Term Deficit

Today I want to talk about inflation a little, and mention some problems we have in discussing it.

What is inflation? Well in ordinary terms it is the condition that occurs when an economy is growing, and wages and prices increase to keep up with growth. Eventually, if the economy is really "hot" (growing fast), a wage and price spiral occurs. At that point a natural upper limit occurs, and the economy reverses into deflation and recession while correcting imbalances that occurred in the boom period. This is the organic business cycle that has been repeating since the beginning of societies.

OK, but printing money, as our Fed has been doing, is also inflation. But that is a very different kind of inflation. Consider - central banks only "print" during slow economic times (to stimulate the economy). So how can you have inflation and a slow economy at the same time?

Well maybe you can't, and the "inflation" induced by printing is a misnomer, at least in classical terms. Printing does drive up prices: where one dollar becomes two, other things being equal, prices double. But if I break a pencil in two, I still have the same amount of wood and lead. Real wealth is not created, as in the case of inflation in an "organic" business cycle and growing economy.

Modern monetary practices are based on the fact that markets are in some measure determined by psychology - two half pencils "seem" like more than one whole one. Extrapolating the metaphor, the game has limits - pencil functionality is reduced, and repeated enough, destroyed.

To monetarists and central bankers, distinctly different terms for "induced" vs "organic" inflation would be conter-productive when the goal of "induction" is renewed confidence. Two distinct terms negate the psychologic effect.

But continuous pencil breaking destroys the thing they are trying to save. Central bankers are not immune to classic human foible, the desire for free lunch. There isn't one.