Correcting the Inflationistas is Self-Defeating

If there is a shortage of money — a demand shortage — and prices are sticky (real cash balances don’t rise on their own), we resort to increasing the supply of money. But, some think that the process of manipulating the money supply is not always very straightforward. At one extreme, the zero lower bound, the conventional process by which monetary policy works is no longer available. This is because when non-money financial assets are earning zero interest, people will reorganize their portfolios to carry more cash, because other assets are no longer earning an adequate premium to compensate for their relative lack of liquidity.

One alternative, or “unconventional,” monetary policy is to target inflation expectations. The Federal Reserve can do this by someway persuading money-holders that the Fed is committing to some inflation rate. Inflation acts almost as a tax on holding money. If people expect the value of their money to fall by some amount (whatever rate of inflation they expect), this may induce them to exchange their dollars for other assets, whether financial or otherwise. In other words, inflation expectations reduces the demand for money, narrowing the demand shortage.

When the Fed originally began its quantitative easing program, there were a lot of people arguing that the end game would be very high inflation, or even hyperinflation. Many bloggers, such as Paul Krugman, have criticized these people heavily. Fed policy, at the lower zero bound, is not inflationary at all! But, isn’t this self defeating? Instead, Krugman, et. al., should flame the fires of inflation fear, letting inflationistas warn without opposition of the impending apocalyptic devaluation of the dollar. In fact, the Fed should hire inflationistas to write for them! That way, they’ll persuade the public and inflation expectations will go through the roof.

6 thoughts on “Correcting the Inflationistas is Self-Defeating

  1. Roberto Severino

    You’ve completely knocked it right out of the park with this post, Mr. Finegold. I haven’t really read your blog in a long while, but it’s great posts like this that have someone like me wanting more.

    I’m so tired of hearing all these doomsday like scenarios I keep hearing from certain people in the financial industry who want to pump up a certain product like gold (it seems like a decent asset to keep as long as you don’t go overboard and try to make too much of that portfolio consist of gold stocks) to scam others and to manipulate them based on their fears.

    It’s just absolute fearmongering and I have no respect for anyone who resorts to such dirty tactics. I’m still waiting for that so-called hyperinflation that guys like Schiff were peddling. I agree completely with your post here. It also doesn’t necessarily invalidate heterodox economic views in general.

    1. Alexi Dernikov

      The problem with Schiff is that although his understanding of economics is good, he keeps making predictions he has no grounds to make. Although the current system is a horrendous clusterfuck of stupid ideas, predicting a phenomenon like hyperinflation is contingent on so many variables as to be nigh impossible. Heterodox economic views, like Austrianism, do not necessitate that we have hyperinflation, either, although there is a concerted attempt by the mainstream to conceal the actual extent of the effects of magnifying the money supply, e.g. in the commodities speculative boom.

      1. JCatalan

        I think, though, that there are some nuances that Austrians who predicted high inflation had missed. These nuances aren’t mutually exclusive with Austrian theory, of course, but they might be things that Austrian theory doesn’t always consider (they’re considerations that would improve Austrian theory).

          1. JCatalan

            For example, that the quantity of money held at the Fed by banks (their reserves) doesn’t necessarily bare a direct relationship to the amount of money loaned (especially if what we’re talking about are asset swaps).

          2. Alexi Dernikov

            See, I always thought this was part of Austrian theory, as Mises always qualified that if the credit expansion did not in fact seep into the economy, the business cycle would not trigger. It may not have been phrased specifically like you did, but the idea is the same.

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