I must deal with an argument that, ... seems to lie at the root of the view which represents inflation as relatively harmless. It seems to be that, if future prices are correctly foreseen, any set of prices expected in the future is compatible with an equilibrium position, because present prices will adjust themselves to expected future prices. For this it would, however, clearly not be sufficient that the general level of prices at the various future dates be correctly foreseen, and these, as we have seen, will change in different degrees.
A main part of the Austrian argument is that prices do not rise simultaneously throughout an economy. Elsewhere in the essays the adjustment of prices is described as a titled plane, where some commodities rise or fall in price before others. This is a way to visualize the fact that money does not flow equally throughout the entire economy. Despite our governments policies, there is only a limited supply of money available and it must flow through the economy. It takes time for inflationary effects to touch any particular segment.
With this background, the quote above is attempting to point out that future valuations will be flawed because the effects of inflation are not consistent and the different degrees by which these changes occur cannot be foreseen.
More important, however, is the fact that if future prices were correctly foreseen, inflation would have none of the stimulating effects for which it is welcomed by so many people.
Now the chief effect of inflation which makes it at first generally welcome to business is precisely that prices of products turn out to be higher in general than foreseen. It is this which produces the general state of euphoria, a false sense of wellbeing, in which everybody seems to prosper. Those who without inflation would have made high profits make still higher ones. Those who would have made normal profits make unusually high ones. And not only businesses which were near failure but even some which ought to fail are kept above water by the unexpected boom. There is a general excess of demand over supply-all is saleable and everybody can continue what he had been doing. It is this seemingly blessed state in which there are more jobs than applicants which Lord Beveridge defined as the state of full employment-never understanding that the shrinking value of his pension of which he so bitterly complained in old age was the inevitable consequence of his own recommendations having been followed.
But, and this brings me to my next point, "full employment" in his sense requires not only continued inflation but inflation at a growing rate. Because, as we have seen, it will have its immediate beneficial effect only so long as it, or at least its magnitude, is not foreseen. But once it has continued for some time, its further continuance comes to be expected...
Or in my own words, when the high wears off businesses realize where the growth came from and are able to adjust future valuations on the inflated prices.
But if prices then do not rise more than expected, no extra profits will be made. Although prices continue to rise at the former rate, this will no longer have the miraculous effect on sales and employment it had before. The artificial gains will disappear, there will again be losses, and some firms will find that prices will not even cover costs. To maintain the effect inflation had earlier when its full extent was not anticipated, it will have to be stronger than before. If at first an annual rate of price increase of five percent had been sufficient, once five percent comes to be expected something like seven percent or more will be necessary to have the same stimulating effect which a five percent rise had before. And since, if inflation has already lasted for some time, a great many activities will have become dependent on its continuance at a progressive rate, we will have a situation in which, in spite of rising prices, many firms will be making losses, and there may be substantial unemployment. Depression with rising prices is a typical consequence of a mere braking of the increase in the rate of inflation once the economy has become geared to a certain rate of inflation.
All this means that, unless we are prepared to accept constantly increasing rates of inflation which in the end would have to exceed any assignable limit, inflation can always give only a temporary fillip to the economy, but must not only cease to have stimulating effect but will always leave us with a legacy of postponed adjustments and new maladjustments which make our problem more difficult.
Let me repeat, only a temporary bump to the economy. I have some more from Hayek's essay to share, but I will leave them for another post.