Economics

Hayek in the Stagflation Days of Yesteryear (and tomorrow)?

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A blast from the stagflation past (and future)? The audio track from Nobel laureate F.A. Hayek's June 22, 1975, appearance on "Meet the Press." Against all odds and all the interviewers, he steadfastly maintains that inflation is a monetary phenomenon, and the government's fault.

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  1. “He steadfastly maintains that inflation is a monetary phenomenon, and the government’s fault.”

    It was crazy that even as late as 1975 people still didn’t understand what inflation was. It was crazy because you didn’t need free market types like Hayek or Mises or Hazlitt or Friedman to explain it to you, because the big government macroeconomists like knew it too. They have have quibbled whether inflation was good or bad, but no self-respecting economist disagreed that inflation was a monetary policy.

    Are we any better today? I like to imagine we are. But I’m probably just being naively optimistic.

  2. People still don’t know what inflation is. I have the Austrian ball breakers on here all the time claiming it’s defined as ANY increase in the money supply – like they can even define “the money supply” with any consistency.

  3. “What rate of unemployment do you think this country ought to be willing to tolerate in order to beat inflation?”

    Oh, those heady Phillips Curve days.

  4. I have the Austrian ball breakers on here all the time claiming it’s defined as ANY increase in the money supply – like they can even define “the money supply” with any consistency.

    How do you define inflation with consistency? I want an objective measure, not one chosen subjectively by a set of economists on the government dole. Subjective measures are not helpful, especially when they are created by those whose interest is in keeping them as unhelpful as possible.

    “The money supply” may be impossible to precisely measure, but there are easily-defined proxies that can give us an idea of its rate of growth over time, thus giving us an objective definition for inflation. See MZM, M2, and M3 for three good examples.

    The Austrians’ key contribution to the field of economics is a theory about the effect of money supply increases on prices. To make this as clear as possible, they define inflation as the action, and assign its responsibility to the central banks, which have primary control over the money supply by having a government-enforced monopoly on the printing press.

    Defining inflation in any other way offers no insight into its cause. The Austrians want the rest of you to understand that inflation doesn’t just “happen”: it occurs for a reason, and they argue a very simple and intuitive reason at that. The easiest way to understand their insight is to imagine the effect of printing up and handing everyone in the world $1,000,000: what do you think would happen to prices if this were to happen?

  5. How do you define inflation with consistency?

    Good point, it’s not any easier than defining money supply. Broadly speaking it’s increases in prices. The devil is in the details, of course…

    “The money supply” may be impossible to precisely measure, but there are easily-defined proxies that can give us an idea of its rate of growth over time, thus giving us an objective definition for inflation. See MZM, M2, and M3 for three good examples.

    The conclusions we would draw from those three measures are wildly different. No so with three more common measures of inflation: CPI, PCE, GDP deflator.

    The Austrians’ key contribution to the field of economics is a theory about the effect of money supply increases on prices. To make this as clear as possible, they define inflation as the action, and assign its responsibility to the central banks, which have primary control over the money supply by having a government-enforced monopoly on the printing press.

    This is kind of like defining a “guy with a cigarette” to be a “forest fire” because one can cause the other and it makes that possibility clearer.

    Defining inflation in any other way offers no insight into its cause.

    And yet, that’s not the point of a definition. As the risk of channeling Slick Willie – let me say: It depends a great deal on what your definition of “definition” is…

  6. This is kind of like defining a “guy with a cigarette” to be a “forest fire” because one can cause the other and it makes that possibility clearer.

    A better analogy would be defining “the guy with his hand on the still-burning flamethrower” to be the cause of “the house fire that just erupted next door”: maybe you can’t prove deductively that he lit the house on fire, but it’s pretty damn clear… especially when the exactly same thing has happened to the same guy a dozen times before.

  7. …flamethrower…

    Until you can point to a time when the Fed actively stoked triple digit inflation, this is preposterous hyperbole. Inflation is not pregnancy: you can be “a little inflationary.”

    The rate of money increase has FAR exceeded the rise in prices. Deflationary Austrians say “sure, but the ‘natural’ direction of prices is for them to decrease – otherwise is THEFT!!!”

    This is like my first squadron commander who said: when you are early, you are on time, when you are on time you are late. It’s useful for highlighting the fact that he wanted people to be on time – but kinda dim if you really are trying to coordinate a meeting at a specific point in time.

