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Source link: http://archive.mises.org/6319/do-central-banks-really-inflate-no-say-the-post-keynesians/

Do Central Banks Really Inflate? No, Say the Post-Keynesians

March 1, 2007 by

The Post-Keynesian school of thought maintains that, as opposed to the popular money multiplier model, central banks do not actively pursue monetary pumping to influence various economic data in the economy. Instead, they claim, the central bank is just aiming at keeping the money market well balanced. The key source of money expansion is commercial banks that, via an expansion in lending, set in motion an expansion in the money supply. FULL ARTICLE


adi March 5, 2007 at 5:51 am

Mike Sproul do not remember that Fed and Govt are same; it’s artificial to separate central bank and govt which control Fed through legislation. Legal aspects are not same as economic reality and this wont change just by using some weird terminology (like that money is backed by some other assets than money itself).

Of course Govt is wealthier if it’s given 100 new dollars which it may spend as it wish. Assets and liabilities view to central banks is false; no other corporation can write check on itself. Fed could increase its holding of Govt bonds to infinity and Govt could pay all interest payments because it will get them back from central bank.

Hyperinflations around the world are examples what happens if central banks try to monetize governments debts.

RBD theory of money is false in its all forms…

adi March 5, 2007 at 6:33 am

Mike Sproul, in your view nominal income should Granger-cause nominal money since you seem to be saying that money backed by assets should not increase price level. If nominal income is increasing then people should demand more money since they have now extra assets to back money.

But what if it’s found out that lagged money supply also Granger-causes nominal income?

Early statisticians did find out something like that even in 1920′s (they didnt have vector auto-regressive models or didnt know about the concept of Wiener-Granger causality).

I must apologize for my empirical questions, but they are usefull in certain sense.

I dont think that Austrian position is harmed if it’s noticed that stable relations between money, incomes and interest rates are not found. This just proves that economists have made errors when making theories which depend on these issues.

Mike Sproul March 5, 2007 at 11:09 am

Mike – Where does excess money reflux in today’s economy?

When the central bank believes there is excess money, it will sell bonds and retire the dollars received. Thus the dollar refluxes back to the central bank that issued it.

Mike Sproul March 5, 2007 at 11:12 am


So pretend the govt and the Fed are the same. The govt can write up a $100 bond and buy wheat with it, or it can print 100 green paper dollars and buy wheat with that. Any person or firm can do the same thing. If the issuer has enough assets to back the paper issued, the paper will hold its value. If not, the paper will lose value.

mikey March 5, 2007 at 12:34 pm

For Mike Sproul- do you believe capital equipment
is the kind of asset that can be used to back the issuance of money?

Alex MacMIllan March 5, 2007 at 5:06 pm


Yes, the gov selling a bond to a farmer for his produce is much different than the government selling newly created paper currency to the farmer for his produce. In the former case, interest is paid to the farmer on the bond, making the bond worth the present value of this interest ($100). In the second case of printing a new $100 bill and selling it to the farmer for his produce, there is no interest to be paid on this currency to anyone, and hence its present value is $0. The only reason the farmer will accept the $100 bill is because the government says the bill is worth $100 (This is the fraud. The game of musical chairs if you will.). The farmer accepts the $100 bill because he believes he can pass it on to others for goods and services. These other sellers of goods and services will in turn use it to buy other goods and services, etc.

Alex MacMillan March 5, 2007 at 5:12 pm


The $100 deposit received from a depositor is recorded as a liability on a bank’s balance sheet. Assuming the bank lends all the depositor’s funds out immediately upon their receipt, then “loans” is the asset that would increase by $100 on the bank’s balance sheet. Bank loans are the primary assets that back deposits. Whether the bank has difficulty in meeting withdrawals in not an asset insufficiency problem but a liquidity (or cash flow problem). Once more, fractional reserve banking does not involve fraud.

Alex MacMillan March 5, 2007 at 5:32 pm


You say Rothbard said that money cannot be created by a social compact or an edict of government. But that’s exactly how our fiat money is created. So, money can be created by an edict of government.

There is no question that fiat money involves a hidden tax imposed by the government, when the central bank issues paper currency or purchases government bonds. But fractional banking involves no tax (or “fraud” if you will) beyond that.

Peter March 5, 2007 at 6:16 pm

The $100 deposit received from a depositor is recorded as a liability on a bank’s balance sheet. Assuming the bank lends all the depositor’s funds out immediately upon their receipt, then “loans” is the asset that would increase by $100 on the bank’s balance sheet.

I know. And that’s precisely the problem! When people deposit money in demand accounts, they’re not making a loan! It shouldn’t show up on the balance sheet – the fact that it does is just an indication of criminality.

Björn Lundahl March 5, 2007 at 6:27 pm

Alex MacMillan

“You say Rothbard said that money cannot be created by a social compact or an edict of government. But that’s exactly how our fiat money is created. So, money can be created by an edict of government.

The regression theory proves that money must “originally” be developed out of a commodity with a previously existing purchasing power, such as gold and silver had, this during the period between a state of barter and a money economy.”

“There is no question that fiat money involves a hidden tax imposed by the government, when the central bank issues paper currency or purchases government bonds. But fractional banking involves no tax (or “fraud” if you will) beyond that.”

