Inflation Deflation Red-flation Blue-flation
02-18-2009, 08:12 AM
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Inflation Deflation Red-flation Blue-flation
Daily Article by Matthew Beller | Posted on 7/24/2008 12:00:00 AM
Inflation Deflation Red-flation Blue-flation - Matthew Beller - Mises Institute
A debate has been raging for some time among those in the finance industry about whether the United States is currently experiencing inflation, deflation, stagflation, reflation, hyperinflation, or maybe even some other sort of "-flation" that only Dr. Seuss could imagine.
Unfortunately, much of this debate is unproductive because the participants use varying definitions of these terms, and even when they use the same ones, deciding on one simple label might not be sufficient to describe the deeper economic forces at work and what their effects are likely to be. Given the confusion, this article will add some color to the debate by offering usable definitions of the terms inflation and deflation and then attempt to show what is occurring in today's economy
............
One reason that Austrian economists place so much emphasis on the phenomenon of inflation is that it often causes boom-bust cycles. It is a specific type of inflation, however, that causes unsustainable booms, which I term "bad inflation." This is the type of inflation that occurs in fractional-reserve banking, where money that is intended to be used for current consumption is loaned out to businesses, sending false signals about people's preferences for current vs. future consumption, which makes it impossible for businesses to properly allocate resources. To the extent that market participants are not aware of the money creation or are not able to determine its rate or otherwise adjust for it, they will undertake business ventures and adopt consumption patterns that are unsustainable. In precisely the same way that Ponzi schemes can operate seemingly healthily for years or more before collapsing, the unsustainable booms caused by "bad inflation" might persist for a while, but will eventually go bust when reality surfaces, prices adjust, and previously profitable enterprises go out of business.
........
Those who insist that Federal Reserve policymakers have the ability to simply print up as much money as they want are completely right in one sense, but they perhaps fail to realize that the bulk of the money supply is in the form of circulation credit, which banks, rather than the Fed, produce. The Fed directly controls only the monetary base, which is basically comprised of physical currency and bank reserves. When the Fed purchases securities through its open-market operations, the monetary base increases by a corresponding amount, but it is ultimately the banks and their customers who determine the amount of circulation credit built on top of the monetary base. This is where the idea of the Fed "pushing on a string" takes its meaning. The Fed can let out slack to the banks by buying securities from them to increase their reserves, but it cannot force them to take up that slack by loaning those reserves to businesses.
.......
Most people are led to believe that deflation is a bad thing, but it is not. In fact, it is precisely what the economy requires to eliminate the malinvestment created by the Fed's inflationary policies. Unfortunately, deflation tends to be politically unpalatable because it causes, among other things, a temporary increase in unemployment as capital resources are reallocated to more productive sectors. Accordingly, it can be expected that the Fed will do anything it can to avoid deflation, not to mention the fact that its chairman, Ben Bernanke, has gone on record discussing the importance of preventing "deflation" (he uses a definition of falling prices).
Inflation Deflation Red-flation Blue-flation - Matthew Beller - Mises Institute
A debate has been raging for some time among those in the finance industry about whether the United States is currently experiencing inflation, deflation, stagflation, reflation, hyperinflation, or maybe even some other sort of "-flation" that only Dr. Seuss could imagine.
Unfortunately, much of this debate is unproductive because the participants use varying definitions of these terms, and even when they use the same ones, deciding on one simple label might not be sufficient to describe the deeper economic forces at work and what their effects are likely to be. Given the confusion, this article will add some color to the debate by offering usable definitions of the terms inflation and deflation and then attempt to show what is occurring in today's economy
............
One reason that Austrian economists place so much emphasis on the phenomenon of inflation is that it often causes boom-bust cycles. It is a specific type of inflation, however, that causes unsustainable booms, which I term "bad inflation." This is the type of inflation that occurs in fractional-reserve banking, where money that is intended to be used for current consumption is loaned out to businesses, sending false signals about people's preferences for current vs. future consumption, which makes it impossible for businesses to properly allocate resources. To the extent that market participants are not aware of the money creation or are not able to determine its rate or otherwise adjust for it, they will undertake business ventures and adopt consumption patterns that are unsustainable. In precisely the same way that Ponzi schemes can operate seemingly healthily for years or more before collapsing, the unsustainable booms caused by "bad inflation" might persist for a while, but will eventually go bust when reality surfaces, prices adjust, and previously profitable enterprises go out of business.
........
Those who insist that Federal Reserve policymakers have the ability to simply print up as much money as they want are completely right in one sense, but they perhaps fail to realize that the bulk of the money supply is in the form of circulation credit, which banks, rather than the Fed, produce. The Fed directly controls only the monetary base, which is basically comprised of physical currency and bank reserves. When the Fed purchases securities through its open-market operations, the monetary base increases by a corresponding amount, but it is ultimately the banks and their customers who determine the amount of circulation credit built on top of the monetary base. This is where the idea of the Fed "pushing on a string" takes its meaning. The Fed can let out slack to the banks by buying securities from them to increase their reserves, but it cannot force them to take up that slack by loaning those reserves to businesses.
.......
