily inflation or deflation, as money may not be changing value relative to wealth)
What makes this really complicated is that wealth (and effective money) can be difficult to calculate accurately, and that either can be created and destroyed by circumstance (or, say, a bubble bursting).