Purpose of Monetary Inflation

[Jcrew]

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What is that purpose?

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Well this is going to astray into political philosophy, which I do hold some views, but I do no think is worth defending.

As another has suggested, some basic research and rational thinking will shed some light on your remaining questions.

[econophile]

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pvn,

if you want to learn more about deflation i suggest you go to the library or do a google search.

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I know all about it. I'm curious as to what your personal view is here.

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i have a feeling that you are not at all curious what my personal view is and that you are simply being contentious. that said, i previously posted

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to add a little more to the quote from Bernanke, the reason having a nominal interest rate of zero is bad is that the central bank can no longer lower interest rates to stimulate the economy. that takes away one of the tools used to smooth the business cycle and could result in prolonged recessions.

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that's a basic description of a liquidity trap, which is one common argument for avoiding deflation. of course if you believe the economy only responds to real shocks, then you won't buy this argument.

[Riddick]

I think I'll step into the fray here...

The first few responses (Brain, MrNow) were dead on.

However I'd like to bring up the consequences of monetary inflation, central bank style.

First, you should be aware of what economist JB Say wrote of consumption and production. (the real theory, not the butchered, fallacious Keynes strawman). You can read it at econlib.org under books, Jean Baptiste Say's Treatise, Book I Chapter 15. In layman's terms, you must produce wealth before you can consume wealth, or in other words, you must supply before you can demand (and hence the butchered interpretation "supply creates its own demand" on which Lord Keynes' legacy rests).

Naturally someone like Tom Hanks' character in Castaway, living alone on an island, cannot consume more than he produces (he can't eat 5 fishes if he only caught 3 that day), but a society that has accumulated wealth over centuries can consume more than they produce. Of course they didn't become an advanced, wealthy society this way but rather the opposite, by producing more wealth than they consumed, yet the other option is there, and of course it is a one way path to destruction (on a side note, society's that discouraged accumulations of wealth, through means such as burying a man not without all of his earthly possessions for example, tended to not go very far)

Year after year increases in the money supply through money printing and the government reinforced and secured system of fractional reserve banking, which would surely die in a free market, initiates and strongly encourages this - essentially capital consumption, wastes of scarce resources, malinvestment, a continual destruction of wealth above and beyond the creation of wealth, and of course the boom and bust cycle of the economy which can and has resulted in depression.

Again, in a layman's analogy, imagine eating 300 calories a day but working out intensely and burning off 6000 calories a day. Pretty soon your body will be eating itself from the inside and you will die. Not good.

So when the Fed instigates a flurry of loans and investments from money created out of thin air by lowering interest rates, at the expense of money-holders (inflation), most people think this is a good thing, when in fact it is the opposite. Increasing consumption of wealth (or increasing aggregate demand) before any increase in production of wealth has occurred, and then having this increase multiplied X times over, turns society into my workout analogy - a bodybuilder burning 6000 calories a day and only eating 300 calories.

In short, the federal reserve is not needed to stimulate the economy, and in fact, it is impossible for the federal reserve to stimulate the economy in any real sense of the word. The growth in wealth of the economy is stimulated by the shear fact that human beings always desire more/better economic goods. The actual consumption of these goods is naturally limited by their (ever increasing) production, and there is no inherent boom-bust cycle in this market phenomena.

Ludwig Von Mises, mentioned earlier in the thread, arguably the greatest economist that ever lived, had this to say, in 1942, about the consequences of inflation - "Inflation and You"

[mattnxtc]

its a tricky definition that he uses and i guess i should have clarified mine more when i was tryin to give the short version i gave. I in fact didnt define inflation as anything...i merely said that when prices go up we can see inflation...i didnt define it. The tit for tat way that it is defined just explains in more detail why we see it...

[econophile]

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there is no inherent boom-bust cycle in this market phenomena.

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of all of the questionable things you have said, this seems the most far-fetched.

edit: i realize there is no point in arguing with devotees of the austrian school of economics, but i would urge the undecided to look at a graph of GDP growth rates over time.

[Riddick]

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edit: i realize there is no point in arguing with devotees of the austrian school of economics

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All of the Austrian economics I've read has thoroughly refuted college textbook (macro)economics. I have an open mind and will anxiously await the textbooks' rebuttal. But somehow I don't think Brad DeLong will bother.

[pvn]

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We dont have enough gold to support a gold backed currency

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Who is "we"?

How much is "enough"?

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so it would be so very uneconomical that it would be disgusting...of the 2 options havin the govt backed money is a lot better

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Can you do more than just assert positions? What's "uneconomical" about it? And if you don't want to use gold, don't. Why do you need someone else to tell you what to use for money?

[pvn]

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to add a little more to the quote from Bernanke, the reason having a nominal interest rate of zero is bad is that the central bank can no longer lower interest rates to stimulate the economy. that takes away one of the tools used to smooth the business cycle and could result in prolonged recessions.

