Why Keynesian Economists Don’t Understand Inflation

[DEAD7]

Even if you agree a 2 percent inflation target is an appropriate policy, inflation should, at least, be measured correctly. Proper measurements are unlikely since mainstream economists today, unfortunately, use a simplified version of the original quantity theory of money. In this version, money is linked exclusively to nominal income, and the CPI or GDP deflator are used as a proxy for prices of the goods and services in nominal income. This version is obtained from Keynes’s theory of liquidity preferences.

Yet, the original, non-Keynesian quantity theory of money clearly shows that the demand for money is to conduct all possible transactions, and not just those that make up nominal income. Money is linked to prices of anything that money can buy, consumer goods, stocks, bonds, stamps, land, etc. From this, an average price cannot be measured since appropriate weights are not obtainable. The use of the simplified, Keynesian version in economic textbooks and by the professional economist has caused immense damage. When your theory is wrong, your policy prescriptions will likely also be wrong.

Unnoticed by many mainstream economists is the fact that we are actually having the inflation everyone was so worried about back in 2009. It is simply showing up in asset prices instead of consumer prices. For some reason we consider higher food prices as bad and something to be avoided, while higher home prices are viewed as a good thing and something to be cheered. But they are both a reduction of your purchasing power. Today, home prices outpace wage growth significantly in many markets, and remain at high bubble-like levels, pricing homes out of reach of many young couples. Their incomes have less purchasing power: the money can buy less of a house, just like it can buy less of a hamburger.

By setting an inflation target, the FED did not let deflation run its course after the crash of 2008, and that was a big mistake. During the 2001-2007 boom years, housing prices shot up. This speculative bubble led to massive overbuilding of both private homes and commercial properties.

Deflation would have allowed a realignment of relative prices closer to what society really wants to be produced, but by inflating the money supply, the FED interfered with this essential clearing process. Housing prices should have dropped, much, much more than they did relative to other prices. Housing should then have remained in a slump possibly for a decade or more, until this overhang of construction had been cleared off. The new ratio of relative prices would have allowed resources to move into the production of goods and services more in line with what society would demand in a functioning market. The carpenter might have moved on and worked on an oil rig, possibly at an even higher salary. But that did not happen.

Today, housing is back, with price increases at bubble-era levels and construction activity picking up. Yet, the overhang has not disappeared. It has just been left in limbo, because of the “extend and pretend” strategy of banks made possible by the central bank’s massive printing over the last five years. Of course, when the music, or money printing, stops, the adjustment in housing will be even more disastrous.

The Fed should draw several lessons from history about inflation. The first is that an ounce of prevention is worth a pound of cure. You treat inflation like sunburn, by protecting yourself before your skin turns red. Second, the FED should not be concerned with consumer price inflation, but the increase in all prices which we are incapable of measuring (the weights being impossible to calculate). The recent increase in asset prices, such as stocks or agricultural land prices should be a strong warning signal.

The real solution is to end fractional reserve banking. The central bank would then be superfluous. It would not be missed. Its record at counterbalancing the negative effects of fractional reserve banking has been disastrous, and if anything, it has made things much worse.

If banks were forced to hold 100 percent reserve, neither the banks nor the public could have a significant influence on the money supply. Banks would then be forced to extend credit at the same pace as slow moving savings. Credit would finally reflect the real resources freed up to produce capital goods. The money supply could then be what it should always have been, a means of measuring exchange value, like a ruler measuring length, and as a store of value.

http://mises.org/daily/6716/Why-Keynesian-Economists-Dont-Understand-Inflation

 

[Domingo Halliburton]

at holding 100% reserves I dont even think that's remotely feasible.

 

[Scientific Playa]

buy seeds, canned goods, ammo and prepare for the eventual reset.

 

[DEAD7]

at holding 100% reserves I dont even think that's remotely feasible.

Why not?

 

[Dusty Bake Activate]

Unnoticed by many mainstream economists is the fact that we are actually having the inflation everyone was so worried about back in 2009. It is simply showing up in asset prices instead of consumer prices. For some reason we consider higher food prices as bad and something to be avoided, while higher home prices are viewed as a good thing and something to be cheered. But they are both a reduction of your purchasing power. Today, home prices outpace wage growth significantly in many markets, and remain at high bubble-like levels, pricing homes out of reach of many young couples. Their incomes have less purchasing power: the money can buy less of a house, just like it can buy less of a hamburger.