  8. The rate of money increase has FAR exceeded the rise in prices.

    You are the only one (apparently) claiming that Austrians think an X% increase in the money supply will immediately result in an X% increase in prices. On the contrary, price increases will occur over some unpredictable period of time and hit some assets more quickly and/or at a greater magnitude than others. (For reference, see the housing bubble.) Eventually, the inevitable bust will destroy some of that money that has been created, but the remaining increase will ultimately reflect itself in higher prices for all things, notwithstanding productivity increases.

    More fundamentally, how could a dollar be worth the same if you (say) doubled the number of them in circulation? Doubling the number of dollars would be equivalent to changing the numbers on the corners to read “2” instead of “1”. “1” doesn’t by itself represent the value of that dollar in trade; all it represents is an arbitrary unit of measure. How those units exchange for capital and goods is exclusively a function of the balance between supply and demand for each of those units. It seems pretty clear that if you double the supply everywhere simultaneously without doubling the demand, the value of each will be cut in half.

    In this case, the supply isn’t being doubled everywhere simultaneously: the new supply is being given to politically well-connected people first, and then over the course of years works its way through the economy to the rest of society, by which time the value of each has decreased to reflect the increased supply that is now sufficiently spread-out to affect prices across the board.

    Deflationary Austrians say “sure, but the ‘natural’ direction of prices is for them to decrease – otherwise is THEFT!!!”

    None of the Austrians I know say that. They say that giving a group of men monopoly control over the printing press leads to inflation. Nothing you have said here argues effectively against that simple hypothesis.

  9. You are the only one (apparently) claiming that Austrians think an X% increase in the money supply will immediately result in an X% increase in prices.

    More fundamentally, how could a dollar be worth the same if you (say) doubled the number of them in circulation? Doubling the number of dollars would be equivalent to changing the numbers on the corners to read “2” instead of “1”.

    Apparently I am not the only one!

  10. Productivity is not the only other variable. There is also the velocity of money – half that, and you must expand 2x to maintain price stability.

    They say that giving a group of men monopoly control over the printing press leads to inflation.

    Then why hasn’t it in the US? And before you start – no channeling Ron Paul with scary sounding comparisons of how many pennies a 1910 dollar is worth today (which use compounding to make a small rate seem like a big problem) – just give me the rates.

  11. I have the Austrian ball breakers on here all the time claiming it’s defined as ANY increase in the money supply

    Inflation is an increase in the money supply without a corresponding increase in actual produced wealth.

  12. You are the only one (apparently) claiming that Austrians think an X% increase in the money supply will immediately result in an X% increase in prices.

    More fundamentally, how could a dollar be worth the same if you (say) doubled the number of them in circulation? Doubling the number of dollars would be equivalent to changing the numbers on the corners to read “2” instead of “1”.

    Apparently I am not the only one!

    I conclude you are trolling now. Go back and read what I said about doubling simultaneously vs. giving new supply to politically well-connected people.

  13. Inflation isn’t a monetary phenomenon if we, like, destroy lots of stuff.

    We just have to destroy stuff in well-proportioned baskets of goods (which is very easy since we already have the baskets constructed for estimating inflation!) until scarcity drives up prices.

    It’s not only a substitute for complex, difficult to calibrate monetary policy; it’s also a jobs program!
    I’ll start breaking windows.

  14. how do changes in population fit in? Money velocity? We can argue about the causes of inflation all day long – and we’d find a lot of common ground there, I think. But my main issue is that inflation doesn’t sloppily get defined as something it isn’t.

  15. I conclude you are trolling now.

    No… You are the one who put two diametrically opposed thoughts in the same post – it’s not my fault if having that pointed out pisses you off.

  16. how do changes in population fit in? Money velocity? We can argue about the causes of inflation all day long – and we’d find a lot of common ground there, I think. But my main issue is that inflation doesn’t sloppily get defined as something it isn’t.

    Okay, let’s stop using the word “inflation”, and simply call the Austrian variant a “money supply increase” and the US government variant “subjectively-defined goods basket price increases”.

    The latter does seem a whole lot harder to reason about: hell, the US government is projecting inflation of a whole *4%* this year, despite the fact that everything I have been eating has gone up by almost 50% over the past year. Almost convenient that it’s too complex to analyze. I guess we can’t figure out why this is happening. Too bad: time for more stimulus!

  17. You are the one who put two diametrically opposed thoughts in the same post – it’s not my fault if having that pointed out pisses you off.

    Except that they aren’t diametrically opposed. Go back and read it again. I’ll wait. Reading comprehension is difficult, but reading is fundamental.

