Friday, February 13, 2009

How to treat a recession III

When everything else fails, there's still the printing press - even though today's money creation happens mostly within the digital realm. Anyhow, politicians praise inflationary policies in recessions as a means to achieve three things:

1) Generating funds to finance stimulus packages without taxation
2) Creating incentives to spend money now due to expected future inflation
3) Preventing falling prices

As for the first part, that's pretty easily refuted. There's no such thing as a free lunch. Even though you don't have to tax at gunpoint in this case, the effects of inflation will be the same as taxing a comparable amount of money. Your dollars lose purchasing power, thus they're worth less - you're likely to need more of them to buy the same amount of goods and services. It may not be as obvious, but it still happens and there's no categorical difference between governmental inflation and taxation. It's merely semantics.

The second point rests on the fallacious view that "consumption drives the economy". If you can stimulate aggregate demand, that'll increase aggregate supply and everything's supposed to be fine again. But an economy exists to satisfy wants and needs. The fact that vast shifts in the structure of production are occuring (with the accompanying recessionary inconveniences) shows there is a vast discrepancy between what is being produced and what is being demanded. Artificially changing these demand patterns by threat of inflation does no good to the general welfare - it's like offering someone a childhood painting of yours for 50 dollars or else he will get shot. Considering his options, your counterpart will probably go for your painting - not because he demands this particular good, but because the only alternative you grant is much worse. Actual demands are not going to be satisfied. It's a charade.

Falling prices and deflation are among the biggest scare stories around. According to some, they will lead us into a downwards spiral that'll only end once we hit rock bottom. However, prices and wages need to drop if necessary adaptions to vast changes in customer demands are to be performed. If nobody wants to build a house anymore at current market rates, what's the use in upholding wages of construction crews? If jewelry is too expensive for the majority of previous customers, why should you keep prices up? It's a clinging to a previous state of affairs that may have been more beneficial to some individual market participants, but turned out to be unsustainable. Trying to freeze the economy in this boom period to prevent a supposed downwards spiral will only hinder essential corrections and prolong the recession.

In short, printing money does not increase wealth. As simple as that sounds, it's a pretty tough story to sell in Washington, D.C..

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