Okay let's just ignore that a house is an investment that one can use to turn a profit on it, and a hamburger is something that you convert into feces.

And that food prices are of such vital consequence because people have to eat, and so much of peoples' purchasing power has to go towards food, which is a neverending necessity until you die; whereas a house is a fixed asset that you eventually pay off, and you don't have to own if you want, you can rent.

The real solution is to end fractional reserve banking. The central bank would then be superfluous. It would not be missed. Its record at counterbalancing the negative effects of fractional reserve banking has been disastrous, and if anything, it has made things much worse.

If banks were forced to hold 100 percent reserve, neither the banks nor the public could have a significant influence on the money supply. Banks would then be forced to extend credit at the same pace as slow moving savings. Credit would finally reflect the real resources freed up to produce capital goods. The money supply could then be what it should always have been, a means of measuring exchange value, like a ruler measuring length, and as a store of value.

Didn't see that one coming.

 

[Hulk Hogan]

INVEST EVERYTHING IN GOLD BARS WITH RON PAUL'S FACE STAMPED ON THEM, BROTHER!

 

[The Real]

Why does mises.org have a layout that looks like it came from a Wordpress default template?

 

[Julius Skrrvin]

Why does mises.org have a layout that looks like it came from a Wordpress default template?

Another case of irrelevant content being framed in irrelevant aesthetics

 

[TLR Is Mental Poison]

http://mises.org/daily/6716/Why-Keynesian-Economists-Dont-Understand-Inflation

Explain how a full reserve system would

- not spiral into deflation with a fixed money supply
- not be subject to abuse if the money supply were "adjustable" by central banks

in your own words.

 

[Futuristic Eskimo]

Switch to full reserve banking system in order to heal the global economy and inadvertently destroy the global economy brehs

 

[DEAD7]

Explain how a full reserve system would

- not spiral into deflation with a fixed money supply
- not be subject to abuse if the money supply were "adjustable" by central banks

in your own words.

I don't think a full reserve system is a good idea, nor have I ever stated that I did.

I do think we need to reconsider quantitative easing... also known as printing money.

 

[Domingo Halliburton]

Why not?

because that would limit really hard what a bank could loan. You would walk in your bank to get a mortgage loan and they would tell you, "well we have to wait until we get another 100k in deposits"

 

[88m3]

 

[TLR Is Mental Poison]

I don't think a full reserve system is a good idea, nor have I ever stated that I did.

I do think we need to reconsider quantitative easing... also known as printing money.

Central banks will always print money. Thats how fractional reserve lending works.

QE was a bad idea, but then so was letting everything reset to zero in a matter of days. Feds can get asset prices in line slowly... they just need to increase rates slowly.

 

[Camile.Bidan]

I don't think there is anyone in the world who still believes in Old school keyensian inflation theories. Maybe the people on this board do.

Inflation is monetary in the long-term.

but (money) (velocity) = GPD * price level. So its not simply quantity that has an effect on inflation.

Short term inflation seems to be a different animal. And so far, inflation expectations, which policy seems to emphasize appears to have a very stong short term effect.

Rothbard's 100 reserve theory is completely anti-libertarian and 100% hypocritical. Banks take lend out more than their reserves because they know that not everyone is going to withdrawl at the same time. In the pre-FDIC days banks were held back by runs. there was always the danger of a bank-run if people got wind of a bank's excessive rIsk taking.

Without fractional reserves, we wouldn't have as much invesment as we do today. businesses need capital to grow, and fractional reserves probably accelerate business and capital growth.


Banking and the FDIC doesn't mix well. The banks can take as much risk as they want and if they fukk-up, the government will bailout the banks and depositors so nobody loses. It's a pretty dumbass system that protects the bankers from risk. Ironically, the same people that "hate the rich and hate the bankers" will fight, tooth and nail, to defend the same policies that protect the hyper rich bankers. Our system is fukked-up.