As banks by themselves increase the money supply, they too impose hidden “taxes” on the public and are fraudulent institutions as they cannot fulfil their obligations against all their depositors.

Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 5, 2007 at 6:34 pm

In other words, if there would be bank runs (which, naturally, would be extremely unlikely under 100% gold reserve money standard), the banks could meet any claims of the depositors.

Some consequences of not having a 100% gold reserve money standard:

• Panic of 1819 http://www.answers.com/topic/panic-of-1819

• Panic of 1837 http://www.answers.com/topic/panic-of-1837

• Panic of 1857 http://www.answers.com/topic/panic-of-1857

• Panic of 1873 http://www.answers.com/topic/panic-of-1873

• Panic of 1884 http://www.answers.com/topic/panic-of-1884

• Panic of 1890 http://www.answers.com/topic/panic-of-1890

• Panic of 1893 http://www.answers.com/topic/panic-of-1893

• Panic of 1896 http://www.answers.com/topic/panic-of-1896

• Panic of 1901 http://www.answers.com/topic/panic-of-1901

• Panic of 1907 http://www.answers.com/topic/panic-of-1907

Why should we have central banks and fractional reserve banks that mess things up in the first place? Why should we have business cycles and malinvestments just for the sake to please some perversive lust for power and fraudulent money? Do we really want to have malinvestments? Is unemployment that good? What is the justification?

Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 5, 2007 at 6:39 pm

Recessions and The Great Depression were caused by Government Interventions!

In a purely free market (without Government intervention), the rate of interest is determined by people’s “willingness to save and invest” (which is called people’s time preferences) for future use, as compared to how much they are “willingly to consume now”. If people change their “willingness to save” (time preferences) and want to save more, the additional savings will cause the rate of interest to fall (increased supply of savings), and businesses will borrow and invest these additional savings. When the Central Bank (for example The Federal Reserve) increases the money supply and expands bank credit (which Central Banks does everywhere and all the time and always “out of thin air”), it initially lowers the rate of interest and thereby misleads businessmen to act in a manner as if true savings have increased, which in turn leads businessmen to invests those supposed savings in capital goods. New projects that were not profitable before, will now suddenly with this lower interest rate, be profitable. While this process is working, the economy is in an inflationary boom phase (expansion). Capital goods such as stocks, real estate etc, will be more demanded and invested in, and prices of those will rise faster and more intensely in relation to consumption goods. As these supposed savings have worked their way through the economy, prices of goods, services and wages have generally increased to a height which prices for them would have not reached without these supposed savings.

As mentioned, people’s “willingness to save and invest” have not changed (people’s time preferences have not changed) for it was only the Central Bank that increased, out of thin air, additional “savings”. When supposed savings have worked their way through the economy and are received, finally, in increased wages, people still spend their real wages in the same manner as before. They save/ consume in real terms and in same proportion to each other, as before mentioned increase in supposed savings. Because of this, a lack of savings will occur and the rate of interest will rise. Projects that businessmen have invested in and that seemed to be profitable when the rate of interest was lowered are now revealed to be unprofitable. All those investments are revealed to be malinvestments. Businessmen will stop investing in those projects and lay off workers. Prices of capital goods, real estate, stocks etc, will fall sharply and relatively to the fall in prices of consumer goods. The economy is in a depression phase. When those investments are liquidated, the economy is adjusted to people’s “willingness to save and invest” and to consume. The economic structure corresponds to the ratio which people want to save and consume. The economy is now healthy again.

Now then, in the 1920s the Federal Reserve, in the US, increased the money supply and bank credit, which in the 30s resulted in The Great Depression. The same story goes with Japan during the 1980s, which during the 90s, resulted in a depression, go to; http://en.wikipedia.org/wiki/Japanese_asset_price_bubble

In Sweden we had banks lending out heavily during the late 80s, which also, led to a depression in the 90s.
All business cycles are caused by the same phenomenon. Economic crisis can occur because of other factors such as wars, boycotts, oil prices etc, but pure business cycles have in common the same cause.

I have tried, in a very few words and in a easy manner, to explain Ludwig von Mises business cycle theory, which is also called the Austrian theory of the business cycle. All faults are mine. Friedrich August von Hayek elaborated this theory and received in 1974 the Nobel Prize* for this. Go to;

If you want to know more about this theory, go to;

And to;

Björn Lundahl
Göteborg Sweden

* Information about the Nobel Prize in Economics, go to;

JIMB March 5, 2007 at 6:42 pm

Peter – read the post again: banknotes are not money, they are ** credit ** i.e. a right to redeem money. You don’t get banknotes today, you get a ‘statement’ where the electronic balance is redeemable in money … that’s credit. That’s why #2 is also correct.

Peter March 5, 2007 at 7:49 pm

banknotes are not money, they are ** credit ** i.e. a right to redeem money.

They’re money substitutes – substituting for the actual money, which is presumed to be stored someone on your behalf. This is not a credit transaction (in which the bank becomes owner of the money in return for a promise to pay it back later).

If you go out to a restaurant, someone might take your car to park it for you and give you a ticket to get it back later, right? Does the parking attendant own your car while you’re eating? If he was asked for a list of his assets and liabilities, would it make sense for your car and the claim ticket to be on the list? No, of course not. Same thing.

