Inflation
Cause or Effect?
I like to think about economic topics but I'm a bit of a contrarion when it comes to main stream economics. A long time ago I noticed the linkage between inflation and interest rates. They would go up and down together.
The conventional wisdom was that inflation forced interest rates to rise because investors need to compensate for inflation. For a while people were raising their prices every year in anticipation of future inflation.
I can see that logic but it always seemed to me to get the causality backwards.
Interest is in itself inherently inflationary.
An economy needs money to facilitate various transactions like buying and selling things. Ideally the amount of money in circulation aligns with the value of the good involved. If there is not enough money then people cannot afford to buy what's for sale. Deflation. Deflation is dangerous because it can cause an economy to collapse altogether in a viscous cycle.
Inflation happens when there is a surplus of money compared to the value of things exchanged in transactions. This causes prices to rise. This is unpleasant if you live on a fixed income - like say a pension or savings. The value of what you have steadily declines. On the other hand, inflation doesn't lead to the sort of destructive spiral that deflation causes. I've lived with inflation for a long time. Once a candy bar was 5cents. Last time I looked, years ago, it was over a dollar. We seem to be coping with that.
But where does that excess money come from? Conventionally it comes from governments just printing up more money to pay off debts. That is, the money comes from noplace without anyone working to produce anything. As a naive youth I was like;
waitaminute here - isn't that what interest is? It's money that lenders get without producing anything. So I held the contrarian view that interest causes inflation rather than inflation causing interest.
Our economy has a pretty complex mechanism that makes money. But it's book-keeping stuff. The government raises the balance in a bank's account and then the bank has money to lend. The bank can then leverage that into being able to lend out up to almost 10 times that amount in commercial and consumer loans. That is, when I borrow money the bank just increases my bank balance.
I won't say the process is simple. I don't know the details but over the years I've seen from the news that it's not just a matter of a president waving their hands magically.
The people in charge of the money supply are aware that there needs to be a balance so that there is enough money for the economy to function; not too little and not too much. In the last 10 years or so an account of how that actually works has emerged called Modern Monetary Theory that is the sort of inversion of conventional thinking that makes a contrarian like me smile. In a nutshell - a sovereign government creates money by spending (lending to banks) and removes excess money from the system with taxation.
This presents an inversion about how we think of inflation - inflation is caused by taxes being too low, not by taxes being too high. Devaluation comes from government not spending enough.
What do you think?
I present regular philosophy discussions in a virtual reality called Second Life.
I set a topic and people come as avatars and sit around a virtual table to discuss it.
Each week I write a short essay to set the topic.
I show a selection of them here.