BREAKING ALL THE RULES Forum

Full Version: You can have low inflation or zero inflation in deflationary depression
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Is price stabilization a good goal of monetary policy?   I say not.
 By inflation I mean an increase in the amount of money in circulation in the real economy.  When I want to speak of an increase in the price level as measured by a price index I say increase in the price level.  The distinction is important for this discussion, because both deflation and inflation of money in circulation can cause prices to increase.  More money will shift demand curves to the right, which works to increase prices.  But less money in the real economy can shift supply to the left causing prices to increase -- as when there are fewer sellers, as when fixed costs must be covered by spreading fixed costs over fewer items sold.   Now for your question:  Why is zero inflation bad?  If you mean, why constant prices as measured by a price index is bad, my answer is that if such an outcome is the object of monetary policy, that such policy puts an unnecessary constraint upon growth and innovation.   Now, we must consider the difference between prices as measured by an index based on some shopping bad of groceries and consumer items or based on producers' commodities on the one hand  and the shifting relative prices of things, often thought of as "the invisible hand" of market allocation at work.  Recall that there is underutilization of productive capital and of the potential labor force in the country.  More money in consumers' hands would improve this situation  -- and a policy of zero increase of price indexes would constrain this improvement.  The real problem is with the all-borrowed national money supply  -- where every deposit dollar has been co-created with a debt-obligation that totals more than the loan money created.  This leads to monetary deflation EVENTUALLY.   The loan comes first, stimulus, and prices go up as new money increases sales selling off inventory and leading to price increases for what remains.  That is the first effect of new money from the loan.  And as that money goes to consumers they buy more.  But soon the payments of interest and principal begin eating away at the new money supply, as borrowers pay on their debts to the lenders, to the financial sector.  The lenders are international and they do not typically either spend their interest earnings on consumer goods or direct investment in the domestic economy.  In fact if there is deflation they profit from a windfall for their idle cash balances and debt instruments that pay them in dollars.  This is the bias that causes the Fed to bless its friends with deflation.  Think of the factories and housing units (rental properties) and privatized utilities and lands that come on the market in deflation  -- those are the lower prices that the lending class looks for when they refrain from lending to obtain unearned and risk-free windfall from deflation.  With the all-borrowed money supply the economy tends to deflation  -- due to the interest drain discussed above.   There are no inflationary bubbles.  The inflation is good and it is a stimulus -- and certainly it does not hurt households, businesses and goverment deep in debt.  But we can't inflate in the short run, without incurring interest drain as interest and principal must be paid later.  New loans add to the money supply, but the borrower paying interest and principal becomes eventually a bigger drain of quantity of money than the amount the loan injected.  Even with a policy of zero price index increase or decrease the same problem obtains.  But remember, prices can go up due to deflation affecting supply as well as due to inflation affecting demand.  A policy to use the discount rate to maintain constant price indexes  _which you call "zero inflation" -- can be conducted during a money-quantity deflationary spiral.  Less money in the public hands causing supply to shift left  which works to increase prices -- while at the same time demand shifts left due to less money reaching households  -- a decaying economy while left-shifts of demand and supply cancel each others effect on the price level so that prices remain constant -- zero "price inflation" -- but in fact bad deflation shifting supply and demand in such a way that prices as measured by an index remains constant.

Dick Eastman
Yakima, Washington