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G. Inflation and Compensatory Fiscal Policy

Inflation, in recent years, has been generally defined as an increase in prices. This is a highly unsatisfactory definition. Prices are highly complex phenomena, activated by many different causal factors. They may increase or decrease from the goods side—i.e., as a result of a change in the supply of goods on the market. They may increase or decrease because of a change in the social demand for money to hold; or they may rise or fall from a change in the supply of money. To lump all of these causes together is misleading, for it glosses over the separate influences, the isolation of which is the goal of science. Thus, the money supply may be increasing, while at the same time the social demand for money is increasing from the goods side, in the form of increased supplies of goods. Each may offset the other, with no general price changes occurring. Yet both processes perform their work nevertheless. Resources will still shift as a result of inflation, and the business cycle caused by credit expansion will still appear. It is, therefore, highly inexpedient to define inflation as a rise in prices.

Movements in the supply-of-goods and in the demand-for-money schedules are all the results of voluntary changes of preferences on the market. The same is true for increases in the supply of gold or silver. But increases in fiduciary or fiat media are acts of fraudulent intervention in the market, distorting voluntary preferences and the voluntarily determined pattern of income and wealth. Therefore, the most expedient definition of “inflation” is one we have set forth above: an increase in the supply of money beyond any increase in specie.131

The absurdity of the various governmental programs for “fighting inflation” now becomes evident. Most people believe that government officials must constantly pace the ramparts, armed with a huge variety of “control” programs designed to combat the inflation enemy. Yet all that is really necessary is that the government and the banks (nowadays controlled almost completely by the government) cease inflating.132 The absurdity of the term “inflationary pressure” also becomes clear. Either the government and banks are inflating or they are not; there is no such thing as “inflationary pressure.”133

The idea that the government has the duty to tax the public in order to “sop up excess purchasing power” is particularly ludicrous.134 If inflation has been under way, this “excess purchasing power” is precisely the result of previous governmental inflation. In short, the government is supposed to burden the public twice: once in appropriating the resources of society by inflating the money supply, and again, by taxing back the new money from the public. Rather than “checking inflationary pressure,” then, a tax surplus in a boom will simply place an additional burden upon the public. If the taxes are used for further government spending, or for repaying debts to the public, then there is not even a deflationary effect. If the taxes are used to redeem government debt held by the banks, the deflationary effect will not be a credit contraction and therefore will not correct maladjustments brought about by the previous inflation. It will, indeed, create further dislocations and distortions of its own.

Keynesian and neo-Keynesian “compensatory fiscal policy” advocates that government deflate during an “inflationary” period and inflate (incur deficits, financed by borrowing from the banks) to combat a depression. It is clear that government inflation can relieve unemployment and unsold stocks only if the process dupes the owners into accepting lower real prices or wages. This “money illusion” relies on the owners’ being too ignorant to realize when their real incomes have declined—a slender basis on which to ground a cure. Furthermore, the inflation will benefit part of the public at the expense of the rest, and any credit expansion will only set a further “boom-bust” cycle into motion. The Keynesians depict the free market's monetary-fiscal system as minus a steering wheel, so that the economy, though readily adjustable in other ways, is constantly walking a precarious tightrope between depression and unemployment on the one side and inflation on the other. It is then necessary for the government, in its wisdom, to step in and steer the economy on an even course. After our completed analysis of money and business cycles, however, it should be evident that the true picture is just about the reverse. The free market, unhampered, would not be in danger of suffering inflation, deflation, depression, or unemployment. But the intervention of government creates the tightrope for the economy and is constantly, if sometimes unwittingly, pushing the economy into these pitfalls.

  • 131. Inflation is here defined as any increase in the money supply greater than an increase in specie, not as a big change in that supply. As here defined, therefore, the terms “inflation” and “deflation” are praxeological categories. See Mises, Human Action, pp. 419–20. But also see Mises’ remarks in Aaron Director, ed., Defense, Controls, and Inflation (Chicago: University of Chicago Press, 1952), p. 3 n.
  • 132. See George Ferdinand, “Review of Albert G. Hart, Defense without Inflation,” Christian Economics, Vol. III, No. 19 (October 23, 1951).
  • 133. See Mises in Director, Defense, Controls, and Inflation, p. 334.
  • 134. See Mises in Director, Defense, Controls, and Inflation, p. 334.