Mike Sproul March 5, 2007 at 10:06 pm


Capital equipment, or anything else of value can and has been used to back money. Note that if backing loses value, then the money will lose value too.

Mike Sproul March 5, 2007 at 10:18 pm


Bank notes can bear interest. The issuer just states that it can be redeemed for 1 ounce today, 1.10 oz. next year, etc. This was actually common in 19th century Britain. The difference you claim between money and bonds would then disappear. Also, you give government a power it doesn’t have: to give paper value just because it says so. Do you value Rwandan currency because Rwanda says so? No; you’d only value it if Rwanda could back that currency.

Björn Lundahl March 6, 2007 at 1:33 am

I quote from the book For a New Liberty, by Murray Rothbard:

9 Inflation and the Business Cycle: The Collapse of the Keynesian Paradigm

”By far the most important route for the Fed’s determining of total reserves is little known or understood by the public: the method of “open market purchases.” What this simply means is that the Federal Reserve Bank goes out into the open market and buys an asset. Strictly, it doesn’t matter what kind of an asset the Fed buys. It could, for example, be a pocket calculator for twenty dollars. Suppose that the Fed buys a pocket calculator from XYZ Electronics for twenty dollars. The Fed acquires a calculator; but the important point for our purposes is that XYZ Electronics acquires a check for twenty dollars from the Federal Reserve Bank. Now, the Fed is not open to checking accounts from private citizens, only from banks and the federal government itself. XYZ Electronics, therefore, can only do one thing with its twenty-dollar check: deposit it at its own bank, say the Acme Bank. At this point, another transaction takes place: XYZ gets an increase of twenty dollars in its checking account, in its “demand deposits.” In return, Acme Bank gets a check, made over to itself, from the Federal Reserve Bank.

Now, the first thing that has happened is that XYZ’s money stock has gone up by twenty dollars—its newly increased account at the Acme Bank—and nobody else’s money stock has changed at all. So, at the end of this initial phase—phase I—the money supply has increased by twenty dollars, the same amount as the Fed’s purchase of an asset.

“If one asks, where did the Fed get the twenty dollars to buy the calculator, then the answer is:
it created the twenty dollars out of thin air by simply writing out a check upon itself. No one, neither the Fed nor anyone else, had the twenty dollars before it was created in the process of the Fed’s expenditure”.

But this is not all. For now the Acme Bank, to its delight, finds it has a check on the Federal Reserve. It rushes to the Fed, deposits it, and acquires an increase of $20 in its reserves, that is, in its “demand deposits with the Fed.” Now that the banking system has an increase in $20, it can and does expand credit, that is, create more demand deposits in the form of loans to business (or to consumers or government), until the total increase in checkbook money is $120*. At the end of phase II, then, we have an increase of $20 in bank reserves generated by Fed purchase of a calculator for that amount, an increase in $120 in bank demand deposits, and an increase of $100 in bank loans to business or others. The total money supply has increased by $120, of which $100 was created by the banks in the course of lending out checkbook money to business, and $20 was created by the Fed in the course of buying the calculator.
In practice, of course, the Fed does not spend much of its time buying haphazard assets. Its purchases of assets are so huge in order to inflate the economy that it must settle on a regular, highly liquid asset. In practice, this means purchases of U.S. government bonds and other U.S. government securities. The U.S. government bond market is huge and highly liquid, and the Fed does not have to get into the political conflicts that would be involved in figuring out which private stocks or bonds to purchase. For the government, this process also has the happy consequence of helping to prop up the government security market, and keep up the price of government bonds”.

“So here we have, at long last, the key to the mystery of the modern inflationary process. It is a process of continually expanding the money supply through continuing Fed purchases of government securities on the open market. Let the Fed wish to increase the money supply by $6 billion, and it will purchase government securities on the open market to a total of $1 billion (if the money multiplier of demand deposits/reserves is 6:1) and the goal will be speedily accomplished. In fact, week after week, even as these lines are being read, the Fed goes into the open market in New York and purchases whatever amount of govern¬ment bonds it has decided upon, and thereby helps decide upon the amount of monetary inflation.”

* The reserve requirement set by the Federal Reserve on banks is exemplified by the ratio 6:1 (the required maximum multiple of deposit to reserves).


Björn Lundahl
Göteborg, Sweden

adi March 6, 2007 at 6:11 am

It seems that Mike Sproul is again spreading his herecies..

There should a Ministry of Truth (MiniTruth) which will dictate what kind of ideas are acceptable. Mike’s monetary theory dont belong to that group..

Alex MacMillan March 6, 2007 at 5:25 pm

Mike, I had problems with my wireless connection or I would have answered earlier.

The federal government purchases $100 of goods and services and sells $100 of new bonds to a domestic person or firm. The government sector has negative savings of $100 from this transaction, while the private sector has positive saving of $100. There is therefore no net saving (or therefore, no net spending) effect from this transaction and no inflationary effect.

When the federal government prints $100 of new currency and spends it on goods and services, there again is $100 negative government savings (positive spending) of $100 from this transaction, but, unlike the previous case, no added saving takes place in the private sector as a result of this transaction. As a result, total spending has increased.

