1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/9246/inflation-targeting-more-monetary-manipulation-and-unending-inflation/

Inflation-Targeting — More Monetary Manipulation and Unending Inflation

January 16, 2009 by

The monetary central planners never stop thinking of new gimmics to manipulate the money supply, price inflation and interest rates.

Ben Bernanke has long been an advocate of what is called “Inflation-Targeting.” The Fed would explicitly set a desired rate of price inflation and manipulate the money supply to hit the target.

See my new piece, “Inflation Targeting by the Fed Means Unending Inflation as Far as the Eye Can See.”

The usual number suggested is a rate of 2 percent price inflation has measured by the Consumer Price Index (CPI). What this means is that the Fed would officially and publicly set a desired rate of continuous currency depreciation.

Even a 2 percent rate of price inflation as measure by the CPI means that in only 20 years prices will have gone up in general by 51 percent. And at the same time, the purchasing power of the dollar will have declined by 43 percent during these two decades.

Why build in a desire rate of price inflation? To permanently prevent any price deflation from every occurring. That is, the Fed Chairman defines any decline in prices as a “bad” that must be prevented at all costs.

This means, of course, that the American citizenry would be prevented from any real increase in purchasing power resulting from productivity and output increases that would normally register as more and better goods available as lower prices.

This is merely a variation on the same theme that Hayek and Mises criticized in the 1920s and 1930s, when the monetary central planners of that time tried to manipulate the money supply to stabilze the “price level.”

Or course, Bernanke and others like him do not want the central bank to simply go on some type of price inflation-targeted “automatic pilot.” Oh, no, Bernanke wants the Fed to retain the same type of discretionary policy options to manipulate inflation rates and interest rates that have helped generated the current economic crisis.

As long as there is paper money, central banks, and monetary central planners we will never be free of the plague of booms and busts, and the distorting harm that always come in their wake.

Richard Ebeling.


Jurilip January 16, 2009 at 11:15 am

There’s a math error in this post. If inflation runs 2% annually for 20 years, the total is 1.02^20, or 49%, not the 51% stated by the article.

Jeff Williams January 16, 2009 at 11:29 am

Another reason that governments like continuous inflation is that it boosts their capital gains tax revenues. They also believe that it spurs economic activity in general. Continuous inflation, and the expectation of it, was a main driver of the housing bubble, which was a bonanza for government.

Governments seldom seem to reflect on the ethical questions having to do with a policy of continous currency debasement. They believe that such a policy boosts government revenues–and that is all they care about. They do not care that it systematically robs savers.

Because inflation stayed fairly well within bounds from the 1980′s until 2007, central bankers were congratulating themselves on their success with a policy that helped fill government coffers.

We are now, however, in a chaotic world that this immoral policy has brought about.

prettyskin January 16, 2009 at 11:47 am

Why did the state liberated the the two largest banks (Citigroup & BofA) of their bad assets?

Why should the federal reserve continue to exist?

Why is there a need to nationalized America?

Why are a few men hold in their hands the faith of nation’s economy without regards to its people?

Why is the new marketplace, Iraq, is being written off as a national failure while a few men are capitalizing handsomely?

Why do we have two presidents at the same time?

Why is the president-elect, who has no power, not even in the senate, is calling the shots by shoring up more money to the banks way before January. 20th 2009?

Where shall I lay my weary soul, tell me how shall I be free from the state’s madness?

Steve Hogan January 16, 2009 at 11:53 am

One only needs to analyze the incentives inherent with monetary manipulation to understand why central planners like the current set up. Who benefits most from inflation? Borrowers. Who is by far the largest borrower? Why, it’s none other than Uncle Sam. He gets to pay his bills is depreciating currency.

The other beneficiaries? The banks. They get the funny money first, before rising prices take hold. And they get to loan out that money at interest without having to keep 100% reserves on hand. It’s a sweet deal for them. For us, not so much.

Inquisitor January 16, 2009 at 12:06 pm

49% still isn’t much of a consolation. :P

Justin January 16, 2009 at 12:52 pm

They can inflation-target all they want. But someone actually has to purchase US debt. If someone holding on to older issues of US debt realizes that the Fed intends to “target” a devaluation of their debt, why not just sell your debt sooner rather than later? If that debt holder is larger enough, they can move the market quickly in their favor.

Where is George Soros when you need him?

Darius January 16, 2009 at 1:13 pm

As pointed above, the increase should be 49%; and the fall in the purchasing power – not 43%, but 33% (1-1/1,49).

