The Spectre of Price Inflation

Max Gillman

Description

Inflation, hyperinflation and deflation have all had profound effects on societies, especially during periods of war and crisis. Today’s approach to managing inflation has been shaped by these episodes and informed by debates between different schools of economic thought from Fisher and Hayek to Keynes and the monetarists. This accessible and authoritative overview explores the role of inflation in the modern economy, from its place in monetary policy and in money supply to its effects on everyday business.

In a compelling analysis, the book shows that since the financial crisis in 2008–09, inflation rates have remained persistently higher than interest rates worldwide, which is the inverse of our basic understanding of how inflation normally affects markets. The result of this inversion has been that the effective real return on investment has become negative, and consequently, the investment rate has dropped across western economies. At a time when inflation once again challenges the world’s leading economies, the book offers valuable insight into the monetary policy of central banks.

Introduction

Part I: Innocence: when principles guided policy

1. Drs Fisher, Friedman and no inflation

2. The rise of inflation

3. The end of metal for money

4. War, peace, deflation and recession

5. Seigniorage versus hyperinflation

6. Blaming the victim

7. Inflation and unemployment

Part II: Ignominy: central banks, insurance and inflation

8. The rise of central banks

9. Fractured insurance

10. Bank failure and crisis

11. The problem of excess reserves

12. Giving away the inflation tax

Part III: Purgatory: capital markets, interest and inflation

13. Fed price-fixing

14. A plague of negative interest rates

15. Shifting money demand

16. The new usury prohibition?

17. Money, inflation and banking reform

Sujets

• Public Policy
• Political Economy
• Economic History
• Economic forecasting
• Monetary economics
• Forecasting
• Theory
• Macroeconomics
• Federal Reserve System
• Economics
• Business
• Finance
• Fisher
• Hayek
• John Maynard Keynes
• Inflation
• Réserve fédérale des États-Unis

Informations

• Publié par: Agenda Publishing
• Date de parution: 24 novembre 2022
• Nombre de lectures: 0
• EAN13: 9781788215398
• Langue: English

