Why inflation is still a menace
by Gerard Jackson
TNA News with Commentary
Saturday 31 March 2001 Inflation is either non-existent or under control. The first is patently false and the second is a fallacy. The issue reminds me of a report on inflation that the IMF (International Monetary Fund) produced about four years ago. It led to Ian Henderson (economics editor of Murdoch’s Australian) to claim that the “monetarist experiment” of the ‘70s and ‘80s was a “policy waste”. Relying on the IMF’s World Economic Outlook, Henderson told readers that monetary policies could not cope with floating exchange rates and an unstable demand for money. Moreover, such policies had failed Australia in the ‘70s and ‘80s and that the cost of cutting high inflation rates is lost output and unemployment — a price that Australia paid in the early ‘90s. Well, I figured that if the IMF said it and Henderson reported it, it must be so. But it ain’t. The demand for money is to hold money. If nobody wanted to hold it, prices would rise to infinity. Rapid and severe changes in the demand for money are always brought about by expectations of changes in its value. Weimar Germany is a well-known example (or should be) of this phenomenon. Bresciani-Turroni’s calculations (The Economics of Inflation) for increases in the velocity of money during the hyperinflationary period were so large that he was left struggling for an explanation. The solution is simple: the value of money is ultimately subjective. If people believe its value will fall, they will offer more in exchange; and if sellers think the value of money will decline, they will demand more in exchange. Another example of this, though little known, are the Japanese notes the Philippines was forced to use as currency during the occupation. When it was realised that Manila would soon fall to the Americans, the prices of goods expressed in term of Japanese notes went through the roof, even though the quantity of notes did not change. In reality, anti-inflationary monetary policy did not fail to cope with inflation and floating exchange rates because there was no anti-inflationary monetary policy. Money supply in the UK, for instance, was allowed to rip; between 1983 and 1990 Australian credit growth never fell below 15 per cent and at one stage it reached nearly 30 per cent per annum. Therefore it completely beats me how anyone can claim monetary policy failed to defeat inflation when the monetary policy of the time was actually inflationary. But then I do not work for The Australian. Obviously, the relationships between money, prices, exchange rates, output and employment are variables that many of our economic commentators find too complex to deal with. Now the IMF endorsed, with unthinking approval of the likes of Henderson, the Reserve Bank’s policy goal of maintaining an underlying inflation rate of 2 to 3 per cent a year, as if this were a radical policy. It was nothing of the kind. This is the same policy that eventually gave us double digit inflation and will do so again if not checked. Let us go back to an article by Professor H. Slichter published in Harper’s Magazine 1952. Calling the article How Bad is Inflation, he attacked as “uncritical and almost hysterical” a distinguished group of economists who warned that “inflation is a threat to the stability of the American economy and the security of the Western world”. Slichter argued that a rising price level, of say 2 to 3 per cent, is essential for prosperity. As Dr Winfield Riefler of the Federal Reserve pointed out, that even if an inflation rate of 2 per cent a year could be controlled “it would be equal to an erosion of the purchasing power of the dollar by about one-half in each generation”. We should not forget that inflation can only do its ‘work’ if it is unforeseen. Once people a rate of inflation has been planned they will take evasive action; unions will plan on inflation adjusted wages, and then some; businesses would increase prices in line with the planned rate of inflation, lenders would raise the interest rates, investors demand greater returns etc. When anti-inflationists warned Slichter of the consequences of creeping inflation he replied that it was wrong to believe that creeping inflation is bound sooner or later to become galloping inflation. In 1957 Slichter was still arguing that creeping inflation could be controlled. Twenty years later, inflation was galloping ahead at 13 per cent per year. The Carter presidency saw inflation wipe out over 40 per cent of the dollar’s purchasing power. So much for Prof. Slichter’s sanguine views on creeping inflation. A vital component of the creeping inflation ‘debate’ that is overlooked is that inflation discoordinates the market process by misdirecting production. Eventually, those lines of production that owe their existence to inflation will require a larger dose of the monetary drug to prevent them from abandoning labour and capital. The effect will be larger monetary doses thus accelerating inflation. This happened before and it will happen again. But do not expect to get this from any newspaper. The tragedy is that though the policy of creeping inflation case has been thoroughly discredited by economic history and economic theory central banks are still implementing it. Fair use for educational/research purposes only!

-- Anonymous, April 04, 2001