Alex MacMillan March 6, 2007 at 5:40 pm


Yes, that’s how the modern fiat money supply expands. I don’t think there’s any dispute about that.

I’m currently doing some thinking about a situation of 100% gold reserve backed money. Obviously all prices would be relative to gold as the effective numeraire. We would still have loan companies, who acquire funds (deposit-like liabilities) from the public and re-lend these funds out at a higher interest rate than the rate on deposits.

I don’t see a problem with fractional reserve banking (any fraud elements, etc. as I’ve argued here), but for some reason, some people don’t like it because the public doesn’t understand it. At least, that’s the argument against it that I think I’m reading. Especially since fractional reserve banking has no effect on the actual money supply, in the sense that the existing central bank (with fiat money) has no difficulty determining any money supply it wishes regardless whether there is fractional reserve banking or not.

I understand that 100% gold-backed money would take money supply control out of the hands of the central bank (we wouldn’t need a central bank), but instead the money supply would then be determined by the supply of gold. I’m not sure whether the amount of money determined this way would be efficient. But, I’m going to do some reading on it, unless someone here has a simple explanation as to why the quantity of money determined by the supply of gold would be a good idea.

Björn Lundahl March 6, 2007 at 7:09 pm

Alex MacMillan

I can not understand the reason for having a difficulty in understanding why fractional reserve banking is based on fraud. It is quite obvious. As banks must redeem, on demand, any cash claims of the depositors, they can not do that because they have, to a great extent, lent them to other people and businesses. It does not matter at all how large assets the banks have as they can not still, on demand, meet all the depositors’ rightful claims. That is also why it is called “fractional” reserve banking.

Haven’t you heard of bank runs? History is full of them. Why bank runs if banks can meet all the depositors’ rightful claims? Or do you not understand that when you make a deposit and the bank makes a loan with the same money, you and the borrower have claims on the same money? So what is the problem?

A true monetary loan is an exchange of present goods for future goods, whereby “the future” is defined as an agreed upon time between the parties when the loan expires. That is, also, the kind of loans the banks should instead focus on.

If, for example, a company (or a bank) issues a bond (IOU) and you purchase it, you and the issuer do not at the same time have claims, on
demand, of the same money.

“I understand that 100% gold-backed money would take money supply control out of the hands of the central bank (we wouldn’t need a central bank), but instead the money supply would then be determined by the supply of gold. I’m not sure whether the amount of money determined this way would be efficient.”

You can not print gold. So the supply is severely limited. You would not have any business cycle, malinvestments and no inflation. That is quite efficient.

Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 6, 2007 at 7:19 pm

The purchasing power of money, the gold standard and fiat money

If the gold supply will, on the average, increase as much as total output in a 100% gold reserve money standard or not, is not a praxeological fact but a speculation. It might be a relatively good speculation, but it still is a speculation. Technological advancements that favour increased gold supplies have, of course, been going on since the beginning of the industrial revolution.

Historically, prices have on the average fallen when economies were on a gold standard and those economies were not even based on a 100% gold reserve money standard.

Deflation defined as increases of the purchasing power of money is not, at all, harmful for the society and the economy.

Rothbard saw falling prices as a natural condition of a market economy, For a New Liberty:

“Thus, falling prices are apparently the normal functioning of a growing market economy.”

“And, indeed, if we look at the world past and present, we find that the money supply has been going up at a rapid pace. It rose in the nineteenth century, too, but at a much slower pace, far slower than the increase of goods and services; but, since World War II, the increase in the money supply—both here and abroad—has been much faster than in the supply of goods. Hence, inflation.”


Now when another masterpiece has been added to the great family of superb books in Austrian economics with the title “Money, Bank Credit, and Economic Cycles” written by Jesús Huerta De Soto, I am pleased to quote the author’s comment about the purchasing power of money under 100% gold reserve money standard page 776:

“Consequently one aspect we can foresee is that in the proposed model, nominal interest rates would reach historically low level. Indeed, if on average we can predict an increase in productivity of around 3 percent and growth in the world’s gold reserve of 1 percent each year, there would be slight annual “deflation” of approximately 2 percent.”

And on page 777:

“The model of slight, gradual, and continues “deflation” which would appear in a system that rests on a pure gold standard and a 100-percent reserve requirement would not only not prevent sustained, harmonious economic development, but would actively foster it.”

I quote from the book “Democracy The God That Failed”, by Hans-Hermann Hoppe, page 58:

“During the monarchical age with commodity money largely outside of government control, the “level” of prices had generally fallen and the purchasing power of money increased, except during times of war or new gold discoveries. Various prices indices for Britain, for instance, indicate that prices were substantially lower in 1760 than they had been hundred years earlier, and in 1860 they were lower than they had been in 1760. Connected by an international gold standard, the development in other countries was similar. In sharp contrast, during the democratic-republican age, with the world financial center shifted from Britain to the U.S. and the latter in the role of international monetary trend setter, a very different pattern emerged. Before World War I, the U.S. index of wholesale commodity prices had fallen from 125 shortly after the end of the War between the States, in 1868, to below 80 in 1914. It was then lower than it had been in 1800. In contrast, shortly after World War I, in 1921, the U.S. wholesale commodity price index stood at 113. After World War II, in 1948, it had risen to 185. In 1971 it was 255, by 1981 it reached 658 and in 1991 it was near 1,000. During only two decades of irredeemable fiat money, the consumer price index in the U.S. rose from 40 in 1971 to 136 in 1991, in the United Kingdom it climbed from 24 to 157, in France from 30 to 137, and in Germany from 56 to 116.