Most people are led to believe that deflation is a bad thing, but it is not. In fact, it is precisely what the economy requires to eliminate the malinvestment created by the Fed's inflationary policies. Unfortunately, deflation tends to be politically unpalatable because it causes, among other things, a temporary increase in unemployment as capital resources are reallocated to more productive sectors. Accordingly, it can be expected that the Fed will do anything it can to avoid deflation, not to mention the fact that its chairman, Ben Bernanke, has gone on record discussing the importance of preventing "deflation" (he uses a definition of falling prices).
02-18-2009, 10:29 AM
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Originally Posted by ryan1234
Those who insist that Federal Reserve policymakers have the ability to simply print up as much money as they want are completely right in one sense, but they perhaps fail to realize that the bulk of the money supply is in the form of circulation credit, which banks, rather than the Fed, produce. The Fed directly controls only the monetary base, which is basically comprised of physical currency and bank reserves. When the Fed purchases securities through its open-market operations, the monetary base increases by a corresponding amount, but it is ultimately the banks and their customers who determine the amount of circulation credit built on top of the monetary base. This is where the idea of the Fed "pushing on a string" takes its meaning. The Fed can let out slack to the banks by buying securities from them to increase their reserves, but it cannot force them to take up that slack by loaning those reserves to businesses.).
Originally Posted by ryan1234
Unfortunately, deflation tends to be politically unpalatable because it causes, among other things, a temporary increase in unemployment as capital resources are reallocated to more productive sectors.
02-18-2009, 11:49 AM
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Originally Posted by RXS676
What about when the securities that the fed "purchases" are U.S. Treasurys? This has been rampant over the last 4-5 months. The fed buys U.S. Treasurys, providing cash to the Treasury which is spent immediately and in full. I understand this is incidental to the point of the article, but the federal reserve absolutely has the ability to directly increase the amount of money the economy. This is a dangerous slippery slope to hyperinflation.
In addition, deflation penalizes debtors, who are the helpless victims du jour.
In addition, deflation penalizes debtors, who are the helpless victims du jour.
I'm not sure I could call debtors helpless victims.
02-18-2009, 06:12 PM
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Another way to look at the inflation/deflation angle is to consider not just borrowing and currency, but to look at the wealth held by all americans. For 2007 it was estimated to be around 57 trillion dollars, much of it held in investments and real estate.
If you were to consider half of that value lost, you can begin to understand just how large a "stimulus" or other intervention would have to be to make a meaningful impact.
There is no doubt that a rapid and severe deflation of prices in equities, real estate, commodities and other financial instruments has happened. This is not good news for debtors, and it makes it very obvious that the Fed and other government agencies have no real control over the economy when the bubble has burst. They contributed to the blow up, but now their ammunition is spent.
The only remedy is to unwind government spending and rejuvenate the economy through lower taxation and by making sure the country offers the highest incentives for worldwide investment. The only way to attract business and investment to this country is through low rates of corporate taxation. You cannot possibly spend your way out of debt.
If you were to consider half of that value lost, you can begin to understand just how large a "stimulus" or other intervention would have to be to make a meaningful impact.
There is no doubt that a rapid and severe deflation of prices in equities, real estate, commodities and other financial instruments has happened. This is not good news for debtors, and it makes it very obvious that the Fed and other government agencies have no real control over the economy when the bubble has burst. They contributed to the blow up, but now their ammunition is spent.
The only remedy is to unwind government spending and rejuvenate the economy through lower taxation and by making sure the country offers the highest incentives for worldwide investment. The only way to attract business and investment to this country is through low rates of corporate taxation. You cannot possibly spend your way out of debt.
02-18-2009, 07:16 PM
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Originally Posted by jungle
Another way to look at the inflation/deflation angle is to consider not just borrowing and currency, but to look at the wealth held by all americans. For 2007 it was estimated to be around 57 trillion dollars, much of it held in investments and real estate.
If you were to consider half of that value lost, you can begin to understand just how large a "stimulus" or other intervention would have to be to make a meaningful impact.
There is no doubt that a rapid and severe deflation of prices in equities, real estate, commodities and other financial instruments has happened. This is not good news for debtors, and it makes it very obvious that the Fed and other government agencies have no real control over the economy when the bubble has burst. They contributed to the blow up, but now their ammunition is spent.
The only remedy is to unwind government spending and rejuvenate the economy through lower taxation and by making sure the country offers the highest incentives for worldwide investment. The only way to attract business and investment to this country is through low rates of corporate taxation. You cannot possibly spend your way out of debt.
If you were to consider half of that value lost, you can begin to understand just how large a "stimulus" or other intervention would have to be to make a meaningful impact.
There is no doubt that a rapid and severe deflation of prices in equities, real estate, commodities and other financial instruments has happened. This is not good news for debtors, and it makes it very obvious that the Fed and other government agencies have no real control over the economy when the bubble has burst. They contributed to the blow up, but now their ammunition is spent.
The only remedy is to unwind government spending and rejuvenate the economy through lower taxation and by making sure the country offers the highest incentives for worldwide investment. The only way to attract business and investment to this country is through low rates of corporate taxation. You cannot possibly spend your way out of debt.
While touring China, he came upon a team of nearly 100 workers building an earthen dam with shovels. The businessman commented to a local official that, with an earth-moving machine, a single worker could create the dam in an afternoon. The official’s curious response was, “Yes, but think of all the unemployment that would create.” “Oh,” said the businessman, “I thought you were building a dam. If it’s jobs you want to create, then take away their shovels and give them spoons!
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