  18. Almost convenient that it’s too complex to analyze.

    They break down the CPI into categories, if that’s helpful.

  19. They break down the CPI into categories, if that’s helpful.

    It’s helpful, but each category still takes into account a subjectively-determined hedonic regression that is undoubtedly chosen to make the numbers look as low as possible.

    Sorry, but over the years I have come to assume malice rather than incompetence on the part of government officials.

  20. Except that they aren’t diametrically opposed. Go back and read it again. I’ll wait. Reading comprehension is difficult, but reading is fundamental.

    Nope – still not impressing me. I *get* what you are trying to say here – but you are leaving out some important things like evidence.

    To wit: why, if the money supply has increased at a rate of 10% has price inflation been only 3%? Despite the fullness of time which allowed the money to work through the economy.

    Inflation (as I properly define it) depends on Quantity, velocity, productivity, credit, financial innovations, investment preferences to name just a few. Sadly, the austrian view focuses almost solely on the quantity – and even in doing that screw up a lot of the analysis.

  21. I won’t apologize for the hedonics part.

    I’ll just say subsititution is a real phenomenon that can’t be ignored in the construction of price indices.

    Now, unfortunately people feel compelled to use a price index to talk about monetary policy. That’s a pity, and we can certainly blame government officials for saying the numbers indicate stuff they don’t indicate.

    You can make the same argument against those talking about the health of the economy using the dollar/euro exchange rate or the DJIA.

  22. CPI catagories etc…

    On the basket: Goods baskets are not meant to be used to predict standard of living (as they have come to be used by unions, government pensions, etc.) They are an economic statistic that is supposed to guage the overall level of prices in the economy.

    Squarooticus rightly points out that prices for different segments fluctuate all the time – this is not inflation. Just because there is an oil bubble that then popped doesn’t mean “inflation” which is why we average it out with other stuff. During truely inflationary envionments we see steady or spiraling upward prices in many, if not all, catagories of goods.

    Hedonistic regression is a scary sounding term that inflation data skeptics use to prove why the guvmint is lying to them. It’s used in a very small subset of item catagories (mostly electronics) where it is absolutely required since the quality of goods changes so fast.

  23. The latter does seem a whole lot harder to reason about: hell, the US government is projecting inflation of a whole *4%* this year, despite the fact that everything I have been eating has gone up by almost 50% over the past year. Almost convenient that it’s too complex to analyze. I guess we can’t figure out why this is happening. Too bad: time for more stimulus!

    Just because it’s easier to understand money supply increase doesn’t mean it’s a better definition for inflation – but I will agree to semantic detante, and use your terms (under duress!) “Easier to understand” also doesn’t mean it’s a better quantity to hold steady or even increase smoothly in any realistically complex economy.

    There are far too many shocks that could occurr in a “quantity managed economy” that would result in deflationary spirals, credit burstings, seasonal recessions, and many other distortionary or otherwise needless harms. In my view – steady 2-6% inflation on a 4 decade + timescale is a dandy alternative.

  24. I would think the obvious definition would be the change in the ratio of money supply to productivity.

    This might, possibly, be best measured by looking at a basket of goods, although it seems a pretty abstract way of measuring it, especially since defining a representative basket of goods seems impossible.

    Using my definition, 3 things would seem to be cause inflation:

    1. An increase in the physical amount of money
    2. An increase in the velocity of money
    3. A decrease in productivity

    Balancing 1&2 with 3* would seem to be hard.

    *3 being change in productivity in the last sentence.

  25. To answer the question domo asked at 3:47, the 10% increase in money supply has mostly been balanced by an increase in productivity, hence only a 3% inflation rate.

  26. domo,

    Some of us lived thru the 70s where they couldnt manage to keep inflation in that 2-6% range.

    My question though is, why 2-6 instead of -2 to 2? If you can balance a 4% range, why not one centered around zero so that money maintains its value over time?

  27. To answer the question domo asked at 3:47, the 10% increase in money supply has mostly been balanced by an increase in productivity, hence only a 3% inflation rate.

    Except that productivity growth has been around 1% annualized over that period – so yes, but…

    Some of us lived thru the 70s where they couldnt manage to keep inflation in that 2-6% range.

    True. I presume it was really annoying, yet not enough to make you get your pitchfork out, right? and to be fair, the stuff we are talking about now, was hardly common knowledge at the time.

    why 2-6 instead of -2 to 2?

    Cause once it gets negetive, you have a devil of a time getting it positive again.

