From an accounting standpoint, future retirement is considered as properly prefunded if either the government sets aside tax money to make future payments or if an individual himself saves his own money for the same purpose.
In the following example, I try to suggest that even if this accounting requirement is satisfied, and even if the government otherwise follows a sound, non-inflationary monetary policy, the retirement funds themselves may well produce just as much price inflation as if the government had simply inflated the money supply to create the retirement funds.
To the extent that the retirement funding merely replaces pre-retirement income, the price inflation will only be the result of a reduction in the supply of labor, and the resulting shortage of goods and services, if not replaced by increased productivity. Seen in this light, the future deficits in social security shouldn’t be seen as a completely monetary and tax shortfall phenomenon, but as in part a supply of goods and services issue. This means that although overseas workers cannot be made subject to payroll taxes, they may still be part of the solution in the form of the goods that they supply.
Assume that I have been retired for 5 years when I unexpectedly start getting a monthly check for $1000. This results in a change in my purchasing choices and will produce an incremental inflationary pressure on the prices of the goods and services that I now buy, whether the goods and services are different or whether I simply am willing to pay higher prices for the same goods and services.
If the $1000 check comes from the government and is the result of it simply creating new money out of thin air, there is no mystery to be explained as I am simply part of the mechanism by which monetary supply inflation is transformed into price inflation.
However, if the money instead comes from a long forgotten government vault last opened 50 years ago, even if I were aware of this fact, it is likely that my purchasing decisions would be the same and the resulting inflationary pressure on prices would be the same.
Similarly, if the source of the money were a long forgotten bank safety deposit box, jointly filled by my brother and myself 50 years ago, the result would still be the same.
In summary, price inflation is the result of an increase in the purchasing power of individuals which they choose to employ to achieve subjective goals. The source of this purchasing power increase may or may not be monetary supply inflation, in either the present or in the past. It may equally well be some form of effective monetary supply deflation in the past.
Since Austrian theory does not allow monetary supply deflation to be considered a remedy for a previous monetary supply inflation, or the reverse, a given increase in purchasing power must be considered just as much of a factor of increase in price inflation, independent of whether the source of the purchasing power is a monetary supply inflation or not.
{ 5 comments }
I don’t understand the last paragraph (or it’s just wrong), and it seems to me that the rest of it isn’t wholly correct either. I think the scenario you’re talking about has no net effect on supply or demand.
If you save up enough money for an extra $1,000 a month during retirement, or if you were taxed enough to fund a $1,000/month check, that means that you did not consume $1,000 a month’s worth of goods and services at the time when you were productive. So by your argument, this would have a ‘deflative’ effect on prices, since there is downward pressure on demand.
On the other hand, if you had not saved or been taxed during your productive years, then no demand for goods and services were deferred. So the way you’re looking at things, not saving or being taxed (for a lock-box fund) amounts to price inflation in the present (as opposed to during retirement).
The net effect is the same in the long term. That $1000 monthly amount is always consumed, either when you first earned it, or when it’s later gotten back as investment or social security. By the time those funds have run their course, the same amount of consumption has occurred.
As for your last paragraph, doesn’t Austrian theory require a deflationary period after an artificial monetary expansion, and state that as the only remedy?
Anyhow – your argument rests on a net increase in purchasing power driving up prices. Since this scenario is actually deferred purchasing power, there is no such net increase.
The argument is silly. You’re saying, if I understand you, that if I put $50,000 in a box for fifty years, and then spend it, that’s inflationary.
Well, what if I put $100 in a box for ten years, and then spend it. Is that inflationary?
What if I put $2.84 in my pocket for twelve minutes, and then spend it. Is that inflationary?
This isn’t “inflationary,” but there are two scenarios to consider:
1. You find a vault of forgotten money. Prices will rise, just like they would rise with a gold strike under a gold standard or if the fed printed more $$$ under a fiat standard. The impact would be pretty small.
2. You save for retirement. Entrepreneurs and managers see that interest rates have fallen. The signal they get is that your time preference has changed: you prefer relatively more future consumption. To the extent that they can correctly anticipate future demand, they will hustle to provide you with more future goods because they expect higher future prices.
Thinking about this graphically, consider two markets, “stuff today” and “stuff tomorrow.” In equilibrium, the price of “stuff today” will equal the price of “stuff tomorrow” with appropriate time adjustments. When you save more for retirement, the demand curve for “stuff today” shifts to the left and the demand curve for “stuff tomorrow” shifts to the right. Prices are no longer equal. The astute entrepreneur or manager will withhold “stuff today” in anticipation of higher future prices, effectively turning it into “stuff tomorrow.” The supply curve for “stuff today” will shift to the left, and the supply curve for “stuff tomorrow” will shift to the right until prices are re-equilibrated.
Art,
You’re absolutely correct, I think.
But since there are so many actors on the economic stage, while some are salting money away for a rainy day, others are opening their rainy stashes and spending. So the effects cancel. Without an increase in the total money supply (cash in circulation plus cash stuffed in mattresses) there’s no inflation.
Art et al,
“This isn’t “inflationary,” but there are two scenarios to consider:
1. You find a vault of forgotten money. Prices will rise, just like they would rise with a gold strike under a gold standard or if the fed printed more $$$ under a fiat standard. The impact would be pretty small….”
We agree in effect on this. When an individual receives an increase in the amount of money that he holds unallocated and available for discretionary spending, the law of diminishing marginal utility implies that he will undergo a reduction in his subjective valuation of money that he will employ in making purchasing decisions about specific quantities of specific goods at specific prices.
It is this tendency to grip his marginal dollar less intensely that, when repeated through the economy by a sufficient number of individuals, will result in observably higher market prices for involved goods. The smallness of the effect here is no more than in any other case in which the actions of individuals combine to produce macro effects.
What is important to understand is that every change in the infinitesimally detailed state of the economy results in the economy trying to adjust to that change in real time. For a variety of reasons, the adjustments in response to a step change in the quantity of money, for example, may take months or years to settle out. But, in the absence of further changes, settle out they will.
The idea that the effects of an increase in the effective money supply now depends significantly on whether a linked reduction in the money supply 50 years ago occurred, is to ignore the fact the the economy is constantly adjusting.
What IS true is that absolute future prices may be higher as a result of a current increase in the effective money supply if there was no past
decrease in the effective money supply 50 years ago to produce a lower starting point for absolute prices.
However, this is of little or no economic significance as it is a clear insight of Austrian Economics that, unlike all other economic goods, the absolute quantity of money, and by implication, absolute prices, is largely economically irrelevant.
It is entirely relative prices that serve to allocate scarce resources to their most highly valued use.
It is also a fundamental insight of Austrian Economics that money is non-neutral. This means that changes in the supply of money do not uniformly change prices, but change relative prices as well depending on details of how the change in the supply of money comes about.
In general, a change in relative prices will tend to require both the creation of new specific capital and the liquidation of existing specific capital in order to optimally allocate resources in accordance with subjective human values, which are themselves in part determined by relative prices. Values and prices are both components of an IMPLICIT equation which the economy solves iteratively. Thus both increases and decreases in the supply of money should be thought of as independent interruptions to which the economy must make an adjustment. When one change trails the other by a time interval which is smaller than the time required by the economy to adjust to the first change, the observable effects will be hard to clearly analyze. Even worse, in the real world, an unlimited number of these changes are going on all the time, and make analysis of the observable effects virtually impossible. However, this in no way affects the theoretical fact that the changes are separable.
Regards, Don
Comments on this entry are closed.