Artículo publicado originalmente el 21 de septiembre en GoldMoney Research.
En él comento algo realmente revolucionario: la inflación depende en última instancia del dinero en circulación en la economía. ¿Toda una obviedad? Pues bien, son muchos los que se resisten aún a admitirlo … .
“Keynesians of all parties”, paraphrasing Hayek’s famous quote in The Fatal Conceit, explain inflation as an expansion of aggregate demand above the existing supply of the economy. Applied to a recession scenario, Keynesian economic advisers suggest well-known fiscal and monetary expansion policies in the belief that they can foster aggregate demand and thus, income and employment, without affecting prices.
And what about money? Has not money anything to do with prices and inflation? The overall spending of families and firms increases when money is abundant in the market. This is the result of the excess of money in their portfolios. In this case, people will try to get rid of the excess of money holdings by increasing their (nominal) demand for goods, services and assets. However, if the rise in the demand matches with a stagnated supply, goods and services will be scarce and prices will rise. Adopting Friedman’s own words, “too much money chasing too few goods”.
This monetary explanation of inflation was masterfully and initially set out by the leading members of the so-called School of Salamanca in the 16th century, as they explained the inflation created in the Spanish crown as the result of the sudden and massive inflow of precious metals from the Americas to Castille. As they highlighted, in the absence of more goods in the market, more currency units leads to a deterioration of the purchasing power of money, as prices will inevitably rise.
Unfortunately, too many times money expansion has been the usual policy reaction in the face of a recession, and we have a well-established record of its undesirable effects. This policy measure is adopted as if the issue of more units of money (either central banks’ bills or banks’ deposits) could create wealth by itself, in a sort of a virtuous Keynesian chain of successive increases of agents’ spending.
What is wrong in this apparently “progressive” mechanism? In essence, (1) the intended increases in agents’ spending are, even in the best case, only ephemeral and unsustainable, as they are just the consequences of a previous increase in money supply that, sooner or later, will result in a growth of the price level. Therefore, in real terms, money growth does not generate persistent nor sustainable changes in the consumption and investment patterns of both consumers and firms.
(2) Under a typical Keynesian scenario, the expansion of money is also accompanied by a rise in public spending and thus, by the need to finance the state expansion either by higher taxes, more public debt or by even more money creation. In all cases, it results in a contraction of the private sector by the operation of the well-known “crowding-out effect”, as the increasing financial needs of the state makes credit more scarce for all, and thus interest rates rise.
Finally, (3) once people have experienced these inflationary episodes several times, they will try to offset their effects on their income in the future. They will do it by increasing prices, wages, and risk premiums in their contracts when the inflationary measure has just been started or even announced. By doing so, the intended increase in agents’ spending will not take place and the expansion of money will have been purely inflationary and useless.
Monetary expansion is not a good policy in a recession. The one exception is a recession caused by a previous unintended monetary contraction. In normal recessions it leads to a stagnant economy and more instability in the markets, as well as higher and more volatile inflation. This phenomenon, known as stagflation, did shock Keynesian economists in the 1970s with the oil crises, because they did not have a theory able to explain it; and, stuck to the old demand-based inflation theories, they still cannot explain this economic phenomenon.
If we followed the scientific method, once a theory is refuted by the evidence, it should be neglected and left aside. Why then many governments and, even more, many academics and economic advisors, still make current use of it? It might be the inertia of the politicians leading them to inject money in the economy as it is the easiest way to calm voters under a recession. In its place, as long as we live under a monetary system so much regulated by the state, governments should abandon the pretense of managing the economy by controlling the supply of money or the interest rate.
Money supply should only rise according to the growth of the supply of goods and services in the economy. This easy rule will preserve the purchasing power of money, as well as its traditional functions as the universal means of payment, store of value and unit of account.