Extrait

THE SPECTRE OF PRICE INFLATION
THE SPECTRE OF PRICE INFLATION
MAX GILLMAN
© Max Gillman 2023
This book is copyright under the Berne Convention.
No reproduction without permission.
All rights reserved.
First published in 2023 by Agenda Publishing
Agenda Publishing Limited
The Core
Bath Lane
Newcastle Helix
Newcastle upon Tyne
NE4 5TF
www.agendapub.com
ISBN 978-1-78821-236-6 (hardcover)
ISBN 978-1-78821-237-3 (paperback)
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the British Library
Typeset by Newgen Publishing UK
Printed and bound in the UK by 4edge
Contents
Preface
Acknowledgements
Introduction
Part I Innocence: when principles guided policy
 1. Drs Fisher and Friedman and no inflation
 2. The rise of inflation
 3. The end of metal for money
 4. War, peace, deflation and recession
 5. Seigniorage versus hyperinflation
 6. Blaming the victim
 7. Inflation and unemployment
Part II Ignominy: central banks, insurance and inflation
 8. The rise of central banks
 9. Fractured insurance
10. Bank failure and crisis
11. The problem of excess reserves
12. Giving away the inflation tax
Part III Purgatory: capital markets, interest and inflation
13. Fed price fixing
14. A plague of negative interest rates
15. Shifting money demand
16. The new usury prohibition
17. Money, inflation and banking reform
References
Index
Preface
My namesake ancestor emigrated to New York to become a US citizen in 1900. His Austrian heritage stimulated my interest in the academic life of his birthplace, from where modern economics arose. He was born in Austria prior to the First World War a decade before Carl Menger became a professor of economics at the University of Vienna in 1873. Menger founded the Austrian School of Economics. His German-language Principles of Economics (1871) showed how people’s utility went down for each additional good that they received. With this decreasing (“marginal utility”) value per additional good, he laid the basis for why the price we would pay, per unit of the good, would be lower in markets as the quantity demanded of the good was higher. Menger thereby gave us a downward-sloping demand curve – revolutionary at the time.
This first foundation of the downward-sloping demand curve appeared in the same year in English with William Stanley Jevons’s Theory of Political Economy (1871), and then again, in French, with Léon Walras’s Elements of Pure Economics (1874). Suddenly, demand was conceived as opposing supply and providing an equilibrium that yielded the basis of value theory, or “price theory”. This theory is still the foundation today of how markets determine equilibrium at the “market-clearing” price, which equates the quantity supplied to the quantity demanded. It laid the first microfoundations of macroeconomics. I learned about this evolution of macroeconomics through independent study of the history of economic thought with Professor Daniel Fusfeld at the University of Michigan, and with Professor George Stigler (Nobel laureate 1982) in graduate school, focusing on Adam Smith’s work.
Austrian economics thereby began as an innovation in economics, which had focused till then on determining price only through the firm’s cost of production – the “labour theory of value”, in Marxian economics – to a balancing of price from firms and consumers alike. Austrian professors provided the concept of deriving market prices by considering scarcity as it affects both the cost of production by firms on the supply side and the demand for the good from the household “consumer” side. The latter was a technological innovation derived using an application of mathematical calculus theory, following up on Newton’s use of calculus to provide the first principles of the laws of motion in physics. Einstein (born in 1879) later generalized the latter laws of motion using further dimensions of calculus at the same time (1905–15) that Austrian economics was evolving in Vienna after Menger.
As a student of Carl Menger at the University of Vienna, in 1880 Eugen von Böhm-Bawerk received the equivalent of a PhD. Böhm-Bawerk is sometimes known as the founder of capital theory – how investment requires a normal return on capital that can be expressed as a rate of return. By thinking of this return on capital as an equivalent interest rate on capital, Böhm-Bawerk pioneered the theory of interest.
Under Böhm-Bawerk at the University of Vienna, Ludwig von Mises focused on the money supply and how this can affect interest rates. Under von Mises, F. A. Hayek (Nobel laureate 1974) also studied at the University of Vienna. Born in Vienna, Hayek’s discourses included how government money supply increases can temporarily drive down the interest rate.
Menger, Böhm-Bawerk, von Mises and Hayek formed a core of thought that became known as the Austrian school of economics, which continues to evolve today. Hayek left Vienna for the United Kingdom, taking these ideas to the London School of Economics. Hayek took his intellect to the United States, as a professor at the University of Chicago for more than a decade (1950–62). There he was a colleague of Milton Friedman (Nobel laureate 1976) during Friedman’s formative years of what turned out to be a long career at Chicago (1946–77).
Friedman ( 1968 ) explained what the government money supply could do, such as leading to temporary changes in interest rates, while being ineffective in causing any permanent increase in the employment rate. Friedman emphasized that inflation is a tax that distorts efficiency, by showing the foundations for postulating the demand for money as a facilitator of exchange, while starting Chicago’s Money and Banking workshop in 1954 with Gary S. Becker (Nobel laureate 1992) as co-director, and then organizing the macroeconomics course sequence at Chicago. Robert E. Lucas, Jr (Nobel laureate 1995), was a student of Friedman, along with fellow students Sherwin Rosen, Sam Peltzman and Eugene Fama (Nobel laureate 2013).
My studies involved classes with all four of these renowned economists while they were professors at the University of Chicago. This study included focusing on George Stigler’s and Peltzman’s economics of regulation, T. W. Schultz’s (Nobel laureate 1979) and Becker’s theory of human capital, and Lucas’s monetary theory. Lucas organized the Money and Banking workshop and was already famous for showing rigorously in “general equilibrium” how a trade-off between inflation and unemployment disappears once people adjust their expectations of the inflation rate to the actual rate prevailing.
This Lucas article ( 1972 ) was later cited as the basis for his Nobel Prize. Lucas’s Critique ( 1976 ) demolished the basis for building large models to conduct policy experiments, by showing how these models omitted changes in consumer behaviour in response to changes in policy. This was astonishing, since Lawrence Klein (Nobel laureate 1980), after starting as a professor at the University of Michigan, won his Nobel on the basis of developing these large models for policy evaluation.
My interest in studying at Chicago came from undergraduate work at the University of Michigan, including a stint as a teaching assistant to Professor Gardner Ackley. His macroeconomics textbook provided a concise explanation of Friedman’s and Lucas’s theories of inflation and unemployment. This occurred just after the end of the Vietnam War (which ran from 1955 to 1975), during which my older brother had to enter the draft, the money supply growth rate had taken off, the last vestiges of the Bretton Woods gold standard had broken down and the rate of inflation was still rapidly rising.
Paul Samuelson (Nobel laureate 1970) and Robert Solow (Nobel laureate 1987) had maintained in 1960 that high inflation was fine because it lowered unemployment. This became a basis of Keynesian economics, which I learned well at Michigan from Professor Saul Hyman, and which still provides the basis of new Keynesian economics today. In contrast, Friedman, Edmund Phelps (Nobel laureate 2006) and Lucas ( 1972 ) disagreed with this Keynesian foundation. Phelps ( 1967 , 1969 , 1970 , 1972 ) also won the Nobel Prize for his work on the lack of a sustainable trade-off between inflation and unemployment. Together with Friedman ( 1968 ) and Lucas ( 1972 ), they strove to show that any such permanent trade-off was an illusion.
Consistent with many elements of Austrian economics but now with the rigorous mathematical precision that had previously been lacking, Lucas’s work jolted us by showing how to understand inflation in rigorous ways. Edward C. Prescott ( 1987 ) and Thomas J. Sargent (Nobel laureate 2011) and Neil Wallace ( 1975 ) joined Lucas in this research agenda. Prescott with Fynn Kydland (joint Nobel laureates 2004) were cited in their Nobel awards for inflation theory and real business cycle theory.
Lucas served as chair of my PhD dissertation committee, with Becker and Yair Mundlak also on the committee. My dissertation built on Lucas’s and Prescott’s monetary modelling. It led me to correspond with Friedman. Altogether, Lucas and his colleagues stimulated a broad-based evolution of monetary theory. This has included new work on explaining interest rates as based on the role of the inflation tax, with a money supply increase and banking policy both able to affect interest rates. Much of this work is based on how money supply growth creates inflation.
Lucas pioneered several models of monetary economics that are used widely today, which Sargent ( 2015 ) reviews. Lucas ( 1980 ) laid the foundation for understanding inflation as a tax, which affects consumer behaviour just like any other statutory tax. Based on inflation acting as a tax, Lucas and Stokey ( 1983 ) built the rationale for a new monetary regime that could replace the gold standard lost during the Vietnam War.
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