Wednesday, 20 September 2017


Are We Still All Inflationists Now?

Posted by
July 14, 2014
in Blog

A recent WSJ news story made the startling claim that the Federal Reserve was “making progress” because the various measures of inflation have been rising recently.  Other   reports have similarly commented favorably on success of the Bank of Japan and European Central Bank in raising inflation rates.  What is going on?

Five years ago, the Sound Money Project asked “Are we All Inflationists Now?”    Clearly I was wrong a few years ago when I asserted “there were no central bankers or ministers of finance who would publically argue that the prevailing inflation rate was too low.”  It now seems they all do.

This is clumsy and dangerous thinking–and we are going to be made poorer as a result.  This odd notion that debasing fiat currencies promotes prosperity and facilitates wealth creation is neither theoretically founded nor does it reflect historical experience.   Indeed, economic theory suggests that “mild deflation” would be best for enhancing standards of living over time.

For many, the word inflation seems to apply only to things they buy; it is rare for people to think that a bigger paycheck or higher prices for the services they provide is a reflection of inflation.  Similarly, farmers and other producers are inclined to assert that falling prices of what they offer to sell is what is meant by deflation.    Ludwig von Mises argued in Human Action that there is so much ambiguity in the terms inflation and deflation that we would be better served by eschewing them.

Economists and policymakers sometimes talk about “price stability,” although individual prices in a market economy need to be free to fluctuate and not subject to imposed price controls.  The rigid, mandated prices of the old Soviet Union were not what is meant by the expression “price stability.”

I have on occasion advocated Honest Money, playing off a former Federal Reserve Governor’s dictum, “A place that tolerates inflation is a place where no one tells the truth.”  Truth about what?  About what is happening to the relative values of both inputs to production and the output of final goods and services desired by consumers–as well as real tangible assets such as land and buildings and the financial assets traded on exchanges.

While there is ambiguity about what people mean by inflation and deflation, there is no ambiguity about their absence.  That is, while economists disagree about which statistical series best measures the pace of inflation–and whether or not to include asset prices in attempts to ascertain what is happening to the purchasing power of money–there cannot be disagreement about the conceptual meaning of the absence of inflation or deflation.  That is what is meant by Sound Money.

With sound money, ordinary people–as producers or consumers–can base their decisions on the expectation that all observed changes in prices of goods and assets, including labor services, are changes in relative prices.  Changes in relative prices result from shifts in demands for and supplies of everything–inputs and well as outputs.  These are the price changes that promote economic efficiency and foster the highest achievable standards of living.  Sound money also means that all observed changes in market interest rates are changes in real interest rates, not contaminated by changes in inflation expectations or manipulations by central bank.  Such changes in real interest rates are essential to ensuring that productive resources go to their highest valued uses.

When money is not sound, mistakes are made.  Observed price changes and interest rate changes do not accurately reflect shifts in underlying demand and supply, so resources are misallocated.  Shortages of some things and surpluses of other things are common.  People devote more of other resources to gathering information about relative price changes and to conducting transactions–including the incorporation of price escalators and inflation hedges in contracts.  All this makes us poorer.

Ultimately people choose to use as money the medium of exchange that best economizes of the use of real resources in gathering information about relative values and in conducting transactions.  That means alternative monies–and competition among currencies–promotes economic well being.  Monopoly money is no more desirable than monopoly in any other economic activity.

One Comment

  1. Leland Yeager July 17, 2014 2:31 PM

    I infer from your blog that you do not agree with a target of 2% inflation rather than of no appreciable inflation. Is that true? I know that there are some good arguments for the 2%, but I do not find them conclusive. Since I respect the opinions of Alan Meltzer also, I wonder if you happen to know what he thinks about the issue.