Money Mischief
Inflation is always and everywhere a monetary phenomenon.
The non-monetary demand for an item used as money has an important effect on its monetary value. Similarly, the monetary demand has an important effect on its non-monetary value.
The Fed determines the nominal quantity of money and the public (through demand) determines the real quantity of money (what the nominal quantity actually purchases).
Money eliminates the coincidence of wants present in barter-based systems.
While helicopter money, on its face, seems advantageous, it eventually leads to price inflation and lowers real wages that leave all holders of that currency worse off.
The nominal quantity of money x the velocity of circulation (number of times money is used) = The average price of goods and services x real income. M x V = P x Y. M x V = Total spending and income; P x Y = Nominal GDP.
A change in monetary growth affects interest rates in one direction at first and then the opposite direction later on. Rapid monetary growth tends to lower interest rates at first, but the resulting acceleration in spending eventually creates inflation and drives interest rates higher.
The demonetization of silver in the late 1800s put significant upward pressure on the gold-to-silver price ratio.
Deflation did not prevent rapid economic growth in the United States during the 1800s, it was actually rapid growth after the civil war that produced the deflation.
Debtors benefit from inflation and creditors from deflation as debt in absolute terms either shrinks or grows, respectively.
Inflation occurs when the quantity of money rises more rapidly than output. Output has natural constraints such as resources and time/effort needed to produce things, but the quantity of money has no real constraints.
Wage increases in excess of increases in productivity are a consequence of inflation, not a cause.
There are five basic truths about inflation:
- Inflation is a monetary phenomenon arising from an expansion of the money supply.
- Governments determine the quantity of money.
- The only cure for inflation is a slower increase in the quantity of money.
- It takes time measured in years (not months) for inflation to develop.
- Unpleasant side effects of the inflation cure are unavoidable.
Inflation or high unemployment is a false dichotomy. The real options are whether we have high unemployment as a result of inflation or as a temporary side effect of curing inflation.