Wednesday, 3 January 2018

Price Inflation Is Not The Worst Part Of Easy Money Policy

By C.Jay Engel

There are many critics of the Fed's recent money supply expansion, especially since 2008, whose chief criticism is that it will result in consumer price inflation. While proponents of the Austrian School agree that high consumer price inflation is one possible result of an expansionary monetary policy, we neither hold it as necessary nor as the worst consequence of money creation.
For the Austrian, who defines inflation as an expansion of the money supply, rising consumer prices only take place to the extent that this new money drives demand for more consumer goods. But as Mises pointed out, new money does not enter the economy neutrally; that is, it enters in specific ways and in accordance with specific mechanisms. This affects where the rising prices will show up first. And if it takes decades for the newly created money to reach consumers, then it will take decades for the consumer prices to rise.
Secondly, rising consumer prices are by no means the primary evil of monetary expansion. The primary evil of monetary expansion under our money and banking system is the harm done to the capital structure. The artificial suppression of interest rates that results from the expansion of the money supply has an eroding effect on the economy's capital stock. When interest rates are suppressed below what they would have been without the monetary expansion, investments in unprofitable projects suddenly appear to be profitable. This is the basis for the Austrian Theory of the Business Cycle. Capital is allocated to projects that the economy cannot in actuality support, and is therefore squandered.
When critics forget that (a) rising consumer prices are not a necessary result (also see Murray Rothbard's America's Great Depression, page 85-87) or (b) that consumer price increases aren't the primary evil of monetary expansion, they don't have much to say in response to mainstream economic narrative of our time: The Fed has quadrupled its balance sheet, so where's the inflation? If anything, the Fed is going to need to do more to create inflation, considering we have entered a dangerous era of "lowflation."
Before a comment is made on what happened to the inflation, let's remind ourselves that the Misesian understanding of the business cycle presupposes that the new money makes its way to the economy via the credit markets. That is, all else being equal, there would be no business cycle if the money was just printed by the government and handed out equally to consumers. The business cycle takes place because the new money is loaned out by banks to businesses which use this money to invest in longer processes of production. The investment with the new money into the capital structure first bids up the prices of the "factors of production."


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