And the thought of regulating the prices in such a way isn’t adequate at all, because, as mentioned in this article, if the production, due to capital accumulation or technological advances, starts to increase, then the natural tendency would lead to a fall in prices – and yet the Fed would speed up the money supply to stay at 2% – thus, in reality, the natural price rise would be higher, accounting to the point, at which we would have been at the natural state. A reverse situation would be more complex, as in a natural state a high price is, probably, unattainable.

Dick Fox January 16, 2009 at 2:07 pm

Ebling’s arguments are not just against a 2% inflation target but against a floating currency in general. Note his statement: If these rates of monetary expansion were not reversed, they would foretell a likely dramatic increase in price inflation in 2009 and 2010, and beyond. But virtually all macroeconomic schools of thought agree that there is no rigid and mechanically predictable relationship between the rate of monetary expansion and the general rise in prices over any given period of time.

Because of this the FED is constantly increasing or decreasing the money supply without knowing why, nor do they know if they are doing the right thing even by their own theories. And with a floating currency this is true whether there is an inflation target or not. The very presence of a floating currency is destabilizing monetarily.

Mike Sproul January 16, 2009 at 3:42 pm

The average American carries about $75 in paper money with him. At a 2% inflation rate, this will cost him $1.50 per year, in exchange for the convenience of being able to trade with paper money. Small wonder that the public is not greatly exercised about inflation.

Bruce Koerber January 16, 2009 at 5:27 pm

Before hyperinflation the dollar still has value. But the distortions in the market caused by the counterfeiting of the legal tender are still very disruptive.

Since 2000 we have seen the inflation bubble move from NASDAQ to housing and now it is attached to the dollar. When the dollar bubble bursts the age of hyperinflation will be upon us!

bearing01 January 16, 2009 at 5:48 pm

Who here thinks the true unfudged CPI numbers by end of 2009 will show 2% price inflation or less? From the articles I have read the true CPI (without hedonics or substitution) is somewhere around 9% annually.

Does anyone here believe any of the facts that the Federal Reserve or US gov’t publishes? Maybe they’ll finally start to include the cost of energy in the CPI equation to some how reduce the number. That will help them report a better GDP number as well.

newson January 16, 2009 at 10:09 pm

dick fox says:
“Because of this the FED is constantly increasing or decreasing the money supply…”

the fed decreasing money supply? look at the ratio of fed purchases vs. sales of treasury paper. the fed is essentially a constant booster of the money supply, only the rate varies. any deflationary tendency would come from the commercial banking sector (and these days is met by stiff fed countermeasures).

Jeremy January 17, 2009 at 12:33 am

Mike – so given your view, we shouldn’t worry about the malinvestments that occur thanks to inflation of the money supply? Or the inevitable recession? Or the almost inevitable expansion of government power when the recession hits?

And we shouldn’t worry about people on fixed incomes, when inflation is calculated much differently than how the US government calculated it 20-30 years ago?

The US has $10 Trillion plus in debt – somebody is holding those dollars and losing a percentage of their value every day. Those who don’t benefit from the inflation (by receiving the money early on in the process), which is the majority, are hurt even more by the inevitable recession and expansion of government power.

DS January 17, 2009 at 8:55 am

There are so many things wrong with “inflation targeting” – a partial list of falacies and wrong-headed assumptions:

1) Problem number one: The definition of “inflation” used is typically percentage increase the CPI or other government administered statistical price index, not an increase in the money supply. Inflation is an increase in the artifically manipulated money supply, one not anchored to a physical quantity but created by fiat.
2) This assumes that it is a proper role of a central bank (and assumes that a central bank should even exist in the first place) to manipulate the prices and financing terms in the economy for a desired end. This also assumes that said “desired end” is good for all citizens and is a reflection of their will (these are the naieve, high school civics class goals of a free society governed by a democratically elected government anyway). Of course, there is no “desired end” that could possibly meet any of these criteria. It is simply a process of selecting winners and losers.
3) This also assumes that a central bank has the ability to manipulate prices in the way that it desires, predictably and precisely, throughout time. It assumes that it has a functioning model of the economy – including being able to predict its feedback effects on the economy – so that it can know what measures to take and can predict their outcome.

