The Fakery of “Fighting Inflation”
Though I am not an Austrian economist, the Austrians are correct to perennially scoff anytime anyone claims that the Federal Reserve is “fighting inflation.” Here’s some typical establishment rhetoric from Brookings’ David Wessel:
The chairman said he was going to be direct, and he was. His speech was shorter than the ones he has given in the past. And I think he was trying to send a strong signal that fighting inflation is their top priority. It means that unemployment probably will get worse, and that is not going to shake them from their resolve.
The Austrian critique, translated into mainstream lingo, is straightforward:
In the real world, large, sustained increases in the money supply are the sole cause of large, sustained increases in Aggregate Demand.
In the real world, central banks are the sole organization capable of causing large, sustained increases in the money supply.
Extreme disasters aside, Aggregate Supply is almost always increasing in modern economies.
Snapping the pieces together, we reach a shocking conclusion: Free markets are fundamentally deflationary. In the absence of monetary intervention, Aggregate Demand stays roughly stable*, while Aggregate Supply is growing. Per every textbook, stable demand and rising supply imply falling prices.
While then is inflation almost always positive in almost every country? Because central banks keep increasing the money supply. If they did nothing, deflation would be the norm.
It is therefore quite absurd to give the Fed or any other central bank credit for “fighting inflation.” You might as well give your hard-partying neighbor credit for “fighting loud noise” because he turned his stereo volume down from 10 to 7. Key point: If the neighbor wasn’t home to “fight loud noise,” the volume would be 0.
The most you can honestly say about any central bank is that they are trying to start causing a lot less inflation. Which sounds underwhelming. Which is why they twist the truth.
But isn’t the free-markets’ built-in deflationary tendency dangerous? Hard to be sure, but likely yes. Specifically: At low inflation rates, there is probably a long-run inflation-unemployment trade-off. Deliberately raising the typical inflation rate from -1% to +2% plausibly keeps the “natural” unemployment rate at 4% instead of 5%. Since unemployment is indeed a grave evil, the overall economic effect of the Federal Reserve is, contrary to Austrians, complicated.
Still, this complexity in no way justifies any of the preposterous propaganda about the Fed’s “fight” against inflation. The Fed is always deliberately causing inflation. If it permanently froze the money supply, the result - for better or worse - would be deflation as far as the eye can see.
*What about population growth’s effect on Aggregate Demand? Counter-intuitively, population growth is actually deflationary, amplifying the free-market’s deflationary tendency. Why? Because more people means greater total demand for real balances. With a fixed nominal stock of money, real balances M/P can only rise if the price level falls.
I want the Scott Sumner response to this framing.
I think the deflation problem is with Government created money vs free banking money. People trust Government too much and so in a downturn the try to accumulate Government money but with free banking, fearful people will try to spend bank money and not hold it.