Tuesday, November 22, 2011

Two Austrian Definitions of Inflation

A post here on the Mises.org blog raises some interesting questions about the Austrian definition of inflation:
Per Bylund, “Inflation and Deflation: Austrian Definitions,” November 18, 2011.
In essence, the author cites this definition of inflation by Mises in his treatise The Theory of Money and Credit (1953):
“In theoretical investigation there is only one meaning that can rationally be attached to the expression Inflation: an increase in the quantity of money (in the broader sense of the term, so as to include fiduciary media as well), that is not offset by a corresponding increase in the need for money (again in the broader sense of the term), so that a fall in the objective exchange-value of money must occur. Again, Deflation (or Restriction, or Contraction) signifies: a diminution of the quantity of money (in the broader sense) which is not offset by a corresponding diminution of the demand for money (in the broader sense), so that an increase in the objective exchange-value of money must occur. If we so define these concepts, it follows that either inflation or deflation is constantly going on, for a situation in which the objective exchange-value of money did not alter could hardly ever exist for very long. The theoretical value of our definition is not in the least reduced by the fact that we are not able to measure the fluctuations in the objective exchange-value of money, or even by the fact that we are not able to discern them at all except when they are large.” (Mises 2009 [1953]: 240).
The significance of this passage is discussed by Horwitz (2000: 78), who argues that it appears to allow the idea that a fractional reserve banking system could create credit (fiduciary media) in response to demand for it, without, in Mises’s view, causing inflation.

In contrast to this, we have the definition of Murray Rothbard in Man, Economy, and State: A Treatise on Economic Principles (1962):
The process of issuing pseudo warehouse receipts or, more exactly, the process of issuing money beyond any increase in the stock of specie, may be called inflation. A contraction in the money supply outstanding over any period (aside from a possible net decrease in specie) may be called deflation. Clearly, inflation is the primary event and the primary purpose of monetary intervention. There can be no deflation without an inflation having occurred in some previous period of time. A priori, almost all intervention will be inflationary. For not only must all monetary intervention begin with inflation; the great gain to be derived from inflation comes from the issuer’s putting new money into circulation.” (Rothbard 2004 [1962]: 990).
This definition obviously contradicts that of Mises, and what we have here is another quite clear division within the Austrian school between those who
(1) hold to the “monetary equilibrium” view of inflation as increases of money greater than the demand to hold it (such as Steve Horwitz, and a view which is most probably held by all Free Bankers), and

(2) the Rothbardians and other anti-fractional reserve bankers who regard any increase in the money supply not backed by commodity money as inflation.
BIBLIOGRAPHY

Horwitz, S. 2000. Microfoundations and Macroeconomics: An Austrian Perspective, Routledge, London and New York.

Horwitz, S. “Mises Defining Inflation the Monetary Equilibrium Way (in 1951),” Coordination Problem, September 3, 2009.

Mises, L. von, 2009 [1953]. The Theory of Money and Credit (trans. J. E. Batson), Mises Institute, Auburn, Ala.

Rothbard, M. N. 2004 [1962]. Man, Economy, and State: A Treatise on Economic Principles, Ludwig von Mises Institute, Auburn, Ala.

11 comments:

  1. Yes, there was actually a heated discussion about this a while ago on the Mises.org and Coordination Problem blogs. Nothing is necessarily "new" here.

    Over his life, Mises was rather ambiguous about the benefits of FRB and whether it would cause a business cycle. However, he always thought that a system of free banking would eventually turn into a 100% reserves system, because as bank failures and business cycles occurred banks would be subject to market discipline and raise reserve ratios over time.

    Rothbard's definition is not entirely his own. I don't agree with Rothbard's definition per se, because (like Mises) I believe that gold inflows can cause a business cycle. See Salerno's first section on the evolution of the word:

    http://www.thefreemanonline.org/featured/money-and-gold-in-the-1920s-and-1930s-an-austrian-view/

    ReplyDelete
  2. "I don't agree with Rothbard's definition per se, because (like Mises) I believe that gold inflows can cause a business cycle. "

    So in your view even a 100% reserve banking system would not end the business cycle in countries subject to significant capital account inflows?

    ReplyDelete
  3. Yep. As did Mises. Gold inflows, mined gold, or even a large dishoarding of gold that is spent primarily on investment.

    ReplyDelete
  4. And that is what I have argued myself, though not using the ABCT.

    Asset bubbles of the familiar type causing debt deflationary collapse would exist even in a Rothbardian world. So much for the allegedly "best" sytem ever devised.

    ReplyDelete
  5. Well, substantial gold inflows, mined gold, etc that is spent on investment and not spent relatively neutral/on consumption would cause an ABCT like bubble. Obviously, under a fractional reserve banking system, these inflows will be magnified since banks can pyramid credit and such.

    Best systems do not have to be perfect. They just have to minimize the problem.

    ReplyDelete
  6. Mises and the ME people, I think, believed that new gold would not cause a business cycle under free banking because the banking system could adjust for this factor and ensure that the new gold would not be used for money.

    ReplyDelete
  7. Jan said:Thank you Lord Keynes,for decoding the
    variations of Tacit knowledge from the Austrian schoolars for us others.Their definitions of economic key concepts seem sometimes wrapped in an enigma.

    ReplyDelete
  8. "Best systems do not have to be perfect. They just have to minimize the problem. "

    Precisely. And a fiat monetary system with financial regulation and a central bank would minimise the problems of FR banking, leaving us with its benefits.

    ReplyDelete
  9. Don't forget a job guarantee!

    Seriously, I find Hugo's observation from a recent post very attractive: run a balanced budget for all government spending except for a job guarantee and you've effectively rendered the money supply endogenous - essentially, operate the JG on a separate account.

    Voila! Money is produced in line with demand, involuntary unemployment suddenly disappears (neoclassicals and austrians alike should love this, since that part of the world suddenly behaves exactly as they already believe it does) and hyperinflation is virtually impossible.

    All the benefits of a gold standard, without the drawbacks of short-term price instability and the translation of basically any shock into a crisis.

    ReplyDelete
  10. "All the benefits of a gold standard, without the drawbacks of short-term price instability and the translation of basically any shock into a crisis. "

    Supply-side inflation would still be a problem. You would require commodity buffer stocks:

    http://socialdemocracy21stcentury.blogspot.com/2011/06/stagflation-in-1970s-post-keynesian.html

    ReplyDelete
  11. Precisely. And a fiat monetary system with financial regulation and a central bank would minimise the problems of FR banking, leaving us with its benefits.

    Regulation cannot stop credit expansion bubbles, because that would imply regulators are able to predict future human choices, and constantly anticipate future human choices before they make them, which is absurd.

    After over 80 years of central bank and regulations "experimenting", the world still has no eradicated the credit expansion business cycle.

    When will you realize your position is based on faith, and not reason or logic?

    A better system, not a perfect system, but a better system, would be one in which credit expansion is minimized. Free banking, and 100% reserve gold standard, are both superior to unlimited credit expansion subject to impossible regulation from power centers.

    ReplyDelete