Economics Questions

Re: Is my view on inflation correct?

meambobbo — Thu, 03 Jul 2008 22:39:37 GMT

I would like to first point out that money != M3. M3 is a measure of a bunch of things that are used in a money-like fashion. M3 contains M2, which contains M1, which contains M0. Familiarize yourself with what these measures actually consist of. In the end, they are all important. They deal especially with the velocity of circulation. Consider your savings account. That's included in M2, but how often do you use it to purchase real goods? M3 contains Eurodollars and other fancy stuff. Do you feel M3 growth would be expressed more in domestic prices or global prices? M3 growth with constant M2 would more likely mean higher prices for oil and other currencies, but less price increase for domestic goods. (How much of our economy is in the exports industry?) This analysis might be too simple, but I just wanted to give you an idea of how the term "money supply" is not well-defined until you understand exactly what goods are being traded and in what markets.

If you are measuring inflation in dollars, it would make sense to include in the money supply anything that is traded at a fixed rate over time with dollars that can be easily traded in and out of dollars. Of course, this gets "funky" when the government fluctuates some things, like gold, in and out of such standards.

your q's:

1. i always qualify the word inflation. austrians take it to mean money growth. most people assume it is price growth. so i say monetary inflation or price inflation. these things are not perfectly correlated...independent of velocity of circulation. for example, economic growth in a static money supply should lead to decreased prices.

2. correct - although i should mention, some people (mostly incredibly dumb) believe that a static money supply prevents economic growth. conversely, we could just shower the streets in money, and our economic output would skyrocket! Make sure you correct anyone making this assumption and tell them that the two relate through prices, not magic.

3. virtually correct - but there's also things like seinorage to deal with...which is important to truly understand the difference between money and currency and a simple consumption good. think how much things like tabacco and gold are used in consumption as opposed to eternal exchange. how do you know if a good is functioning as money or as a consumer good?

4. i think velocity of circulation plays into how fast price inflation catches up to monetary inflation, although i am not 100% sure. the liquidity trap sounds like something FDR and Keynes talked about...

Re: Is my view on inflation correct?

jcernharth — Thu, 03 Jul 2008 15:41:21 GMT

Read through Frank Shostak's posts on this site. Especially his most recent in the Daily section. Those will give you a decent background, especially in present events context. Also, familiarize yourself with Austrian Money Supply (AMS) recently renamed True Money Supply here at Mises.org. You should read Rothbard's material on money supply, and how it works.

Re: Is my view on inflation correct?

pj86 — Thu, 03 Jul 2008 15:24:45 GMT

I don't see how spending my 5K increases money supply with 5K nor do I see how it removes goods from the economy. Before my spending spree, I had 5K and no goods. Afterwoods, I had goods and the seller has 5K. Since both the seller and me are part of the economy, M3 is still the same and dito for output.

Re: Is my view on inflation correct?

fsk — Thu, 03 Jul 2008 15:15:54 GMT

pj86:
I still fail to see why spending your money faster increases inflation.

Why do you think they spend so much effort saying "Inflation is low! The CPI is only 2%-3%." If people get concerned about inflation, that causes even more inflation.

Suppose you spent your paycheck immediately after receiving it, but you were the only one who did it. If your paycheck is $5k, it's like the money supply increased by $5k. You removed $5k in goods from the economy, but the overall supply of money is the same. In M3/Output, you replaced "Output" with "Output-$5k", but the numerator is the same.

If you hold onto cash, you're letting people steal from you via inflation. If you don't hold onto your cash, immediately spending it, then you're not letting yourself get ripped off by inflation.

The willingness of people to hold onto cash reduces the apparent inflation rate.

For all practical purposes, you should assume that the velocity of money is constant. During hyperinflation, the velocity of money spikes in addition to the supply of money.

Re: Is my view on inflation correct?

pj86 — Thu, 03 Jul 2008 14:59:23 GMT

Thank you for the reply.

