Thursday, May 24, 2007

Monetary Policy and Inflation (4) - No Excuses

The following often get blamed, but they cannot cause inflation.

  • Businesses cannot start inflation, because they do not control the money supply.
  • An oil shock cannot cause inflation by itself. If the price of major commodity doubles, those who buy it will no longer be able to afford other things that they used to buy, so the prices of those are likely to fall. There will be a change in relative prices, not an increase in overall all prices.
  • A housing boom cannot cause inflation. If people suddenly get obsessed with owning houses, the prices of houses will go up. However, if people are spending their money on houses, they will have to stop buying other things and the denand for those things will fall. A housing boom can only turn into inflation, if the government supports it by increasing the money supply. Alan Greenspan supported the Dotcom bubble in 2000 by reducing the discount rate.
  • Tax cuts do not cause inflation. Money that was previously spent by the government will be spent by the taxpayer. They may spend their money differently, which would result in a change in relative prices, but no extra money should be spent. Tax cuts only become inflationary, if the government continues to spend the money that it no longer receives in taxes. In this case the money is spent twice, once by the tax payer and once by the politicians, who give tax cuts, but are not willing to give up any of their wonderful schemes.
Only governments have the power to cause inflation. I would not expect a Parliamentary committee to discover new and better ways of managing money. They are the cause of the problem, so they will be unlikely to find a solution. They are more like to come with more creative ways of avoiding the blame for the damage that governments do to our money.

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