indessed roscivs

We live in a rapidly progressing society, with technological gains making it cheaper and easier to create everything from food to electronics. Yet every year, everything gets more expensive. How exactly does that make sense?

An excellent question! It’s because of the money supply.

If the amount of money in circulation remains constant, then a single dollar can buy more and more things each year. This is exactly because of those technological and economic gains that make everyone better off. (For example, if we had the same number of dollars in circulation now as in the 1950s, they’d be worth about ten times as much—gas would be worth 30 cents a gallon, and $10,000 would be an awesome yearly salary.)

The Federal Reserve (the nice folks who manage how much money gets printed) doesn’t do this, though. They print more and more money every year. They could print just enough more money so that the amount the dollar could buy remains pretty much constant, but they don’t. Instead, they print a little over-much money so that we get a rate of inflation of a few percent each year. There are a few reasons they do this:

1. (the conspiracy-theory reason)
   It’s a subtle form of taxation. Each extra dollar they print devalues every other dollar by a fraction of a cent (”1/n USD” to be exact, where n is the number of dollars currently in circulation). But most people don’t understand this, nor do they realize exactly how much extra money the Fed prints every year, so it’s a much subtler form of taxation than income tax or sales tax.
2. (the Keynesian economic reason)
   The economy has normal ups and downs, but psychologically the downs are much worse than the ups and can spiral into recessions. This is exacerbated by the fact that wages are usually the first thing to go down, and companies are much more likely to fire people than to simply lower everyone’s wages by 2-3%, which results in increased unemployment and that recession spiral.

   However, if you manipulate the money supply so as to cause a slow but steady increase in inflation, then the economic “downs” are much less visible. Rather than having to lower everyone’s wages by 2-3%, you just don’t give your employees any raises, and inflation automatically lowers everyone’s “real” wage. This prevents the “Boom and Bust” cycle that plagued economies for centuries until fiat money became widely used.

Now, whether or not this actually works is heavily debated. Keynesians think yes. Others think it softens the “boom and bust” cycle but doesn’t actually prevent it. The Austrian School (popular among libertarians and Randians) thinks it can only delay it, and that fiddling with the money supply only makes the inevitable “bust” worse. If they’re correct, then when the “bubble” of the American economy bursts, it will be a disaster much larger than the Great Depression or any economic catastrophe the US has ever seen.

This entry was posted on Friday, October 26th, 2007 at 10:25 am and is filed under politics, economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.