If I understand you correctly, you say P = M3 / Output is a good way to think about inflation, but somehow you have to assume velocity of money is constant.

I still fail to see why spending your money faster increases inflation. Well, there will be short term effects, but M3 is still the same.

So maybe we have:

1. Long term prices = M3/Output

2. Shor term prices = Liquidity/Output

Velocity of money increases liquidity now, so this temporarily increases price levels.

Correct?

Re: Is my view on inflation correct?

fsk — Thu, 03 Jul 2008 14:46:32 GMT

pj86:

1. Consider inflation in the sense of increasing prices.

2. A price is a monetery quantity paid for a product. (P=M3/Output)

Hence, the two structural drivers of inflation are the money supply (M3 is best?) and the output in an economy.

3. Perception may be different than reality.

Hence, over short periods of time, inflation may be lower or higher than M3/output growth, but this is not sustainable in the long run.

4. How to include velocity of money, liquidity, etcetera in this reasoning? I don't really know, but here is what I can think of:

a. Velocity of money: Means more transactions took place, I don't see how trading a product more increases its price by definition.

b/ Liquidity crisis: = lower M3, so deflationary? Does not seem like a thing to solve if you want to tackle inflation.

1. If you print more money, then prices go up. That's how inflation works. People who give alternate explanations of inflation are fools or intentionally misleading you.

When new money is printed, the people who print and spend the new money are stealing from everyone else.

2. If you double the amount of money, and the amount of goods stay the same, then prices should double. If you keep the supply of money constant and the amount of goods increases, then prices should decrease. This assumes the velocity of money does not change.

M3 is a reasonable measure of inflation. Unfortunately, the Federal Reserve no longer publishes M3. They still publish M2, but M2 is growing at a much slower rate than M3, because of items included in M3 but not M2. I consider the price of gold to be a reasonable substitute for M3. If you use the price of gold as your index of inflation, then inflation is 20%-30% per year for the past few years.

3. Money supply inflation does not lead to uniform price inflation. Price bubbles occur. In the long run, money supply inflation and price inflation should be correlated. In the short run, there are variations. For example, wage increases typically lag money supply inflation. Money supply inflation allows wages to be cut without reducing the number on your paycheck.

4. During times of hyperinflation, people become reluctant to hold unbacked paper. They rush to spend their money immediately after acquiring it. If the velocity of money increases, this increases price inflation.

Here's a way to calculate velocity of money. Suppose my annual salary is $60k and I keep an average of $5k in my checking account. Using first-in first-out (FIFO) accounting, money stays in my checking account an average of 1 month. The velocity of my money is 1 month. During hyperinflation, I'll spend my paycheck the same day I receive it. In this case, the velocity of my money is less than 1 day, causing 30x more price inflation.

Is my view on inflation correct?

pj86 — Thu, 03 Jul 2008 11:33:25 GMT

Hello,

I have had lectures where teachers quickly explain the Fisher equation and start acting like inflation is something that can be managed.

People speak about liquidity crisis, velocity of money, perception/trust and all kinds of other buzz words. More often than not it implies they know it better, that I should stop asking for logic, and accept that they, or the ECB/FED will manage my money better.

Fortunately, there is Mises.org.

Would you be so kind to tell me what is right or wrong about my reasoning on inflation:

1. Consider inflation in the sense of increasing prices.

2. A price is a monetery quantity paid for a product. (P=M3/Output)

Hence, the two structural drivers of inflation are the money supply (M3 is best?) and the output in an economy.

3. Perception may be different than reality.

Hence, over short periods of time, inflation may be lower or higher than M3/output growth, but this is not sustainable in the long run.

4. How to include velocity of money, liquidity, etcetera in this reasoning? I don't really know, but here is what I can think of:

a. Velocity of money: Means more transactions took place, I don't see how trading a product more increases its price by definition.

b/ Liquidity crisis: = lower M3, so deflationary? Does not seem like a thing to solve if you want to tackle inflation.

So, how dumb or smart am I? What about my teachers?