Is There Such a Thing as Good Inflation?
Last week a student in my MBA-level intermediate-macro seminar raised a provocative question. We were discussing the various kinds of (price) deflation and which kinds, according to Austrians, are benign and accommodate consumer preferences, and which are malignant and conflict with consumer preferences.
In view of the Austrian emphasis on inflationary monetary policy as the primary cause of the business cycle and the current financial crisis in particular, the student asked if Austrians considered any kind of inflation as “good” for the economy. I gave a short response in the affirmative and then thought about it more over the weekend. Here is the note on the subject that I wrote up for discussion in class tomorrow. (The last two paragraphs on free banking were not part of the original note.)
One kind of “good” inflation typically results when innovations and changes occur that permit people to economize on the amount of money they need to hold in their cash balances. For example, the introduction and increasing availability of credit cards bring about a decrease in the demand for money, which, all other things being equal, causes a general rise in prices. Credit cards operate as an alternative means of payment for many transactions and therefore reduce the amount of money people need to hold in currency and bank deposits in order to finance their anticipated exchanges at the prevailing level of prices.
These “excess” cash balances produce an increase in the demands for goods, the supplies of which have not increased. The result is that overall prices rise. But inflation here performs an important function: it reduces the buying power of the dollar to the point where money no longer is in excess supply, because people are now content to hold the total supply of money in existence in order to finance planned transactions at the new, higher level of prices. Another way of putting this is that the “real” money supply, that is, its total purchasing power in terms of goods, has been reduced to exactly the level desired by consumers.
What we might call “cash-economizing” inflation tends to occur as a result of any financial innovation, including the invention of money-market mutual funds, ATM machines, PayPal accounts, and so on. It may also result from organizational or technical innovations in business that promote vertical integration of operations, where capital goods previ
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