Inflating Our Way to Prosperity? Say what? By William L. Anderson
| November 10, 2010
According to Paul Krugman, getting out of this depression
is as easy as cranking up the printing presses at the U.S.
Department of the Treasury. However, I believe, as a card-carrying
member of the “Pain Caucus” (foolishly, or maybe
my motives are darker), that the government’s current
economic policies of borrowing and spending might not do
anything but dig our economic hole even deeper.
Krugman and many other economists believe that the government
is much too stingy and that what it needs to do is not cut
back on spending and borrowing but rather throw the spending
levers full forward. I present their views (as fairly as
possible) and then look at them from another perspective.
The Keynesians – including Krugman – hold that
the key to recovery is spending, increasing “aggregate
demand” to move our economy out of an alleged “liquidity
trap.” (A “liquidity trap” is a special
situation, according to Keynesians, in which interest rates
are near zero and people are holding money and not spending
it. The way to bust out, say Keynesians, is for governments
to borrow and spend in order to give the economy “traction.”)
Furthermore, with Ben Bernanke at the Federal Reserve System
claiming that the Fed needs to find creative ways to ratchet
up the rate of inflation to at least match “target”
rate of 2 percent, we have the supposed experts claiming
that inflation is the magic carpet to prosperity and full
employment.
The thinking behind such policy prescriptions is this:
Inflation will lead individuals and businesses to spend
now, which supposedly will clear the inventories and convince
producers to make more goods to put on the shelves. Further
inflation will encourage people to continue spending, and
the process will go on indefinitely. According to Krugman
and others, this will give the economy traction, and from
there the spend-produce-spend machine will grind along.
No Perpetual Motion
Excuse me if I differ with this assessment. First and most
important, a surge of new money, while encouraging people
to spend now, will not result in the economic perpetual
motion that inflation advocates predict. What is more likely
is that producers will gladly sell their current inventories,
but they also would recognize the rush of spending as temporary
at best.
The problem is that the new money injected into the system
will not encourage longer-term capital investment, and why
should it? Unlike the producers in economists’ mathematical
models, which assume that firms automatically invest in
new capital when spending increases, people in the real
world are living, breathing, and thinking entities who actually
observe economic conditions.
Second, with the hostile rhetoric against businesses coming
from the Usual Suspects in Washington and in the media,
the climate amenable to long-term investment simply is near
nonexistent. Economist Robert Higgs writes that the current
political environment is fraught with “regime uncertainty”:
Entrepreneurs and capitalists are unwilling to commit resources
long-term if the government is likely to confiscate them
or create an economic climate so hostile that profitability
is impossible.
As Henry Hazlitt wrote, with inflation the “good
effects” come first and the bad effects follow. In
the beginning people have more money in their pockets, and
they purchase things at prices that existed before the surge
of new money. It looks as though prosperity has returned.
However, as more and more money is pumped into the economy,
not only do prices go up but so do inflationary expectations.
Long-term capital investment is jettisoned for assets that
will increase in value relative to money during inflation,
and in the end the economy is mired in both higher prices
and higher unemployment.
Hazlitt likened inflation to the “Dead Sea Fruit,”
which “turns to ashes” in one’s mouth.
Unfortunately, the most “brilliant” minds are
demanding we harvest and eat this fruit, and when it turns
to ashes they will blame businesses and free markets. They
always do.