Similarly, during more than seventy years, from 1845 until the end of World War I in 1918, the British money supply had increased about six-fold. In distinct contrast, during the seventy-three years from 1918 until 1991, the U.S. money supply increased more than sixty-four-fold.”

Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 6, 2007 at 7:25 pm

Increase of gold supplies does not either cause business cycles in a 100% gold reserve money standard.

America’s Great Depression:

“The potential range of such cyclical effects in practice, of course, is severely limited: the gold supply is limited by the fortunes of gold mining, and only a fraction of new gold enters the loan market before influencing prices and wage rates.”

Read the rest “Gold Changes and the Cycle”:


Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 7, 2007 at 2:16 am

What Has Government Done to Our Money? By Murray Rothbard:

“Defenders of banks reply as follows: the banks are simply functioning like other businesses—they take risks. Admittedly, if all the depositors presented their claims, the banks would be bankrupt, since outstanding receipts exceed gold in the vaults. But, banks simply take the chance—usually justified—that not everyone will ask for his gold*. The great difference, however, between the “fractional reserve” bank and all other business is this: other businessmen use their own or borrowed capital in ventures, and if they borrow credit, they promise to pay at a future date, taking care to have enough money at hand on that date to meet their obligation. If Smith borrows 100 gold ounces for a year, he will arrange to have 100 gold ounces available on that future date. But the bank isn’t borrowing from its depositors; it doesn’t pledge to pay back gold at a certain date in the future. Instead, it pledges to pay the receipt in gold at any time, on demand. In short, the bank note or deposit is not an IOU, or debt; it is a warehouse receipt for other people’s property. Further, when a businessman borrows or lends money, he does not add to the money supply. The loaned funds are saved funds, part of the existing money supply being transferred from saver to borrower. Bank issues, on the other hand, artificially increase the money supply since pseudo-receipts are injected into the market.

A bank, then, is not taking the usual business risk. It does not, like all businessmen, arrange the time pattern of its assets proportionately to the time pattern of liabilities, i.e., see to it that it will have enough money, on due dates, to pay its bills. Instead, most of its liabilities are instantaneous, but its assets are not.

The bank creates new money out of thin air, and does not, like everyone else, have to acquire money by producing and selling its services. In short, the bank is already and at all times bankrupt; but its bankruptcy is only revealed when customers get suspicious and precipitate “bank runs.” No other business experiences a phenomenon like a “run.” No other business can be plunged into bankruptcy overnight simply because its customers decide to repossess their own property. No other business creates fictitious new money, which will evaporate when truly gauged.

The dire economic effects of fractional bank money will be explored in the next chapter. Here we conclude that, morally, such banking would have no more right to exist in a truly free market than any other form of implicit theft. It is true that the note or deposit does not actually say on its face that the warehouse guarantees to keep a full backing of gold on hand at all times. But the bank does promise to redeem on demand, and so when it issues any fake receipts, it is already committing fraud, since it immediately becomes impossible for the bank to keep its pledge and redeem all of its notes and deposits. [15] Fraud, therefore, is immediately being committed when the act of issuing pseudo-receipts takes place. Which particular receipts are fraudulent can only be discovered after a run on the bank has occurred (since all the receipts look alike), and the late coming claimants are left high and dry. [16]”


Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 7, 2007 at 2:33 am

*Above reasoning done by Murray Rothbard refers to a fractional reserve system working under a gold standard. Implicitly it refers to any fractional reserve system such as a “fiat money standard”.

Björn Lundahl

mike sproul March 7, 2007 at 11:11 am


It’s not clear who you say is saving or dis-saving or why, but I assume you mean that when the govt buys wheat with a $100 bond, then the govt has dis-saved $100 because it issued the bond, while the farmer has saved $100 because he bought the bond (with his wheat). There is no difference between this and a case where the govt prints $100 and hands them to the farmer. The govt dis-saves $100 because of the dollars, while the farmer, assuming he holds the $100 just like he held the bond, is saving $100. (You never addressed my point that paper money can bear interest, just like bonds, so paper money can be “saved” just like bonds.) Even if the dollars bore no interest, and the farmer spent them, that just transfers his saving to someone else, which is exactly what would have happened if the farmer has transferred the bond to someone else.
You’ve also never addressed my claim that the amount of spending is irrelevant. It’s backing that matters. As long as every new dollar is adequately backed, the dollar will hold its value as new dollars are issued. That’s clearly true of every financial security, but you deny that it’s true of a certain financial security that happens to have the label “money” pinned on it.

adi March 7, 2007 at 1:19 pm

Mike Sproul is right that it’s the backing of money substitutes which matters: if bank do not have 100% commodity reserves against money substitutes it has issued, it’s notes are valued below par.

Bank cannot sell some IOU’s for commodity money and destroy these paper notes when customer comes asking for the real thing because there will a deflationary spiral. These IOU’s wont be worth as much as the number printed on them.

