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Inflation caused by printing too much money Original Source Link: (May no longer be active)
http://quote.bloomberg.com/apps/news?pid=10000039&refer=columnist_baum&sid=a2WnQ1aK8zBghttp://quote.bloomberg.com/apps/news?pid=10000039&refer=columnist_baum&sid=a2WnQ1aK8zBg
Bloomberg Columnists
Caroline Baum , author of the forthcoming book, "Just What I Said," is a columnist for Bloomberg News. The opinions expressed are her own.
What Causes Inflation? Not Those Pushy Costs: Caroline Baum
Oct. 5 (Bloomberg) -- Somehow in the hurricane alphabet between K (Katrina) and R (Rita), I (Inflation) reared its ugly head.
That's what a typical reader would be led to believe from the myriad of articles being rushed into print in the last couple of weeks.
Unfortunately, our observer would be no more informed as to the true nature of the inflation process after poring over all the news that was fit, or unfit, to print.
One of the most tenacious myths in economics is the idea that costs push prices, and the price level (inflation), up. The idea of ``cost-push'' inflation implies that producers are content to charge the same price, day in, day out, until one day a bell goes off to alert them that their costs of raw materials or labor (wages) have gone up.
Golly, gee, these costs are killing me, our average businessman opines. I'm going to have to raise my prices.
There is something intuitively appealing about the idea that costs push prices up. The fact that it's incorrect does nothing to limit that appeal.
The cost-push view of inflation ``is based on the notion that prices are set by the costs of production and that prices rise only when costs rise, regardless of demand,'' said Sandy Batten, economist at Bear Stearns Cos.
Squeezed
Of course, Batten said that in 1981 in the Federal Reserve Bank of St. Louis's June/July Economic Review. The points he made in that article, ``Inflation: the Cost-Push Myth,'' are as relevant today as they were then.
What about all the anecdotal reports of companies being squeezed by higher transportation and production costs as a result of soaring energy prices? Just this week, the chief executive of BASF AG, the world's largest chemical maker, announced plans to raise prices on all North American products ``to address the record increases in feedstock and energy costs.''
Well, la-di-da. What better evidence do you need than a hands- on manufacturer admitting that costs are forcing him to raise prices?
``Most businessmen believe that higher costs of production are the motivation for'' raising prices, Batten wrote in that same 1981 article. ``They seldom identify the real cause --increased aggregate demand resulting from increased money growth.''
The initial increase in final demand may be camouflaged by the existence of inventories as a buffer. Businesses can't be sure if the stronger demand they're experiencing is seasonal, sporadic or sustained. So they don't raise prices at first.
Starts With Demand
Once their existing stockpiles are depleted, companies step up their orders, which filter down to the bottom of the food chain to raw materials producers who, if they have more demand than they can satisfy, raise their prices. Wholesalers raise the prices they charge to manufacturers, who in turn raise their selling prices.
While it may appear as though ``increased raw material costs have caused a higher final product price, the actual cause of the higher prices at every level of the manufacturing and distribution network is the initial increase in aggregate demand for the final product,'' Batten said.
And increased economy-wide demand is a function of an increased supply of money relative to what the public wants to hold (money demand).
You get the drift. It's always convenient for governments to shift the blame to ``greedy businessmen, grasping trade unions, spendthrift consumers, Arab sheikhs, bad weather, or anything else that seems even remotely plausible,'' said Milton Friedman, Nobel laureate in economics.
Printing Press
It's true that businessmen are greedy, trade unions push for higher wage settlements, consumers spend too much, Arab sheikhs manipulate the oil price to their advantage and the weather is often bad. ``All these can produce high prices for individual items; they cannot produce rising prices for goods in general,'' Friedman said. That's because ``none of the alleged culprits possesses a printing press.''
Of course, he said that 26 years ago in ``Free to Choose.''
Friedman demolishes many inflation myths in the book, which he wrote with his wife, Rose. One that made an appearance post- Katrina is the notion that the additional government spending for the recovery effort is inflationary.
``Higher government spending will not lead to more rapid monetary growth and inflation if additional spending is financed either by taxes or by borrowing from the public,'' Friedman wrote. ``The government has more to spend, the public has less. Higher government spending is matched by lower private spending for consumption and investment.''
Making It Last
If additional government spending causes inflation to rise, it's because the central bank is printing enough money to accommodate more government spending without forcing consumers and businesses to cut back.
What about the lost output from Katrina, which knocked out a chunk of oil production and refining capacity in the Gulf? Isn't that inflationary?
A supply shock -- reduced output, higher prices -- will cause a one-time adjustment in the price level. It will not raise the rate of inflation unless the central bank increases the supply of money faster than the output of goods and services. That's why the Fed is so determined to keep raising overnight interest rates.
Friedman uses the different experiences of the U.S. and Japan after the 1973 OPEC embargo to make his point. Why did inflation tumble in Japan, a country that imports 100 percent of its energy needs, in the aftermath of the oil shock while inflation in the U.S. remained stubbornly high?
Wage Inflation
No discussion of cost-push inflation would be complete without reference to that mother of all costs, labor. Friedman makes short shrift of that beast known as wage inflation, too.
``Wage increases in excess of productivity are a result of inflation, not a cause,'' Friedman wrote.
Even productivity, which is the source of our economic welfare, is ``a bit player for inflation'' because changes in output are dwarfed by changes in money, he said. ``Money is center stage.''
It may be center stage, according to Friedman, but don't be surprised if 25 years from now those pushy costs are still rattling around in the wings.
Last Updated: October 5, 2005 00:01 EDT
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