Inflation in Japan: Cause for Celebration?
The New York Times along with most of the other financial media reports that Japan has finally achieved what many Federsal Reserve economists (see for example 1, 2, 3) , including Bernanke and (non-Fed economist) Paul Krugman have identified as the key goal for Japanese economic health: positive inflation. Krugman, as economist Benjamin Powell notes, has advised that Japan pass a law requiring the central bank to inflate at a minimum rate of 4% for the next 15 years. Similarly, the monetaris school have advised a policy of inflation.
The Fed economists have the story wrong from start to finish. As Benajmain Powell writes in Explaining Japan's Recession,
- Japan’s problem, however, is not inadequate aggregate demand but a structure of production that does not meet consumers’ particular demands. Producing things that nobody wants and propping up malinvestments cannot possibly help any economy. This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them. Neither policy will revive the economy because neither forces businesses to realign their structures of production to match consumer demands.
The problem with the mainstream explanation of Japan is that it focuses on the monetary aggregates and ignores the real structure of production. There is nothing about falling prices that makes production more difficult or impossible. Entrepreneurs attempt to identify opportunities for expliating differences between input prices and output prices. The general price level is not particularly important.
The rapid deflations resulting from credit contraction are the effect, not the cause. The stage for these contractions is set by a prior credit expansion, which resulted in a misallocation in the pattern of investment within the economy. As Powell notes, "The recession or depression that follows an artificial boom is not something to avoid but is essential to the alignment of consumer time preferences and the structure of production. According to Austrian theory, the late 1980s boom was artificial, caused by the Bank of Japan’s expansionary monetary policy."
The misplaced focus on the deflation ignores the real cause of the problem, in the previous round of inflation, and the unsustainable pattern of investment that resulted. Advising a further policy of inflation only layers more mal-investments on top of the existing ones and makes it more difficult for investors to allocate capital in a manner consistent with consumer preferences.
Inflation is the problem, deflation is the cure. The mainstream has demonized deflation as a rationalization for the preferred inflationary policies, and to justify activist central banking. Here, Hülsmann refutes othe deflation myths. Many Austrians would agree with Hayek when he wrote (cited by Salerno):
- It is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation. Indeed, there is a sense in which inflation is infinitely more dangerous and needs to be more carefully guarded against. Of the two errors, it is the one much more likely to be committed. The reason for this is that moderate inflation is generally pleasant while it proceeds, whereas deflation is immediately and acutely painful. . . . The difference between inflation and deflation is that, with the former, the pleasant surprise comes first and the reaction later, while, with the latter, the first effect on business is depressing. There is little need to take precautions against any practice the bad effects of which will be immediately and strongly felt; but there is need for precautions wherever action which is immediately pleasant or relieves temporary difficulties involves much greater harm that will be felt only later. . . . It is particularly dangerous because the harmful aftereffects of even small doses of inflation can be staved off only by larger doses of inflation. Once it has continued for some time, even the prevention of further acceleration will create a situation in which it will be very difficult to avoid a spontaneous deflation. . . . Because inflation is psychologically and politically so much more difficult to prevent than deflation and because it is, at the same time, technically so much more easily prevented, the economist should always stress the dangers of inflation.
Comments (11)
"This policy is equivalent to the old Keynesian depression nostrum of paying people to dig holes and fill them." Professor Powell and Mr. Blumen make an important point.
With Keynesian/mainstream beliefs such as these, how can any individual that possesses basic common sense have nothing but ridicule for Keynesian theory? My 12 year old can understand the futility of digging holes and then filling the same holes up again, since nothing of worth has been produced. But yet this type of reasoning is one of the foundational principles of Keynesian, if not mainstream, economics. The entire Keynesian system is one of the worse retrogressions in scientific thought to have occurred in the 20th century.
Published: February 6, 2006 10:36 AM
Don't the Japanese have helicopters and printing presses? If they could somehow find a way to combine that with the above mentioned practice of digging holes and filling them back in (possibly putting money in the holes before filling them, to encourage more digging in five minutes) the Japanese would be the richest people on the planet. No doubt about that. :)
Published: February 6, 2006 11:13 AM
Dennis,
"My 12 year old can understand the futility of digging holes and then filling the same holes up again, since nothing of worth has been produced."