This is certainly not the case. Central banks manipulate the supply of base money to the banking system – the effects on prices, interest rates and the economy can vary greatly and are unpredictable. The vision of the Fed sitting atop the economy precisely manipulating the money supply to make prices and economic activity go up and down is an incorrect one. The Fed sits atop the banking system creating tiny changes in the base money supply available to banks that are then multiplied tens and hundreds of times throughout the financial system and in the real economy. This all happens over periods of years and even decades – a dollar of base money created today can result in money created in the financial system years from now. The Fed chief is not a puppet master or supernatural being diabolically moving chess pieces around the economy, he is doctor Frankenstein who has little idea what his monster will do once he has created it.
4) Even if all of those fallacies were magically wisked away, the Fed has an information problem and a time lag problem. It cannot measure actual economic activity and prices, it can only measure their effects through government statistics like CPI, GDP and the Unemployment rate. It cannot measure things like “demand” which is a loose philosphical construct not a thing to be measured. It can only measure what has already happened, with a lag. Further, it cannot predict the future better than anybody else, so it can only decide to change its manipulation in the money supply based on what has already happened. It cannot even measure what its own past affects have been because the act with a log of varying length, sometimes years and decades.
5) Even if information about past economic activity were sufficient to predict the future, the government statistics used to measure the economy are highly suspect, none more than the CPI. The CPI and other related measures of price inflation are also used to manipulate other government measures.

The changes, seasonal adjustments, hedonics, constant manipulations and fudging of the inflation statistics, unemployment, GDP and the like have been well documented. At the very least today’s government statistics cannot be compared to previous time periods, at worst they are blatant lies.

But even more fundamentally, the CPI and GDP are misguided measures even if they were compiled by objective, credible organizations and were measured consistently over time.

The CPI tries to measure the prices of a typical basket of goods and services over time. But there is no typical basket of goods. If you have ever tried to calculate your own inflation rate (the increase in the things you buy from one year to the next) you will probably find that it differs greatly from the measured value, especially the farther away you are from the “average” person that they use to determine the basket. Increases in consumer prices affect people differently based on their income and their consumption/saving ratio. To try to create once price inflation rate and have it apply across all people in the economy is pointless. But that’s how most people get a cost of living raise from their employer every year. Think of the recent spike and then fall in the price of gasoline – this had a devastating effect on a guy who works at Walmart, but a negligible affect on Oprah Winfrey. How does a government that has the responsibility to treat everybody equally justify manipulating consumer prices in one direction or another?

The government and economists generally use the CPI to measure the value of the dollar, but it is not that becasue so many things are excluded from the CPI. Asset prices in the stock, bond and derivatives markets are ignored, only final prices are considered, housing prices are not directly measured but are laughably measured by “equivalent rents” which aren’t equivalent and certainly aren’t a good substitute for housing values (during the run-up in housing prices this measure barely moved, and may have even gone down).

GDP (and GNP before it) is a flawed concept. GDP was never meant to be a measure of economic well-being of a nation, and certainly not a way to measure “economic” growth or wealth. Yet it is routinely used as THE measure of economic health for an economy.

GDP is a rather simplistic model that acts kind of like an income statement for a corporation. But as every accountant knows looking only at the income statement can allow a company to hide lots of things. The balance sheet is where the wealth of a company is measured, not the income statement. The goverment produces no balance sheet and does not produce anything that approximates it. This allows it count government spending as economic growth, while hiding the effects of money printing, government debt and unfunded liabilities like social security. If you have ever read a basic economics text you will see all kinds of pervese claims like consumer spending IS economic growth, increasing taxes also increases savings (and vice versa), reducing taxes reduces investment, increasing government spending increases GDP – especially if it comes from borrowing and not taxes…etc, etc. These are logical readings of flawed equations, so they are not technically wrong, they just don’t reflect reality (not always a concern for academics and mainstream economists). You can see these comical claims on a daily basis on CNBC or FBN from the economists and politicians who are paraded across their stages propagandizing for this stimulus and that government intervention. The other midguided by-product of all this is the belief that govrnment is what drives the economy and economic growth, and that the “correctness” of government policy is what determines whether the ecomomy shrinks or grows.

Of course inflation in prices makes nominal GDP to go up without an actual increase in output, so it is made “real” by subtracting the “inflation” rate. This is also fraught with problems and is where the most blatant manipulations occur. The “price deflator” used is subject to the same problems as the CPI and is calculted the same way. It most certainly does not measure the increase in the components of GDP due to “inflation” and is chronically understated in order to make the GDP numbers positive – so that politicians and bureaucrats can claim that the economy is growing.
6) It is also incorrectly assumed that an increase in prices is the worst by-product of monetary inflation. Prices for all goods and services go up and down for a variety of reasons, and their increase or decrease in itself is not a reason for concern, unless you assume that there is an “optimal” price level for everything (and then how would you determine such a thing anyway?).

The real problem with continual, artificial increase in the money supply (inflation) is that it distorts the functioning of the free market because it acts very unevenly. If the effect of inflation was to simply re-set the price of everything by the same amount, at the same time, then inflation would truly be benign. But monetary inflation acts unevenly across the economy and over time. Setting aside the fairness of the beneficiaries versus the victems, the real problem is malinvestment. The uneven nature of monetary inflation causes distortions and bubbles in the economy, causes over-investment in sectors that are being artificially blown up and under-investments in other sectors that do not produce the temporarily inflated returns of the bubble sectors. The market eventually corrects all of this by liquidating the over-investments. This leaves the under-served sectors weakened, and the bubble sectors destroyed.

