Monday, February 18, 2013

Do We Have Inflation, Deflation or the Two Co-existing

In How To End the Depression Now, I proposed that, instead of printing $89 billion a month to buy treasury paper, the US Government (a) abolish the minimum wage, (b) deny welfare to the able-bodied unemployed, (c) send every worker a monthly check equal in amount to the current minimum wage, thereby providing every worker with a living income, and (d) claw-back the free money from better paid workers, but at a rate that does not impose a severe marginal tax rate on the low paid.

These suggestions infuriated one commentator who repeatedly demanded to know why I thought:
... the current Fed policy of increasing the money supply by monetizing debt is inflationary, but wouldn't be if those same counterfeit dollars from thin air were sent to individual workers instead?
In fact, I do not think what that person thinks I think, and I never said that I did. What I said was that, if the Fed is to continue printing $89 billion a month, why not use the money for something more useful than buying government debt. In particular, I proposed the scheme outlined above for driving down wages of marginal workers to the market rate without forcing those workers  to starve.

Additional to the elimination of unemployment, benefits of the program would include (1) a huge saving in welfare costs and other costs associated with mass unemployment and under-employment, and (2) a boost to business and the GDP through the availability of several tens of millions of workers in North America and Europe prepared to work for wages comparable to those of the Third World.

To consider the inflationary consequences, if any, of current central bank money printing operations was not the objective of my earlier post. It is an interesting question however, that I will consider here.

In ordinary palance, inflation is taken to mean a general increase in prices and fall in the purchasing value of money. To economists, however, it is generally understood to be an increase in money supply, achieved either by debasing the currency, if based on precious metals, or by issuing additional paper (or digital) currency.

US Money Supply Growth to 2008. St. Louise Fed.
The terms monetary inflation and price inflation tend to be used interchangeably because it is generally assumed that monetary inflation leads to price inflation. But that is not necessarily the case as is evident from events since the finacial crisis of 2008, when the US Fed approximately doubled the US money supply as variously defined.

Prices of energy and food, it is true, have risen sharply, though they have not doubled, and the price of many things has actually declined. Automobiles, for example, cost roughly the same in America today as they did more than a dozen years ago, although they have undergone many technological improvements. Home construction costs in Canada are no higher today than several decades ago. And prices of all those hand-held electronic devices and the cost of network connectivity on which so many people spend so much of their income continually fall.

There are several reason why monetary inflation and price inflation are so loosely connected. One is that, for many goods and services, increased demand lowers the marginal cost of production, which in a competitive market will lower prices.

Cell phones, i-Pads and many other manufactured goods fall into this class. The big costs are the up-front costs of design, marketing, setting up a manufacturing process. But once those first-copy costs have been incurred, the cost of production may be relatively trivial. The economics of cellphone and internet access fall into this category. Likewise, digital products such as movies, downloadable music, e-books, learning solutions, etc.

Furthermore, although the marginal cost of some goods is higher than the average cost, e.g., food and energy, an increase in the availability of money may have little effect on demand for such goods. One can only eat so much in a day, however, much money one has to spend on food. Similarly, people won't necessarily raise the thermostat or drive more miles because their income has edged up a bit.

Curiously, therefore, insofar as central-bank-created money gets into the hands of consumers, its overall effect may be price deflationary.

There are many other things that could be said about this, a discussion of the role of credit in determining demand and its effect on prices being perhaps the most obvious.

What is clear, though, is that the price inflationary effects of money inflation are not immediately apparent, and that it is quite possible to have monetary inflation with price deflation and rising unemployment. Moreover, without arrangements that allows marginal workers to work for less than mandated by minimum wage laws, mass unemployment will likely be endemic in the West indefinitely.


  1. "In fact, I do not think what that person thinks I think, and I never said that I did."

    Oh. Excuse me. What, then, did this mean?

    "The US Federal reserve is currently printing $89 billion a month to purchase treasure bonds, thereby increasing the money supply in an operation that appears destined to create not jobs but hyperinflation."

    Do you have a different definition for hyperinflation other than the extremely high rates of inflation that occur after people lose all faith and trust in the government's fiat currency and get rid of it as quickly as they can in exchange for things with actual value?

    Printing $89 billion a month is either inflationary, or it isn't. It makes no difference what it's used for.

    And of course, the current $89bn/mo in debt purchased with the $89bn/mo created out of thin air is financing government spending. Government is spending counterfeit money.