We remember from historical episodes that there will be a flight to quality papers when some economic disaster occurs.

And Mike Sproul should remember that RBD regime is very unstable since only one discount rate brings stability. Otherwise there will be a Wicksellian “cumulative process”.

adi March 7, 2007 at 1:42 pm

Some Austro-Swedish idea’s about inflation:

cumulative process

Mike Sproul March 7, 2007 at 10:20 pm


Wicksell’s cumulative process assumes banks lend at, for example, below-market rates. That assumes foolish behavior on the part of the bank. Realistically, a bank would only lend at the market rate, and as long as it does, new money lent will always be matched by new IOU’s acquired. Besides, if the central bank only buys and sells bonds at auction, it can’t help but acquire equal-valued assets every time it issues a new dollar.

Alex MacMillan March 8, 2007 at 8:58 am


Yes, I’ve heard of bank failures, just as I’ve heard of other business failures. But I wouldn’t outlaw business just because some fail.

Let’s suppose I start a loan business. I raise funds for the most part by issuing interest paying debentures. Some debentures are redeemable on specific maturity dates, and some are redeemable on demand for gold. The ones that are redeemable on demand, of course, pay less interest. Also, the debentures that are redeemable on demand are transferrable. Can you see any fraud in this business activity?

Alex MacMillan March 8, 2007 at 9:11 am


Mike, when the farmer trades his wheat for government bonds, the farmer is saving (not spending). When the farmer accepts money for the wheat, the farmer spends the money (and it doesn’t matter if the money is interest bearing). If the farmer decides to not spend the money, then you are assuming an increase in the demand for money occurs that is exactly equal to the increase in money supply ($100 in this case). But the assumption that when the government issues more money it is always accompanied by an equal increase in money demand is totally unrealistic. The argument is that inflation occurs when the money supply is increased relative to money demand. So to illustrate by example why this occurs one must assume that an increase in the money supply ($100 in my example) takes place in the face of an unchanged demand for money, otherwise you are refusing to deal with the issue: How an increase in money (relative to demand) causes inflation.

Alex MacMillan March 8, 2007 at 10:32 am


I am going to read that Rothbard money article you referred me to. Thanks.

Björn Lundahl March 8, 2007 at 1:46 pm

Alex MacMillan


My pleasure!

Best regards


mike sproul March 8, 2007 at 5:07 pm


You are assuming that the $100 was issued when there was no demand for it. As long as the central bank only issues a dollar to people who offer a dollar’s worth of stuff for it, dollars will only be issued when they are wanted. You are saying that if the government issues a white piece of paper called a bond, and buys goods with it, then there will be no inflation, but if it issues green pieces of paper, there will be inflation.
Part of the problem is that you use supply and demand to analyze money. Supply and demand is a model for consumable goods–not for financial securities that can be created and destroyed at the flip of a computer chip. If I want to explain why the value of GM stock is $60 per share, I explain it by way of GM’s assets and liabilities–not by the supply and demand for GM stock. Money is valued in the same way.

Björn Lundahl March 8, 2007 at 5:23 pm

Alex MacMillan

“Let’s suppose I start a loan business. I raise funds for the most part by issuing interest paying debentures. Some debentures are redeemable on specific maturity dates, and some are redeemable on demand for gold. The ones that are redeemable on demand, of course, pay less interest. Also, the debentures that are redeemable on demand are transferrable. Can you see any fraud in this business activity?”

The “debentures” that are redeemable on demand are not loans as they are redeemable on demand and lack maturity dates. They also pay interest. Logically they are totally a contradiction in terms and should therefore be legally invalid.

Björn Lundahl
Göteborg, Sweden

Alex MacMillan March 8, 2007 at 6:48 pm


If I borrow money from you and pay you interest (or not) and agree that I shall repay you on demand, why should that be illegal? Do you believe all demand loans should be illegal? If so, why?

I have read the first part of that article of Rothbard, enjoying it so far. Shall try and finish it tonight.

Alex MacMillan March 8, 2007 at 6:57 pm


I can’t follow your logic. First of all, supply and demand analysis is valid for assets as it is for goods and services. Your theory that demand and supply should only be used in the context of consumable goods is a new one on me.

The whole point of money and inflation is that additional money is put into the economy when there is no demand for it. Hence people spend it rather than save it. If the government buys $100 of sgoods from us, almost always, we don’t want the cash; we want the goods and services that we can acquire by soon spending that cash.

greg March 8, 2007 at 7:37 pm

“You are saying that if the government issues a white piece of paper called a bond, and buys goods with it, then there will be no inflation,…”

Gov bonds do not have the liquidity of money. That is, until the Fed buys them. {laughs}

Mike Sproul March 8, 2007 at 11:29 pm


Supply and demand works for goods like silver, but not for pieces of paper with “IOU 1 oz. of silver” printed on them. If one of those IOU’s ever sold for 1.01 oz, demand for them would fall to zero while supply would be infinite. If they sold for .99 oz, demand would be infinite while supply would be zero. The only correct way to draw supply and demand curves for IOU’s is to draw them both az horizontal lines with a height of 1.00 oz., which of course makes them meaningless. This is why econ textbooks always put consumable goods on the axes of supply and demand curves. (Except for macro books, but that can’t be called economics.)