There is no way to accurately predict the effects that the central bank’s Frankenstein monster will create, better to not create it at all.

7) In the end all of the basic assumptions coming out these mainstream economics and the government statistics is a few persistent, nagging fundamental errors:

Consumer spending does NOT drive economic growth, it is precisely the opposite. By reading the flawed GDP equations, and with lack of a true measure of real wealth of a nation, it can inferred that borrowing money to buy consumer goods leads to economic growth, when it is actually a wasteful decrease in wealth of the nation. This is exactly the kind of quackery that has been implemented for years and is about to be implemented on an even more massive scale now. The result has been an indebted consumer driven population with no savings who has actually become poorer while it thought it was becoming more wealthy.

Constant inflation in prices is not a benign lubricant of a properly functioning economy it is a corrosive, subtle destroyer of wealth – transferring savings from the producers to financiers and the government. On the flip side price deflation is not a cancer to be avoided at all costs but a by-product of a properly functioning, growing economy.

REAL economic growth – a long term increase in wealth – comes from increases in productivity, not mindless leveraged spending on trivial consumer goods. Real economic growth results in a decrease in the price of consumer goods and an increase in the value of savings – which is the fundamental driver of further increases in productivity and wealth. Inflation is precisely the opposite and results in a destruction of wealth.

Ralph Fucetola JD January 17, 2009 at 10:36 am

Inflation can be quite hilarious – take, for example, Zimbabwe, which last week issued its first 1 billion Zim-dollar note (the 10 million note was a couple weeks ago, the 1 million a couple months earlier). Well, the Zimbabwe central bank just announced the introduction of the 1 trillion dollar Zim-dollar, to “keep up with inflation…”

Here is the article:

Apparently the Zimbabwe central banksers haven’t figured out that their printing presses cause the inflation.

Yes. The case of Zimbabwe would be a cause for droll humor if people weren’t starving there, and dieing there of treatable diseases while the politicians still have their heads on their shoulders… but, perhaps, not for long. History has shown, over and over again, the results of such madness.

I remember Murray Rothbard telling us that economists and philosophers can only show us the likely results of our choices, ultimately between free societies and free markets on one hand and thug societies on the other. It is then up to us as ethical humans to choose…

Can anyone say “Zimbabwe America”? I fear soon enough we will be experiencing it.

Hand Reardon January 18, 2009 at 6:24 pm

The government uses inflation to compensate for the miss-management of entitlement programs (fed, state and local pension plans in addition to the federal SS and Medicare programs). They promise a dollar today that won’t be worth a dollar when they payoff the promise.

gene berman January 20, 2009 at 5:50 pm

Mike Sproul:

The “inflation multiplier” is not an amount paid for the convenience of using paper (rather than metallic) money; nor is it’s cost (to the average guy–the one who, at any given time, is carrying about $75), as a percentage, applicable only to the $ in the pocket, but also, to all assets denominated in those same $$: life insurance policies (both indemnity amounts and cash values, where applicable), bonds, etc.

The problem with the rate is that repeated iterations of the same percentage fail to produce the market phenomena sought; higher rates become required to produce somewhat results equivalent to the previous. Price increases occur simply as the result of the increase in money supply: some, especially those who are in a position of selling those things whose prices have advanced, are “cool” with it while others are disadvantaged. Government is affected, though not quite predictably: prices for many of the things they buy shall have advanced; so, too, may some tax-revenue streams. But, as time proceeds, the idea becomes clearer that saving is, with near-certainty, a losing proposition and that “consumption now” is the wisest choice; trade deficits are one obvious illustration: we are anxious to get rid of the currency, a commodity we value as less with each approaching period of the future.

Investors times January 26, 2009 at 5:26 am

Inflation or the expectation of an increase in price give people the drive to perform commerce. People would most likely buy and sell if they know that the price might increase. They would not think that the real value of the good have remain constant.

However if if falls with time they would still not think that the new lower price has the same real value as the old price.

It is all human nature. Hence if price falls people would also postpone their spending, even if on the long run their wages would decrease and that their real purchasing power will remain constant. This will cause a deflationary spiral.

As such it is human nature that prefers inflation. Had all humans been economics they would have known that the real purchasing value of the wages would remain constant whether nominal price increases or decreased.

Comments on this entry are closed.

Previous post:

Next post: