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.