Monday, September 26, 2011

Monetarist theory of deflation is dead, dead, dead

Occasionally you will still see some libertarian-leaning web site quoting Friedman,  "Inflation is always and everywhere a monetary phenomenon."
This has lead to a great deal of anticipation in the last few years for an extreme bout of inflation, as the Fed Reserve has continued to print out new money to capitalize the otherwise-insolvent banking industry. 
Popular economic theorist Mike Shedlock has a great article concerning how both the Monetarists and the Austrians have been subject to numerous false inflation calls because of their theory of money.  Quoting Mish:
Although the Keynesian and Monetarist economists have missed the boat on what is happening and why, Austrian minded folks who fail to understand the importance of credit and how little the Fed can do to revive it have blown the call as well.....
Focus on Money Supply Alone is Fatally Flawed

Deflation is about credit, it is also about attitudes that govern the demand for credit.

As I have stated many times over the years, and as stated above in the Contrary Investor, there is nothing the Fed can do to force businesses to expand or banks to lend.

That point explains why Austrian economists who focus on money supply alone have failed and will continue to fail.

Until consumer demand returns, businesses would be foolish to expand. Unfortunately, the Fed's misguided easing policies have stimulated commodity speculation thereby increasing manufacturing costs, while simultaneously clobbering those on fixed income and reducing final consumer demand.
In other words, the key element in our modern economy is the debt demand/credit supply, which is much larger and more influential than the strictly-money supply. 
The current economic catastrophe is due to a Deflationary Depression, caused by real-estate speculation, i.e., the build up of a debt bubble based on the monetization of real estate.
The best cure for this type of Debt-collapse Deflationary Depression is to liquidate the bad debt as quickly as possible.  Unfortunately, our public policy today is the exact opposite of that. 


Unknown said...

Many measures of the money supply include credit

Justin said...

Yeah, it seems they should, or be irrelevant. There is also the problem of the "velocity" of money to worry about too.