24 January 2009

Can We Still Avoid Inflation?

I really enjoyed the essays from the Austrian school of economic thought on the trade cycle. I have another point I want to mention, and a few more posts worth.

The essay Can We Still Avoid Inflation? by Friedrich A. Hayek was given as a lecture on May 18, 1970. I find this question interesting, as it seems to be a given in our time that inflation will always be with us.

In the elementary textbook accounts, and probably also in the public mind generally, only one harmful effect of inflation is seriously considered, that on the relations between debtors and creditors. Of course, an unforeseen depreciation of the value of money harms creditors and benefits debtors. This is important but by no means the most important effect of inflation. And since it is the creditors who are harmed and the debtors who benefit, most people do not particularly mind, at least until they realize that in modern society the most important and numerous class of creditors are the wage and salary earners and the small savers, and the representative groups of debtors who profit in the first instance are the enterprises and credit institutions.

I don't know if most of us really know that inflation is helpful in paying off debts, but the larger debtors (e.g. our government) I am sure do know. When you can use money worth less to pay off past amounts it makes economic sense in that transaction. Hayek moves on beyond this point, and this I find interesting given the little that I have learned about valuing companies. Again quoting from the essay.

There is, however, another more devious aspect of this process [inflation] which I must at least briefly mention at this point. It is that it upsets the reliability of all accounting practices and is bound to show spurious profits much in excess to true gains. Of course, a wise manager could allow for this also, at least in a general way, and treat as profits only what remains after he has taken into account the depreciation of money as affecting the replacement costs of his capital. But the tax inspector will not permit him to do so and insist on taxing all the pseudo-profits. Such taxation is simply confiscation of some of the substance of capital, and in the case of a rapid inflation may become a very serious matter.

My short summary, inflation is bad. Savings are a much healthier form of growth, if only we could have more discipline in these matters. I am curious what the arguments for inflationary policies are, how do they defend what I view as corrosive practices. More to come shortly.

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