Conventional open market operations do not put money into the economy unless there is a demand for it, since the Fed only issues dollars to people who offer a dollar’s worth of bonds in exchange. Of course this is the point we’ve been going back and forth on. If you don’t mind reading the long version of my argument, google “Sproul fiat money” for a paper of mine entitled “There’s No Such Thing as Fiat Money”

Björn Lundahl March 9, 2007 at 1:48 am

Alex MacMillan

“If I borrow money from you and pay you interest (or not) and agree that I shall repay you on demand, why should that be illegal? Do you believe all demand loans should be illegal? If so, why?”

I might claim my money the next second, minute, day, week, month, year etc.

All demand “loans” should be illegal as they are demand deposits, this because they are redeemable on demand and whenever the depositors claims their monies. The “borrowers” would not be able to use them as they must have the deposits available for any rightful claims of the depositors. This is also why they should not pay any interest and are a contradiction in terms.

A true loan has a maturity date.

If we fool each other greatly enough we shall pay through experiencing another great depression.

Björn Lundahl
Göteborg, Sweden

Alex MacMillan March 9, 2007 at 10:50 am


I’ve read the Rothbard article. It was most useful in defining such jargon as “long and short orders of production”, with which I have been somewhat confused when I have read such terms at this site. I have a personal distaste for any jargon when simpler English will do the trick.

I immediately agreed with a great deal of the argument presented in the article, but I need to go over it again and write it down in my simple English. When I do, I’ll perhaps ask you some further questions.

However, the argument that when someone borrows money on demand the borrower should (in some moral or legal sense) be required to hold gold (or some other commodity acceptable to the lender) exactly equal to the amount of the demand loan is still perplexing to me. Of course, I see that the result of such requirement would mean that such demand loans would not exist because there would be no incentive to the borrower. The borrower has to pay demand loan interest but cannot earn a rate of return with the funds acquired.

The theory that expansions in the money supply cause business cycles while expansions in gold (under a 100% reserve-gold standard) would not, I must seriously think about.

Anyway, what if there were a legal requirement for the central bank to adopt a zero inflation target, with a relatively tight short run + or – operating zone around zero? (I realize that you don’t want a central bank at all, but leave that aside for the moment.) Whether there is “fradulent” fractional reserve banking or not is irrelevant to the ability of the central bank to achieve this target. In Canada, for example, there is fractional reserve banking with no reserve requirements at all, and the Bank of Canada has a 2% inflation target with a short run range of 1% to 3%, which the Bank always achieves. As a consequence, no one is fooled about inflation. There is also discussion underway to perhaps make the inflation target 0%. This means that, at all times, people understand the real wage rate and the real rate of interest. It strikes me that Rothbard’s argument for injections of money to cause business cycles requires inflation fooling with regard to interest rates and wage rates. How would business cycles ensue in a world of perfectly understood zero inflation, according to Rothbard?

mikey March 9, 2007 at 12:57 pm

Mike Sproul- I don’t see how capital equipment can be used as a basis for issuing money, as you claim.For when the holders of these notes came to claim the equipment, I would have lost the means of producing consumer goods, making my business,
and all my other outstanding notes(based on consumer goods) worthless.

Björn Lundahl March 9, 2007 at 2:03 pm

Alex MacMillan

“How would business cycles ensue in a world of perfectly understood zero inflation, according to Rothbard?”

During the 20s the purchasing power of money was relatively unchanged, but the money supply was still increased and brought about a depression.


What bring about the business cycle are not changes in the purchasing power of money but the expansion of bank credit (increases of the money supply).

Expansion of the money supply through bank credit does not reflect “consumer’s willingness to invest and save”, but, still, this expansion of bank credit initially lowers the rate of interest as if consumers have saved more. This process brings about a business cycle.

Always remember that the greatest proportions of bank credit are loans that are borrowed to businesses and do not reflect consumers saving ratios. Consumers spend a much greater proportion of their incomes on consumer goods.

Please read my above comment “Recessions and The Great Depression were caused by Government Interventions!”

Please read also “Bank Credit and the Business Cycle”, (chapter from the book “For a New Liberty”, by Murray Rothbard):


Björn Lundahl
Göteborg, Sweden

Mike Sproul March 9, 2007 at 8:07 pm


Certainly, if the capital goods lose their value, then the money they back will lose its value too. That’s why it’s not common. But of course a bank could issue $40,000, use it to buy a tractor, use the tractor to earn (say) $80,000 over 10 years, and have more than enough assets to back the $40,000, even if the tractor depreciated to zero.

Björn Lundahl March 10, 2007 at 5:39 am

That central banks have “inflation targets” or the objectives of keeping inflation (inflation defined as decreases of the purchasing power of money) around 2% yearly are quite common.

I do believe that the origin of these policies can be derived from the influence of Milton Friedman during the 70s and 80s. The means and objectives of the central banks are not exactly what Friedman once proposed as he wanted zero inflations and monetary rules, but they are similar.

It is probably true that central banks can meet those objectives.