But your twelve year old has probably been asked to give the proposition a second thought before accepting it. This is not a privilege most public school educated people have had.
I once discussed with my father the very difference, from an economic perspective, between digging holes and filling them up, and building war planes to be shot down over Europe. It was hard for him to see the parallel. I really think it was hard for him to see my point at all. The war as prevailing wisdom had it, and still has it, pulled the economy out of the depression, after all.
Published: February 6, 2006 12:25 PM
My 3-year old has learned alternate words to a children's song...
Let's call it pre-deprogramming.
Published: February 6, 2006 5:57 PM
How will the banks do this? By lending money at less than their inflation rate? By losing money?
Published: February 7, 2006 12:57 PM
Billwald, the Japanese banking system has had 0 or negative lending rates for years. They do this by maintaining loans on the books made to people who made off with the money without paying it back. If Japanese banks were to all "write off" the bad loans they hold, many of them would be bankrupt instantly.
Rothbard's comments about defaulting on the National Debt are just like this. The Debt is so great, that if the government were to simply write it off...what? Nothing. The world would not end. It may be interesting for a while, but would be panic be really all that bad?
The problem is that the Federal Reserve, just as the Japanese central bank has done, would simply print more money and hand it to the banks/government to keep them "solvent".
Published: February 7, 2006 1:19 PM
A plausible scenario: someone applies for a gov't grant to open a business to employ people to dig holes and refill them. Included in the grant request would be funds requisite for the purchase of land, shovels, and ibuprofen.
Published: February 7, 2006 11:50 PM
Money is a promissory note on future production of something you want or need, and which is the product of someone else's labor or industry. It is a store of value, if you expect to be able to buy something useful with it from someone else in the future. That something may be digging holes just to fill them, building helicopters just to be shot down, or to blow up homes in Iraq so they can in turn be rebuilt. These are not necessarily a waste of money, if that's what you want, for some bizarre reason. One would hope that, instead, money would be spent on items that make life better, and invested in processes to make them at lower cost, thus freeing up money to create new items of greater usefulness. If it turns out what you bought was not really what you wanted (e.g. a disaster in Iraq), and you now have buyer's regret, then the waste of money just became a waste of time. Something else more useful could have been bought instead. You now have to start over saving for whatever that is. Keep this behavior up, and eventually your life runs out, and the next generation has to clean up your stupidity. If you borrowed the money you wasted and now leave the debts to your heirs, they would be smart to default, or matters will only get worse for them as they will be burdened by servicing the debt of dead people -- a continuing waste of time/money -- and the liquidity these foolish dead people dumped into the monetary system buying worthless products and services they really did not want or need will drive up the price of those items more useful. That's called inflation. Wasting borrowed money, and its by-product, inflation, are sustainable at low rates, so long as the vast majority of people are too stupid to notice how it really destroys their livelihood. We've been at it since 1913. Who is to say we really can't be fooled another 100 years?
Published: February 11, 2007 7:24 PM
"Money is a promissory note on future production of something you want or need"
No it isn't.
Published: February 11, 2007 9:20 PM
From the www.mises.org quiz.
Money always emerges out of barter. The difficulties of finding trading partners under barter systems results in the emergence of commodity monies. Durable, portable, and divisible commodities, like gold and silver, typically fit the bill as money best. Money and related institutions emerge as an unintended consequence of self interested trading. The evolution of such institutions is best left to the competitive market forces that created them in the first place, as governmental intervention will result in inflation and other distortions.
Published: February 12, 2007 10:01 AM
The Indian People in the Pacific North West had no metals but were so rich that they had to invent the potlatch to determine social/tribal status. There was an old National Geographic program about a tribe someplace that used pigs for money. They didn't present any evidence that this tribe was less happy than people who traded with gold.
Published: February 12, 2007 11:26 AM