Posted on August 5, 2022
Inflation is here, and ready to last if nothing is done to counter it. At the same time, the corrective action of central banks must not generate what the economist Friedrich Hayek calls a secondary depression, ie a second negative shock to the present crisis, thus generating a cumulative process.
Findings on inflation
Let us make an observation: inflation is mainly monetary, that is to say that it results from an excess of monetary creation in relation to the demand for money, at the same time as it is linked to concerns about supply on the supply side: problem of supply structure, shortages linked to external shocks, changes caused by health policies during the Covid period, etc., which have a negative effect on the costs of entrepreneurs and their expectations.
We are therefore faced with two major sources of price changes, and this is where the task becomes complicated. An Austrian economist would tell you that monetary policy, playing on money creation via credit creation, will have the effect of artificially lowering market rates below their natural rate (i.e. the rate that balances demand and the supply of loanable funds, or the demand for loans and savings).
This is how the process of monetary expansion and inflation begins, with the aim of making easy credit for entrepreneurs or public debt. Central banks must therefore raise their rates in order to put an end to inflation (as Chairman Paul Volcker did in the 1980s) to end the cycles and allow the economy to purge itself of the malinvestments produced during this period. period of monetary accommodation. This summary is deliberately and vulgarly shortened, but it is sufficient for our subject.
The problem is that at the same time we can rightly think that the expectations of entrepreneurs, in view of the various national and global problems (international instability and uncertainty on the side of international trade, in addition to all that we have listed previously) , the demand for loanable funds must have decreased, leading de facto to a decrease in the natural rate of interest.
The risk then being that the rise in rates does not bring market rates back to the level of the natural rate, but above it, causing a restriction of credit in addition to the problems that entrepreneurs are already facing: we would face a monetary imbalance. deflationary, where individuals would rebuild their monetary balances by reducing their purchases. That’s what happened in 2008, according to people like George Selgin at Market Monetarists. The Fed moved from an accommodative policy to an overly restrictive policy, causing the level of global nominal income (MV in the quantity theory) to collapse.
Different solutions to inflation
Changes in the value of products linked to changes in relative scarcity and productivity must therefore be able to manifest themselves through changes in price. This is the only way to promote the transition and the return to balance. A fiscal policy of cutting taxes, public spending and freeing up the economy could also help solve supply-side problems (this was the path chosen by Australia during the Great Depression of 1929, which did not was never large on the side of our Australian friends). And writing checks to offset the effect of inflation is a bad idea. Ultimately, this means further increasing inflationary expectations. At his level, even Paul Krugman admitted that he was wrong to weigh the inflationary scope that Joe Biden’s stimulus policy would have.
At the same time, we must fight against monetary inflation and the pernicious expectations it generates in individuals. Inflation generates more serious problems than a simple decrease in the purchasing power of money.
Inflation redistributes purchasing power (this is the Cantillon Effect: there cannot be a general increase in all goods at the same time, only in certain goods compared to others, cf John Stuart Mill) , and above all, undermines confidence in the institutions of the market, favoring in passing the increase in the prerogatives of the State and the implementation of policies such as price controls (the worst we can do at present) .
All inflationary episodes have generated important institutional changes, good ones (with the arrival of the conservative revolution, the return to controlled inflation and a reduction in taxes and the role of the State) as well as very bad ones (such as the case of German hyperinflation in the 1920s, for obvious reasons).
The proposal of free banking theorists (or market monetarists) to fight inflation effectively without causing additional problems for the economy would be to stabilize MV (Hayek’s rule), or to target aggregate income nominal (Nominal Gross Income Targeting), that is to say that monetary growth follows the growth of current transactions (the eventual solution being of course the end of the Central Bank system and inconvertible currencies): on these propositions and on the history of the phenomena inflationists, I refer the reader to my article on The Productivity Standard in History and Practice.
Let us remain hopeful: perhaps the bad moment we are experiencing (and which will get worse, no doubt) will bring us back to the 1980s, and that France will not miss its chance to really apply a program a semblance of liberal this time around. In any case, music and series have already followed suit towards this time when making a supply policy was not a dirty word.