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Source link: http://archive.mises.org/16054/does-economic-growth-cause-inflation/

Does Economic Growth Cause Inflation?

March 16, 2011 by

A true expansion of wealth, which promotes individuals’ well being, cannot at the same time generate bad things such as a general increase in prices, which undermines people’s living standards. FULL ARTICLE by Frank Shostak

{ 14 comments }

Jonathan March 16, 2011 at 9:11 am

In a fiat money/Fractional reserve banking system, then there will be a correlation. Growth will be tied up with confidence, more credit, prices rise. Given that this is the system we live in, it is reasonable to see growth as being linked to inflation as defined by the general public, i.e. prices rising.

In a hard money system growth would presumably be defined as greater productivity and thus lower prices.

K. Chris C. March 16, 2011 at 10:06 am

Of course, it’s only a matter of time until “core” inflation is deemed to be the price of kids marbles. As long as one doesn’t eat, drive, heat, read, communicate, etc., inflation is non-existent.

Iain March 16, 2011 at 10:35 am

Before reading the article I would guess that it depends on what is fueling thay economic growth.

The Fringe Economist March 16, 2011 at 12:45 pm

Can someone please define monetary turnover? I’m a bit confused by the term. Thanks!

Joe March 16, 2011 at 4:19 pm

I believe he is referring to the Velocity or circulation of money that some economists still hang onto. The theory of velocity of money has been disproven many years ago. Just do a search on this site for velocity of money and there are several good articles.

Rick March 16, 2011 at 2:51 pm

Call me crazy but this is silly. Most of us should realize that Economic Growth in a true free market society would mean lower prices, not higher.

James March 16, 2011 at 2:59 pm

Does Economic Growth Cause Inflation?

All else being equal no. But as someone mentioned earlier, with growth comes confidence, dollars that have been sitting on the sidelines, may begin to reenter the economy, new loans may also occur. It seems to me anyway, that in this light, growth could lead to inflation.

AG March 16, 2011 at 4:21 pm

Are you ignoring the demand side of the supply/demand equation? Simply, to answer this question:

Again, why should more wealth, which raises people’s living standards, also generate bad things such as a higher rate of inflation?

Because more wealth leads to higher demand which, until production catches up with the increased demand, leads to higher prices, which is what CPI measures.

I assume the counter argument is that the increase in wealth must have followed an increase in production, therefore the demand should be filled. However, this is a chicken-and-egg/tiger-and-tail issue, growth leads to confidence, which leads to people bringing money out from “sitting on the sidelines” which leads to increased demand, which leads to increased output (growth). Answering which came first, production or demand, is all-but-impossible.

Jonathan M. F. Catalán March 17, 2011 at 12:29 am

AG,

Inflation in the mainstream sense refers to a general increase in prices (increase in the “average” price, if you will). A price is a figure which is derived, without getting into too much detail, from the amount of money (aggregate demand) bid towards a number of goods (aggregate supply). An increase in demand of one good can lead to an increase in price, but if the number of dollars in an economy is fixed it follows that the price of another good must fall. A general increase in prices requires an increase in the quantity of money.

AG March 17, 2011 at 2:41 am

Note that in my comment I stipulated that there was money waiting on the sideline that comes out when confidence increases.

Scott Turley March 17, 2011 at 12:44 am

The demand side of the economy is exactly what this article misses. This recession we’re now experiencing was not caused by any supply shocks, the problem came completely from the demand side. As was mentioned in other comments here, a lot of money was removed from the economy and parked on the sidelines. Without an expansionary monetary response, we would have seen deflation and not because our productive capacities increased, but because the demand for all of our global wealth fell off the cliff.

Living in Phoenix, AZ I can literally see that in the housing market. We have a ton of houses, and if we wanted to, we could have literally kept building more – we have really productive construction companies and a lot of skilled labor and access to equipment and supplies to keep it up. But, obviously, we overbuilt and now we have way more supply than demand.

And the demand is artificially low right now. There are a lot of people I know who would love to buy a house but either they can’t because they had to dump a house they purchased at the peak through a short sale (and have to wait until their credit recovers) or they are waiting until the prices bottom out. Additionally, it’s now a lot harder to get credit than it used to be (even before the credit bubble – even reliable people have a hard time getting it now). So, all of these people, who otherwise would be reliable home consumers, are now flooding the rental markets. But because a large number of people are waiting to buy, house prices keep falling.
Falling house prices really hurt home owners especially those who have a mortgage. Deflation is a really, really bad thing.

But another side effect of deflation because of weak demand is that it causes high unemployment which further weakens demand (unemployed people have no money to buy stuff, those with jobs are afraid they may join those who are unemployed and are trying harder to save). High unemployment is really bad because it decreases global wealth.

I know of very talented people in both landscaping and construction who have experienced both unemployment and underemployment, and this is tragic in very real terms because every hour they are not working when they otherwise would like to be is an hour of production that the world will literally never see. You might say we don’t need more houses, but there are so many neighborhoods that are literally crumbling. We could literally move all of that talent in construction and landscaping from the edges of our city to renovation projects and really transform Phoenix. It’s literally a missed opportunity.

So, as the economy finally recovers, and more people work and produce and add to our pool of goods and services, demand will go up and because our federal reserve has flooded or economy with money, inflation will rise – which is exactly why they’ll have to try to time it right to keep inflation under control.

But I think it’s pretty obvious that both inflation and deflation are bad. What’s required is price stability which is exactly why we have a central banking system.

Now deflation caused by increases in capacity and wealth is good, but what happens is not necessarily deflation but usually demand increases to soak up the supply.

Technology is the classic deflationary example – but people aren’t buying the computers like those built in 1980 – which would now be worth basically nothing. They are actually spending more now on computing devices then they did then. They are now just getting a lot more than they could before – instead of one slow, big desktop, they are spending money on mobile devices, iPads, etc. We just grow our consumption along with supply – which keeps people working and innovating.

Demand and Supply are vitally important. Oddly, libertarians seem to put all of their marbles on the supply side of the graph, but maybe I’m missing something.

Nick Bradley March 16, 2011 at 11:46 pm

What a silly article. Of course economic growth causes inflation…in a fiat central-banking system. There is a trillion dollars of untapped base money that has been created in the banking system over the past two years.

As the economy recovers, uncertainty dissipates and demand for loans will increase, and the demand for money will go down. In other words, participants in the economy will want to borrow money and exchange it for goods and services. Even if the demand for loanable funds does not increase, the mere decrease in demand for money will cause inflation.

Michael March 17, 2011 at 7:15 am

Nick, aside from the provocative title how is the article silly? Frank has written volumes on how central banks cause inflation.

By the way when you say there are trillions untapped don’t forget to count the 55.6 trillion Yen (roughly $600 billion) the BOJ created in the last three days. I see a major financial crash coming.

Nick Bradley March 17, 2011 at 3:35 pm

I call it ‘silly’ because economic growth clearly causes inflation — or an increase in the rate of inflation — underneath a fiat central banking system. Demand for debt goes up, demand for money goes down.

I would even argue that economic growth caused inflation under the 19th Century gold standard. Why? Because the demand for money drops during a recovery.

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