    What you are effectively recommending, is replacing government spending with government spending on different things, specifically free money to workers. What difference do you see in terms of inflation?

    And, who, exactly, are the workers you would shower with this unearned largesse? Current full time workers? All workers? Unemployed workers?

    And, as I asked before, what about retirees and others who live on income from investments and savings and who aren't part of the workforce?

    Some additional explanation would be helpful.

    1. You accuse me of saying, and I quote:

      "... the current Fed policy of increasing the money supply by monetizing debt is inflationary, but wouldn't be if those same counterfeit dollars from thin air were sent to individual workers instead?"

      But nowhere did I say that.

      It is true that if printing $89 billion a month for one purpose is inflationary it is likely to be so for another purpose, although that is not certain. Printing money to pay a job subsidy will increase the GDP by increasing the number of people in the workforce (because the minimum wage has been abolished and labor at lower rates is now available), and hence the total output of goods and services, which in turn will counteract the effect on prices of an increased money supply.

      But in fact, as I have tried to explain to you here and at Carpe Diem, the proposal for an employment cash benefit to insure that those earning below what heretofore has been the minimum wage would not be in dire poverty, need not depend on printing any money.

      In fact, the proposal I have made would be largely if not entirely self-financing though savings in other programs, e.g., the US $75 billion dollar a year food stamps program, to name only one of many.

      If those savings were insufficient to cover the entire cost, then the cost could be covered through taxation. Since the proposed benefit would be received by all those in employment, the tax would largely be a recovery of the benefit paid to higher paid workers.

      I hope that clears things up.

      And as for retirees, they are a different matter on which I have made no proposals. My concern is with those of working age who need, and in a viable democratic society must have, an opportunity to work for a living wage.

  2. Nice explanation of monetary inflation, price inflation, and the difference between them.

    The most likely reason for the current apparent disconnect between monetary inflation and price inflation in the US is due to the fact that most of that additional money supply is "sitting in bank vaults", so to speak, in the form of higher bank reserves, and isn't being spent in the economy. When that changes, we can expect to see the predicted price inflation.

    "Curiously, therefore, insofar as central-bank-created money gets into the hands of consumers, its overall effect may be price deflationary. "

    Not really. As you pointed out there are two opposing but unconnected forces at work on prices. One is the inevitable downward pressure on prices exerted by the forces of innovation, automation, increased productivity, and competition for market share that is the hallmark of a capitalist, relatively free market economy, and which drives most prices lower over time, making us all better off.

    The other is the upward pressure on prices caused by more dollars chasing the same supply of goods and services due to increases in the money supply.

    You noted the higher cost of food and energy, both directly related to commodities that are bought and sold on global markets. This can result from the lower value of the USD relative to other world currencies.

    Have you considered that a national plan to reduce worker's wages to levels similar to those of foreign workers could result in other countries following similar strategies so that nothing would change but the numbers?

    The Chinese yuan is currently pegged to the USD so nothing would change with respect to the relative rates of US wages and Chinese wages.

    Or, perhaps you are recommending that all US workers should, in essence, work for, and be paid by, the US government.

    More detailed explanations would really help.

  3. Re: Money and prices

    You speak of "upward pressure on prices caused by more dollars chasing the same supply of goods and services due to increases in the money supply."

    That is true only of certain goods and services.

    For many goods and services, and in particular the goods and services upon which an increasing proportion of income is expended, there is no limit to supply and the marginal cost of supply is less than the average cost.

    For example, cell phone minutes, Internet bandwidth, music and movie downloads and ebooks, all have a high first-copy cost and a negligible marginal cost. So the greater the demand the lower the price will be — provided that the market is competitive, because providers will compete for increased market share by lowering their prices as volume of sales increase.

    The same applies to a greater or lesser extent with many manufactured goods, where billions may be expended on design, research and development, and marketing, but which cost rather little to manufacture. For example, an i-phone costs only five or ten dollars to assemble but retails without phone company subsidy for hundreds. As sales ramp up, the prices of such goods are sharply reduced.

    In other words, for many goods, monetary inflation leading to increased aggregate demand tends to lower prices.

    So there is a disconnect between the effect of increased aggregated demand on things such as food and energy, where supply is constrained and the marginal cost of production exceeds the average cost, and the types of goods and services discussed above.