Relay-Version: version B 2.10 5/3/83; site utzoo.UUCP Posting-Version: version B 2.10.2 9/18/84; site ratex.UUCP Path: utzoo!watmath!clyde!ratex!mck From: mck@ratex.UUCP (Daniel Kian Mc Kiernan) Newsgroups: net.politics Subject: Inflation in a Free Economy? (Nota bene, Baba!) Message-ID: <756@ratex.UUCP> Date: Fri, 18-Jan-85 19:59:18 EST Article-I.D.: ratex.756 Posted: Fri Jan 18 19:59:18 1985 Date-Received: Sat, 19-Jan-85 04:19:27 EST Distribution: net Organization: Terran Mystery Poodles Lines: 117 This is a re-posting; the original vanished mysteriously. BASIC MONETARY THEORY-- M*f=nT In other words: the quantity of money in circulation (M) multiplied by the frequency with which money changes hands (f) equals the aggregate nominal value of transactions (nT). If this is not immediately obvious to you, try looking at it this way: f=nT/M Next, nT=P*T That is: the aggregate nominal value of transactions (nT) is equal to the price level (P) multiplied by the real value of transactions (T). Therefore M*f=P*T (This is called the "transactions version of the quantity equation of money"; the transactions frequency is usually called "velocity", but that is a misnomer which I choose to avoid.) From this, we derive dM/M + df/f = dP/P + dT/T or dP/P = dM/M + df/f - dT/T (This is called the "dynamic form of the quantity equation".) What is tells us is that a change in the price level is brought about by a) a change in the money supply, b) a change in the frequency with which money changes hands, or c) a change in the aggregate real value of transactions. REAL LIFE APPLICATION-- Let's work thru that list backwards: c) Historically, real national income has generally grown for the past several decades, and, with it, T; ceteris paribus, this would lead to a gradual LOWERING of the price level, but the price level has instead increased. b) Transactions frequency increased gradually until recently. These increases, which were not enough to offset the increases in T, were brought on by innovation (the introduction of credit cards, etc) and by expectations of price increases (the holder of money spends it faster than he would otherwise, fearing that it will lose value as he holds it). Recent increases in frequency have been more dramatic, corresponding to increased expectations of increases in prices. Even these more recent increases in f cannot fully account for the increases in the price level; and, more importantly, they are secondarily causal (they were themselves brought on by prior increases in P). Which brings us to (guess what, guys an' gals): a) the money supply which has been ever increasing. How does this come about? 1) Much as the government loves to tax, it loves to spend even more. 2) To cover the difference, the Treasury issues securities. 3) The Federal Reserve Bank buys some or all of these securities. 4) To pay for these securities, the Fed PRINTS MORE MONEY. 5) This increase in the monetary base is then amplified by partial reserve banking. INFLATION IN A FREE ECONOMY?-- Let's go back to our list of the causes of price-level increases, and again work backwards, this time for the case of a laissez-faire economy: c) In the long run, the free economy grows faster than the command economy, because the free economy can take advantage of an undistorted price system (In the short-run, socialist governments, if starting with an LDC and having access to information about prices an production in more-advanced and more market- oriented economies, can attain high growth-rates by diverting production from consumption and to further production. In the long-run, this doesn't last. But take a course on the economic performance of CPEs, 'cause I don't have time to go into the hows and wherefores.), and there is a corresponding growth of T. b) Transactions frequency would rise only as a result of financial innovation. Without prior increases in the price level to trigger expectations of further increases, the frequency would have an expectations component of zero; and there would be no increases because... a) Legal tender laws would be abolished. No one could be FORCED to accept anything as money. Instead, those attempting to buy would have to present something which has value without the force of government behind it. We can expect that whatever becomes the dominant form of money will also serve as the unit of account, the standard of deferred payment, and the store of value. This requires that dM/M be approximately equal to dT/T - df/f Some Libertarians expect that gold or silver will become the dominant monies. While I expect that this will be true for an initial period, I, like Hayek, expect better forms of money to evolve in the long run (but I won't go into that). BUT HOW DO WE MAKE THE TRANSITION?-- Easy! Take the amount of gold held by the government, divide it by the quantity of outstanding Federal Reserve Notes, and then back each Federal Reserve Dollar by that quantity of gold. ------------------------------------------------------------------------------- I wrote the above in response to the mocking disbelief with which some met the claim that there would be no inflation in a Libertarian country. These people displayed their wholesale ignorance of economics. It is incredible that such people pontificate about something of which they know almost nothing. And it's incredible that they choose to be ignorant in the first place, for two reasons. First, some understanding of economics is important for an understanding of the world around us. Secondly, these people undoubtably vote, which is to say, they sit in judgment of the individuals and institutions which make up the economy. If, for example, Baba were on trial, how would he feel if most of the jurors SLEPT thru the proceedings? Maybe someday I'll explain why the only unemployment in a free economy would be the frictional component. Filled with disgust, Daniel Kian Mc Kiernan 9120 Hawthorn Pt Westerville, OH 43081-9605