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Fooled by the Numbers

Mises Daily: Monday, September 13, 2004 by

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Modern central banks pronounce economic and monetary stability as their target. But what they are after is not the real thing but a statistical chimera. Ludwig von Mises put it this way:

"The money equivalents as used in acting and in economic calculation are money prices, i.e. exchange ratios between money and other goods and services. The prices are not measured in money; they consist in money."

and

"All methods suggested for a measurement of the changes in the monetary unit's purchasing power are more or less unwittingly founded on the illusory image of an eternal and immutable being who determines by the application of an immutable standard the quantity of satisfaction which a unit of money conveys to him. It is a poor justification of this ill-thought idea that what is wanted is merely to measure changes in the purchasing power of money. The crux of the stability notion lies precisely in this concept of purchasing power." (p. 221)

"Price stability" is a misleading and an inherently contradictory concept. When such a construct as the price index becomes the guiding post for central banks, they will tend to produce and reinforce the very instabilities they proclaim to fight.

What is getting published as "the consumer price index" represents a statistical hodgepodge. It can be concocted in almost any way, and one can do this without violating common statistical rules. Hedonic calculation is just one example. But despite all the statistical tricks that are being invented and applied, the core issue remains unresolved: what actually is being measured by "purchasing power" and what is the value of money—other than subjective and individualistic—upon which the calculation could be based?

Along with the statistics related to the figures about the domestic and national product, the price index is one of the most unreliable, most deceiving and most abused statistical economic numbers. This is even more the case as the price index provides the basis for a series of other statistical indicators as it serves as a deflator and enters economic growth and productivity figures.  

These macroeconomic numbers suffer from the illusion that the properties of an object—called "the economy"—could be objectively observed and measured. Whatever finesse will be applied to their calculation in order to make these statistics more accurate, it cannot do away with their basic invalidity that results from the impossibility of obtaining a fixed standard of measurement for value.

Attempts to measure the economy as if it were an object has its origin in government planning. Treating the economy as a whole becomes necessary for socialist central planners and under the conditions of total war. They take place under the presumption that some center with decision-making power has the proper knowledge about the means and ends of economic action. The results of these plans are well known; but while socialist-type total economic planning is off the screen even for many devout socialists, central monetary planning through the manipulation of money, credit and the exchange rate ranks still high on the public agenda. Indeed, central banking may be called the last refuge for those still under the spell of the pretense of knowledge.

Fixing their eyes on the so-called "price stability" or following the now fashionable inflation targeting schemes, central bankers are not just after a movable target but one that is more symbolic than real. This way, they neglect the inflation that takes place in the expansion of money and debt.

While central banks theoretically do have the instruments to control at least the monetary base, they are rarely willing to pay the price of a contraction and instead favor an illusory permanent expansion. They act like pushers selling cheap drugs to a gullible public with the financial sector as the intermediary. There is hardly any central bank free from this disease, which is inherent to an unanchored fractional reserve banking system.

Like with individual prices, the prices of groups of goods and services rise and fall. There are always inflationary and deflationary spots in an economy at the same time. When small aggregate price movements occur or when opposing forces are at work, the price index renders no valuable signal. If, however, strong tendencies in one or the other direction of the general price level are under way, and when this finally shows up in the price index, it is usually too late for the central banks to catch up. 

Price indexes necessarily average out the extremes; they are unable to signal the more subtle price movements and they leave out relevant items such as asset prices. This way, it is not only the general public that is being deceived, the central banks themselves are falling victim to their calculations like the joke of the statistician who drowns while crossing the water that he had thought was easy to wade based on the arithmetic average of its depth.

Currently, for example, the depreciating value of the dollar is already visible in oil, real estate, precious metals, domestic services, health care, tuition or even when calculated against other fiat monies such as the Euro. In this perspective, there is inflation taking place and it has been taking place for quite some time at a remarkable pace. However, when counting in a considerable portion of computer storage capacity and imported gadgets, the picture changes and the perspective of a deflationary trend could be diagnosed by that yardstick.

The great cheat of the stabilizers consists in spreading the illusion that a stable or a moderately increasing price index would imply economic stability and would have no effect on the capital structure. Neither do monetary policy measures publicized under the heading of stabilization imply a constancy of purchasing power. Such measures rather mean that old distortions are covered up while new ones are being created.

Temporary success, like is also typical of deficit spending, makes central banking even more dangerous. Modern central banking is a hideous endeavor. The true dimension of the devastations caused by easy money policies become visible only in the longer run when inflation begins running wild and as such can only be stopped by a deflationary contraction.

Currently, central banks again fail to recognize or remain inactive in the face of the flood of liquidity. Swamping the globe with monetized debt drives the system inexorably on a path where the alternative of either accelerating price inflation or deflation becomes more pressing. When economic actors finally form a dominant expectation, a spiral of feedback processes begins and actions will be adapted accordingly. This is the point where the game slips out of the hands of the stabilizers and hyperinflation and depression loom.

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Antony Mueller is a professor of economics at the Universidade de Caxias do Sul (UCS) in Brazil and an adjunct scholar of the Ludwig von Mises Institute. E-mail: antonymueller@terra.com.br. See his archive. Post comments on the blog.