Saturday, August 28, 2010

Reduction (2)


I don't dispute the quantity theory of money. I take it as a "given." But suppose something weird happened: Suppose it came about that we needed 3% annual money growth to keep prices stable, but we needed 6% money growth to keep the economy growing at a satisfactory rate. This would be a problem.

It would be a problem because the money growth required to keep the economy growing would be too much to assure price stability. It would be a problem because reducing money-growth enough to assure price stability would undermine growth. It would mean that we couldn't have growth without inflation, and we couldn't reduce inflation without reducing growth.

This is not a problem that would be. It is exactly the problem that we have had since the 1970s. Because of this problem, we cannot get growth enough to balance the budget. We can't get growth enough to keep unemployment low. We can't get growth enough to keep living standards rising. We can't get growth enough, period.

And still we've had inflation -- too much inflation, for too many years.

Worst of all, we cannot solve the problem. The problem arose in the 1970s. This is 2010, and we still have not solved the problem. And now on top of it we have financial crisis: Out of the frying pan, into the fire.

The problem is not that we have inflation. The problem is not that economic growth is weak. The problem is that we need an inflationary increase in the money in order to get decent growth. Since we have chosen to keep inflation at a low level, we are limited to a low level of economic growth. This problem cannot be solved by thinking of inflation and growth as two separate problems.

Q: What is it that might inhibit growth, except in conditions of high inflation?

A: Cost. Rising costs inhibit growth. Rising costs, for consumers, mean pay hikes are necessary or, barring that, living standards must fall. Rising costs for businesses mean prices must go up, profits are squeezed, and business is not good.

Cost is the problem that inhibits growth. But as it turns out, creating some inflation compensates for rising costs, and gets us a little growth. So policymakers have opted for low but continuous inflation.

Cost is the problem that inhibits growth and demands inflation.

Costs are rising. We knew this in the 1970s. Back then, people said there was "a wage-price spiral." Basically, policymakers and the media said prices were going up because wages were going up. So it was our fault. That was nonsense. Still, the problem is that costs are rising.

Q: If not wages, then what is the problematic cost?

A: You know the answer to this. Simon Johnson has pointed it out. ContraHour has pointed it out. Probably many others as well. Finance is the problem.

The excessive growth of finance is the problem. But of course, finance fills a need. So then, we may say the excessive reliance on credit is the problem.

Now it sounds like our fault again. We did the borrowing. For that matter, we did the lending, too. There is too much borrowing and lending, too much reliance on credit, too much cost of credit use. This is the cost that created our economic problems in the 1970s. And since that time, finance has only grown.

If I have said this well, there is only one loose end. Your question must be --

Q: Why is our reliance on credit so high?

A: Policy.

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