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that's a basic description of a liquidity trap, which is one common argument for avoiding deflation. of course if you believe the economy only responds to real shocks, then you won't buy this argument.

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The central bank monkeying is what causes the business cycle in the first place!

[LinusKS]

PVN, I want to present a hypothetical.

To be 100% up-front, I suspect you of being a gold-bug, which is fine, but this story has gold in it, and I'm curious what you'll say.

Suppose in the town of Flatland, there's one bank. The bank accepts deposits in gold, and charges a nominal fee, to hold it safe. Half the town's gold - 50 bars - is in the bank. The other half circulates as currency.

How much "money" is there? (50, 100, or something else?)

Now let's say the bank starts issuing receipts, or certificates, showing the amount of gold each customer has on deposit.

Each certificate is transferrable, meaning a customer can collect his own gold by taking the certificate down to the bank, or can transfer it by transfering the certificate.

Over time, the certificates begin to circulate, as people begin paying for things with certificates, rather than making extra trips to the bank.

How much money is there now? (50? 100? or 150?)

To keep track, now there's 50 bars of gold in the bank. 50 bars circulating around town, and 50 bank-certificates, which also circulate.

Now the banker gets an idea. He prints up an extra batch of 50 certificates, each identical to the 50 already printed, and offers them as loans. Each certificate carries a simple (not compound) interest rate of 10%. At the end of ten years, the borrower must pay them back, plus interest. For the sake of the example, let's say 50 people each buy (borrow) one certificate each.

Now there's 50 gold bars in the bank, and 50 circulate in town. There's also 50 (original) certificates, plus 50 new ones (identical to the first).

So how much money is there?

Lets say, after ten years, the good people of Flatland all pay back their loans, plus interest. The interest works out to 50 bars' worth - the same as the principle.

Now the bank has the 50 loaned certificates, plus 50 more, which works out to be all the certificates. It also has the 50 bars on deposit (which it now owns).

How much money is there at this point? How much of it belongs to the bank?

Because it seems to me the bank has dramatically increased the money supply (and then decreased it), and that it's done it without the benefit of government, solely by issuing certificates backed (or supposedly backed) by gold.

[pvn]

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PVN, I want to present a hypothetical.

To be 100% up-front, I suspect you of being a gold-bug, which is fine, but this story has gold in it, and I'm curious what you'll say.

Suppose in the town of Flatland, there's one bank. The bank accepts deposits in gold, and charges a nominal fee, to hold it safe. Half the town's gold - 50 bars - is in the bank. The other half circulates as currency.

How much "money" is there? (50, 100, or something else?)

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100 units.

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Now let's say the bank starts issuing receipts, or certificates, showing the amount of gold each customer has on deposit.

Each certificate is transferrable, meaning a customer can collect his own gold by taking the certificate down to the bank, or can transfer it by transfering the certificate.

Over time, the certificates begin to circulate, as people begin paying for things with certificates, rather than making extra trips to the bank.

How much money is there now? (50? 100? or 150?)

To keep track, now there's 50 bars of gold in the bank. 50 bars circulating around town, and 50 bank-certificates, which also circulate.

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Still 100. The notes only circulate while the bars they represent are actually in the bank.


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Now the banker gets an idea. He prints up an extra batch of 50 certificates, each identical to the 50 already printed, and offers them as loans. Each certificate carries a simple (not compound) interest rate of 10%. At the end of ten years, the borrower must pay them back, plus interest. For the sake of the example, let's say 50 people each buy (borrow) one certificate each.

Now there's 50 gold bars in the bank, and 50 circulate in town. There's also 50 (original) certificates, plus 50 new ones (identical to the first).

So how much money is there?

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Now there are 150 units.

What happesn when the people holding the notes worth 100 bars show up at the bank and demand the 100 bars? The bank still only has 50 bars.

The bank has issued fraudulent notes. The bank has committed a crime.

If this somehow works, and there is no run on the bank, the value of each unit will approach 67% of their original value. But eventually someone is going to figure out what's going on and try to convert as many notes into gold as they can.



The bank will default, anyone left holding the remaining 50 paper money notes will be hosed.

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Lets say, after ten years, the good people of Flatland all pay back their loans, plus interest. The interest works out to 50 bars' worth - the same as the principle.

Now the bank has the 50 loaned certificates, plus 50 more, which works out to be all the certificates. It also has the 50 bars on deposit (which it now owns).

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Wait. Where are the 50 bars that the bank owns? Are you saying that the original 50 bars are now no longer owned by the original owners and are now owned by the bank? The owners of those 50 bars just happened to take loans and pay interest exactly equal to the amount of gold they had on deposit?

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How much money is there at this point? How much of it belongs to the bank?

Because it seems to me the bank has dramatically increased the money supply (and then decreased it), and that it's done it without the benefit of government, solely by issuing certificates backed (or supposedly backed) by gold.

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Backed by *somebody else's* gold, or gold that didn't exist at all in the first place. Wow, what a system.