Sveriges Riksbank (The Swedish Central Bank):

“The objective of monetary policy
According to the Sveriges Riksbank Act, the objective of monetary policy is to “maintain price stability”. The Riksbank has interpreted this objective to mean a low, stable rate of inflation.
More precisely, the Riksbank’s objective is to keep inflation around 2 per cent per year, as measured by the annual change in the consumer price index (CPI). There is a tolerance range of plus/minus 1 percentage point around this target. At the same time, the range is an expression of the Riksbank’s ambition to limit such deviations. In order to keep inflation around 2 per cent the Riksbank adjusts its key interest rate, the repo rate.”


ECB (European Central Bank)


The primary objective of the ECB, and the wider ESCB, is “to maintain price stability” within the euro area, i.e., to keep inflation low. The present target is to keep inflation below, but close to, 2%.”


Reserve Bank of New Zeeland:

“The Reserve Bank’s primary function, as defined by the Reserve Bank of New Zealand Act 1989 is to provide “stability in the general level of prices.””

“The Reserve Bank Act requires that price stability be defined in a specific and public contract, negotiated between the Government and the Reserve Bank. This is called the Policy Targets Agreement (PTA). The current PTA signed in September 2002, defines price stability as annual increases in the Consumers Price Index (CPI) of between 1 and 3 per cent on average over the medium term. Previously, price stability was deemed to be 0 to 3 per cent inflation over 12 months.”


Reserve Bank of Australia:

“In practice the Reserve Bank concentrates on the first objective, that is to control inflation through monetary policy. (See also open market operation.) The current objective is a policy of inflation targeting aimed at maintaining the annual inflation rate at between “2-3 per cent, on average, over the cycle”. This target was first set in 1993 by the then Reserve Bank Governor Bernie Fraser and was then formalised in 1996 by the Treasurer Peter Costello and incoming Reserve Bank Governor Ian Mcfarlane.”


The Swiss National Bank (SNB):

“The National Bank equates price stability with a rise in the national consumer price index (CPI) of less than 2% per annum.”


As mentioned those policies do not end the business cycle once and for all and I do not believe that anyone expects that, not even central bankers.

For an example: New Zeeland which has adopted this policy of targeting inflation since 1989 has experienced recessions:

“In recent years, New Zealand has been perceived as a vigorous economy and attracted international attention. After the economic restructuring of the 1980s, the New Zealand economy sank into a recession starting with the sharemarket crash in October 1987. The recession deepened in the early 1990s when unemployment topped 10%. However in 1993 the economy rebounded smartly and apart from a smaller recession in the late 1990s, New Zealand enjoyed a substantial economic boom up until 2005. New Zealand’s unemployment rate is now the second lowest of the 27 OECD nations with comparable data.”

Björn Lundahl
Göteborg, Sweden

Björn Lundahl March 10, 2007 at 5:56 am

Above information of New Zeeland’s recessions I got from:


Björn Lundahl

Björn Lundahl March 10, 2007 at 6:29 am

I think the following will illustrate Rothbard’s thoughts about “constant increases of the money supply”, from the book America’s Great Depression:

“Since it clearly takes very little time for the new money to filter down from business to factors of production, why don’t all booms come quickly to an end? The reason is that the banks come to the rescue. Seeing factors bid away from them by consumer goods industries, finding their costs rising and themselves short of funds, the borrowing firms turn once again to the banks. If the banks expand credit further, they can again keep the borrowers afloat. The new money again pours into business, and they can again bid factors away from the consumer goods industries. In short, continually expanded bank credit can keep the borrowers one step ahead of consumer retribution.”


Björn Lundahl
Göteborg, Sweden

Alex MacMillan March 11, 2007 at 10:12 am


Have downloaded Rothbard’s book and am going through it. I shall digest it and summarize the arguments for myself. I’m sure I’ll get a chance to let you know what I think later.


Björn Lundahl March 11, 2007 at 11:20 am


Yes, we will probably “meet again”.



Björn Lundahl March 11, 2007 at 2:23 pm


Well, I am back again! It did not take me long (laugh)!

I still would like to mention this as it might help you to receive some insight and you do not need to reply.

If the government printed dollar bills and gave them in cash to each citizen, that wouldn’t either cause a business cycle as it would not distort the market in the same way as bank credit expansion. Bank credit expansion initially lowers the rate of interest, or alternatively, makes it lower than it otherwise would be which induces businessmen to act in a manner as if savings have increased. By printing of dollar bills and handing them over in cash to each citizen, does not produce such a result as consumers voluntarily use this monies in the way they want, and the economy responds to their preferences accordingly. The economy need not, therefore, at a later date be exposed of consumer retribution, or at least not in a 100% fiat money reserve standard. Such a standard would also be, logically, the only one that could be acceptable to analyze in an example like this, as we wouldn’t want any influence of fractional reserve banking. What we instead want to analyze is only the impact of printing of dollar bills in regard to the business cycle.

Apart from fraud and other distortions, the printing of dollar bills would be similar with respect to the business cycle as a newly arrived inflow of gold would be.

I would also like to additionally mention why expectations of “zero inflation” or unchanged purchasing power of money does not at least prevent the occurrence of the business cycle, as increases of bank credit gives the borrowers (businessmen) a command over economic recourses and thereby influence the production of capital goods.

Alternatively, if you would have a printing press and printed dollar bills, it surely would give you a command over economic recourses and this regardless of what people expects.


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