Inflation

The inflation rate is a measure of the increase in asset prices, measuring the percentage change in the average price level from the previous year. Where a positive inflation rate means rising prices, a negative inflation rate means falling prices, and a declining positive inflation rate means rising prices at a slow rate. Inflation can be predicted by the interest rate as it represents the amount of capital accumulation which is available to be lent out. Interest rates can be freely determined through market price signals when moneylenders are owners or producers of capital. The interest rate determined from individual’s time preference, assuming people value present goods over future goods. In this market inflation would be less prone to inflation-induced “boom-bust cycles” that arise from monetary policy credit expansion and low price fixed-rates, directly benefiting the large government debt. See my article on Tulip Mania for more on price increases. Without a central bank for collateral, banks issuing demand deposits with unbacked reserves (trading insolvent) try to only cause inflation temporarily guided by the bank run.

Alternately, inflation is a monetary phenomenon when governments use it as means to repudiates debt. The producer of inflation, therefore must be the creator of money and currency monopoly holder, the central bank. Why no other than the central bank currently has this right. Attempts at stimulating inflation must lead central banks to hold a monopoly on fiat money to prohibit any effective circulation of competing currency, or commodity money such as gold bullion/minted coins with intrinsic value. Rather, a central bank indirectly alters market interest rates which deviate from originary rate of interest and the supply of capital goods available for production.

Positive market interest rates calculated from the discount of future goods relative to present goods, is relied on to assess the risk of diverting scarce goods to entrepreneurial ventures which best satisfy needs. A zero market interest rate is where the lender/saver would not receive any discount of future goods relative to lending/saving present goods. The hundred percent interest tax, however, benefits borrowers for debasing real value of outstanding debt. This intrigued governments being the largest borrower which grants itself little risk vested in its power to create credit and collect tax revenue. In attempt to inflate the credit/money supply, negative market interest rates are adopted, which charge a premium of future goods relative to lending/saving present goods. Charging banks to hold reserves increases lending to borrowers with lower repayments and to prevent losses depositors withdraw cash. When banks hold excess reserves or people have cash rather than checking accounts, it restricts the ability for monetary policy to inflate the credit/money supply and reduces the money multiplier. Saving and investment would otherwise cease should a central bank make market interest rates negative in real terms. Note time preference and ordinary interest are positive. Here one would not lend savings to another and risk losing them only to get back less money. Unless taxation, inflation or a government policy increased the cost of holding money than loaning it out, in the adjustment costs to inflation, there can be unfair tax treatment.

If notes were dropped by an airplane or as helicopter money the government would not receive seigniorage revenue from the resulting inflation, which would have been raised through printing money. Note commercial banks create more credit in the money stock not “money out of thin-air” and transfer accounting liabilities of banks to the treasury. At worst, zero or negative rates arise as low rates and the recession quit producing intended aggregate demand rises, and so money printing/making arise as zero rates quit producing intended inflation. If not careful, a hyperinflation arise as money printing maxes out asset prices. Repudiation would continue to occur if inflation is expected, people demand a higher nominal interest rate (real interest plus inflation rate) which compensate debtors as debt still falls as the price level rises, though increases the opportunity cost of holding money which taxes savers and cash holdings. When money printing stops and bonds interest elevates, the government debt defaults. To prevent this worst case scenario, governors formulating monetary policy are given long terms in a bid to encourage independence from short-term political pressure.

Markets influenced by expansionary monetary policy supplying money and cheap credit make people aware of malinvestment and asset price inflation. Where M2 is used to forecast inflation – inflation is the increase in the supply of money and its fall in purchasing power. To combat unemployment, businesses expand and people’s income and spending tends to rise along with imports. Inflation is seen to improve labor markets allowing them to reach equilibrium without cuts in nominal wages. The sale of dollars for other currencies with more purchasing power increases along with new goods purchases and decreases the currency exchange rate. Conversely, markets influenced by contractionary monetary policy – tightening the money supply and cheap credit, make people aware of declines in incomes, spending and asset prices. Raising the exchange rate lessens demand of foreign currency and imports as people’s incomes fall.

There is a trade-off between long-run inflation and short-run unemployment/production. The popularity of inflationary expansionary policy ignores productivity for full-employment, and it is wrong to assume inflation reduces or increases real wages. As in the long run, the real wage is determined from the marginal product of labor and not the price level or inflation rate. Here, in the short run nominal wages are fixed, and may not adjust immediately. The social costs of inflation include transaction and adjustment costs and redistributive effects. However, nowadays ATMs and online banking cause little shoeleather costs. This is one of the social costs of inflation, where the second results from changing prices. However, businesses change prices at different times in the year, causing relative price distortions and mis-allocation of resources.

General inconvenience can also be another problem to the adjustment for inflation, and can complicate long-term planning, as it makes it difficult to compare nominal values from different time periods. Cantillon effect considers the redistribution effects of inflation. If everyone added or subtracted a nought on each dollar of money in the economy everyone would be the same amount richer or poorer had this not of happened. The only part that would have to change is adjustment to the new money supply. However, inflation benefits those at the core of the financial system first, this is called the Cantillon effect. This in affect takes wealth from one part of society and gives it to some other part of society. Furthermore, it’s impossible to predict when inflation will turn out higher than expected, when it will be lower, and how big the difference will be. So, these redistribution’s of purchasing power are arbitrary and random. 


Featured image supplied from Unsplash.

Copyright © 2016 Zoë-Marie Beesley

Creative Commons License Licensed under a Creative Commons Attribution 4.0 International License.

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