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Wednesday, February 16, 2011

The Inflation Addiction

The premise of the Keynesian Business-Cycle analysis is that there is too little aggregate demand in the economy. To solve this issue, government needs to take measures by inflating the dollar through actions such as discretionary spending and low interest rates. However,

Keynesian ways of thinking were quite wide spread in England (and indeed, the United States) before the publication of Keynes' General Theory. What has caused the misunderstanding is that in 1936 Keynes turned on many of his former supporters precisely because they had, directly or indirectly, argued that wage-rate reduction could restore the flow of wages and income, although they had been careful to insist that such a solution was 'unrealistic'. (Hutt 1971)

The argument that “undercomsuption” was the cause of the economic downturn served the interest of politicians who hoped to obtain the support of the voting masses. It means that politicians now have the economic justification to buy votes and avoid telling the voting public that the problem of economic recovery stems from sticky-wages imposed by big unions. “It implies income transfers to 'the poor' will restore a declining economy because 'the poor' are less thrifty than the rich, and so will 'spend' not 'save' the income diverted to them.”

To further sell this point, Keynes made the argument that pumping more money in the economy will not cause price inflation. Instead of calling the government's actions inflationary, Keynes was careful to call his economic plan “the maintenance of effective demand”. However, the true goal was to cause price inflation so as to lower the real wages of workers indirectly, instead of taking the more direct approach of allowing businesses to restore the wages of workers to their market value during the period of deflation.

The effects of this indirect approach on the economy is something similar to the effect crystal meth has on its user. At first it seems there really is economic recovery and wealth is being created. However, the effects are only temporary as resources are misallocated and then from the boom must come the bust . Like any good drug dealer, the Keynesian pushes, “just a little more inflation and your economy will be back on track.” Once again malinvestment and over consumption causes another boom and then another bust. This process continues on and on, with the effects of the bust getting worse each time and the Keynesian pusher always calling for more inflation.

The voting public is addicted to inflation. Any attempt to solve the real problems of economic disorder are thrown aside as being unrealistic. Try to take away their handouts, their free tuition, their bailouts, and their minimum wage laws. What will result is protests, violence and calls for impeachment and change of government. Any attempt to decrease the bureaucracy and government programs is met with howls of anger. Heaven forbid one cuts the military, the police, or the education budget. Just like any drug addiction, purging easy money from the system is a difficult and painful task.

All the while, the economy just gets sicker as the new overdose of inflation pours through its system. The people want a quick fix which only results in a temporary high but leave them worse off in the end than when they started. This addiction is unsustainable.

What is required is for strong politicians to stand up and end this addiction for easy money. They must be honest with the people. Instead of inflating the economy and lowering wages through trickery, they must take the honest approach. Allow businesses to adjust in times of recessions to reallocate resources in a sustainable and upfront manner.

To continue to demand the “quick and easy” fixes of the Keynesian school will only destroy the economy in the long run. It takes time for entrepreneurs to reallocate the economy and restore real price signals. It is time to purge the economy of easy money otherwise society will rot in its own disease.

(1971) Hutt, William H.; Politically Impossible ;Institute of Economic Affairs


  1. I think Keynes did recognize that monetary expansion could cause inflation, because he advocated inflation as a means of tricking workers into accepting lower wages. He believed that wages are less sticky when nominally growing, and so decreasing their real cash balances through inflation was an easier means of establishing labor market equilibrium than through wage cuts.

    Also, I would argue that Keynes predominately put emphasis on deficit spending, not inflationary spending. Keynes believed that depressions were caused by a lack of sufficient private investment (the fall in aggregate demand), which was caused by a fall in consumption and a rise in savings. Therefore, Keynes supported "socialized investment" as a means of overcoming the fall both in consumption and the lack of sufficient investment to make good those savings.

    It's important to realize that Keynesian theory has radically changes since The General Theory. Most "Keynesians" generally applied their own world view and accepted only Keynes's points about socialized investments, uncertainty, and price stickiness. That's why I think the Keynesian school is generally so theoretically convoluted.

  2. The point of the article is that not only did Keynes knew that inflation causes prices to rise, but stated otherwise to gain political favor. Keynes duplicity to obtain political favor is now infecting the field of economics, so I am just showing how this process also affects society as well