  28. BTW – nothing I’ve said contradicts the notion that inflation (however you define it) is “always and everywhere a monetary phenomenon.”

    I am arguing about what the best way to set up the system, and then gauge it’s effectiveness given that knowledge.

  29. Good point, it’s not any easier than defining money supply. Broadly speaking it’s increases in prices.

    You’re both right. Due to the confusion over the term, “inflation” now means *both* a general increase in prices *and* an increase in the money supply. If one is to be accurate, one should use the terms “monetary inflation” and “price inflation”.

    But the cause and effects are still clear: monetary inflation causes price inflation. It is not the other way around. The increase in money causes the increase in prices. To quote a non-Austrian, “inflation is always and everywhere a monetary phenomena”.

  30. why 2-6 instead of -2 to 2?

    Because deflation is the big bogeyman everyone is scared to death of. It’s not discussed in polite economic circles. Merely suggesting that deflation is a corrective mechanism for excessive inflation is enough to get you disinvited from the better economic soirees.

    After the 1929 crash we had a period of excessive deflation that turned a bust into a full blown depression. The money supply fell by a third. That’s a far cry from a mild -2%, but good luck finding any mainstream economist who won’t pee his pants at the thought of it.

  31. but good luck finding any mainstream economist who won’t pee his pants at the thought of it.

    too right – and ith good reason. The usual tools “printing money” by increasing bank reserves just dont do crap once deflation gets cooking. You can only put the rate to zero – and as japan in the 90’s proves – even quantitative easing doesn’t do much.

    Bernanke (ironically) said he would “drop money from helicopters” to combat deflation in such a situation. This should give you some idea of how inedequate current thought is when dealing with deflation – Bernanke is recognized to be THE expert.

  32. domo,

    recognized by who?

    AFAICT, he is an idiot. Probably not literally, but I wonder.

    In pre-fed days, every deflationary period was followed by an inflationary one to balance things out. Its easy to get out of deflation. Just wait.

  33. by other idiot economists! – he’s not an “idiot” c-mon…

    DRINK!

    (I am…)

  34. DRINK!

    (I am…)

    Still an hour to go for me… damn you! 🙂

  35. …but good luck finding any mainstream economist who won’t pee his pants at the thought of it.

    On a more serious note, prices include wages, so a deflation will cause drops in wages. Declining wages and high unemployment are things the American public don’t tolerate very well, and will start voting out congressmen over it. Thus government likes to keep inflation well above zero line.

    As for getting deflation back up above zero, it’s only hard because most instances of deflation were corrective episodes following inflationary booms. It’s damn hard getting rid of deflation when the market is trying to correct itself. On the other hand, if we have a low but steady target rate, it’s not a problem if we occasionally dip into the -2% range.

  36. This whole discussion completely ignores tha fact tha when the term inflation was invented by classical economists it was used to refer to the ACTION of increasing the money supply. The action of actually creating more pound notes.

    So whatever problems you may have with the austrian definition, it does make more historical sense than using the term to describe (as CPI does) the consequences of inflation.

  37. using the previous analogy… it is like the term “starting a fire” was redefined to mean “burning leaves” and we then argued about how much firestarting led to exactly how much % increase in burning bushes…

  38. “Inflation (as I properly define it) depends on Quantity, velocity, productivity, credit, financial innovations, investment preferences to name just a few. Sadly, the austrian view focuses almost solely on the quantity – and even in doing that screw up a lot of the analysis.”

    Austrians focus on the main cause, the human cause, of a general change in prices. You are talking about many mostly natural and complicated causes of change in prices.

    Austrians say if you manipulate prices, by manipulating the quantity of money and credit you screw up capital structure of the economy because you depress the interest rates, thus misrepresent the time preference of people, thus causing booms and busts and on top of that transfer wealth from some people to others.

    The rest of the reasons, the natural reasons of price changes are actually good because it spontaneously directs production and use of scarce resources.

    In short if you just focus on the changes of general price levels you may get lost. Sometimes money and credit expands but doesn’t reflect on everyday goods prices but screws up the capital structure just like during the 1920’s and 1990’s and early 2000 years.

    For you to understand the monetary theory and the cycle theory you have to understand the capital theory too.

  39. In a barter economy, relative prices of every good can and would fluctuate. But you wouldn’t get a general rise in all prices (that would be a paradox because every price would be in some other good) or booms/busts cycles.

    For those you need some thing in the middle of exchange that you can manipulate.

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