Home » Defense of Austrian economics » Vickrey’s Fallacy 4, Inflation is Good, Fighting Inflation is Bad.

Vickrey’s Fallacy 4, Inflation is Good, Fighting Inflation is Bad.

Source: http://www.columbia.edu/dlc/wp/econ/vickrey.html

You have the floor, Mr. Vickrey, Nobel Prize laureate, in italicized font. Dave will comment in regular font.

Fallacy 4

Inflation is called the “cruelest tax.” The perception seems to be that if only prices would stop rising, one’s income would go further, disregarding the consequences for income.

What he means is that sure, your income looks like it will go further if there is no inflation, but without wonderful wonderful inflation, you may not have an income in the first place.

First he lays out his case that your income won’t really go further:

Current reality: The tax element in anticipated inflation in terms of gain to the government and loss to the holders of currency and government securities, is limited to the reduction in the value in real terms of non-interest-bearing currency, (equivalent to the increase in the interest rate saving on the no-interest loan, as compared to what it would have been with no inflation), plus the gain from the increment of inflation over what was anticipated at the time the interest rate on the outstanding debt was established.

An 85 word sentence. What does it say? That yes, the govt does gain from inflation, and yes it is a tax. And who pays this tax? Anyone the govt owes money to [since he will be repaid in money with less purchasing power] and anyone who has US dollars in his possession [because his dollars now have less purchasing power].

But how much will these people really lose? Only whatever purchasing power was lost [for those who have dollars], plus a loss of interest [for those who lent their money to the govt].

In other words, yes, you will lose money, but Vickrey will soon claim that when the chips are down, you won’t lose anything. The banks will reimburse you, unless you are some silly old fogey.

What’s really bad is deflation:

On the other hand, a reduction in the rate of inflation below that previously anticipated would result in a windfall subsidy to holders of long-term government debt and a corresponding increase in the real impact of the debt on the fisc.

Because if there is deflation, the people who lent money to the govt will get a “windfall subsidy”. Not only that, the govt will lose money. The national debt will increase in real terms.

This is nonsense. In an economy where there is anticipated deflation, loans will be made with due consideration of that fact. The terms of the loans will stipulate that in case of deflation, the real, not nominal, amounts of money are what count.

Such stipulations happen all over the world for inflation, things like cost of living increases and the like. We are so unused to actual deflation that we don’t realize that it can be handled in contracts and loans just like inflation is today.

Bottom line, Vickrey admits you lose money because of inflation, that it is a tax, that the govt makes money from inflation. But that was only in the bad old days:

In previous regimes where regulations forbade the crediting of interest on demand deposits, the seigniorage profit on these balances, reflecting the loss to depositors in purchasing power, that would be enhanced by inflation would accrue to banks, with competition inducing some pass-through to customers in terms of uncharged-for services.

Those stupid previous regimes didn’t know how to protect you. And who made money from inflation back then? Banks, that’s who. They should have been giving you interest to compensate you for your losses due to inflation, and they didn’t.

In an economy where most transactions are in terms of credit card and bank accounts with respect to which interest may be charged or credited, the burden will be trivial for most individuals, limited to loss of interest on currency outstanding.

After all, 90 percent of the money in the US is not cash, but exists in computers in banks. So you won’t lose any purchasing power from that 90%, nor from any cash you were smart enough to put in a bank. You’ll just lose a trivial amount of money, what you had in cash. What do you care about a few pennies, right?

Right there we saw an example of the imaginative thinking that got Vickrey his Nobel prize. Because the banks can give you some free interest because you lost money due to inflation, Vickrey took it for granted that they will. But guess what? It’s not happening, and never has. It’s hard for me to express the contempt I have for someone who wrote that last italicized paragraph. Not because he’s stupid, which he isn’t, but because of the intellectual dishonesty involved.

Continuing his Bizzaro world fantasy that all cash in a bank is safe from inflation, Vickrey then resolves a little brain teaser. If nobody loses from inflation, then how how does the govt gain [something he freely admitted at the very start]? How is it a tax if nobody loses anything?

Most of the gain to the government will be derived from those using large quantities of currency for tax evasion or the carrying on of illicit activity. plus burdens on those few who keep cash under the mattress of in cookie jars.

The govt will gain from criminals who use cash, and from fools who don’t trust banks. And those fools are few in number, so don’t worry about them.

So waddaya know? Who is doing all the hoarding in our economy? Nobody. And what about the Keynesian thing, which Vickrey believed in, that hoarding is what is ruining our economy, and we need the govt to save us from hoarding? Well, that hoarding is coming from tax evaders and people carrying on illicit activity.

How far we have come from the simple days of John Maynard Keynes. He wrote that everyone will hoard. Now it turns out that the only reason to hoard is because the govt is taxing us and making things illegal. In other words, Vickrey is saying that if the govt lowered taxes in the first place, and legalized marijuana and the like, there would be no hoarding. Govt taxes and laws are ruining the economy, he is saying here.

Did he ever come out in favor of lowering taxes drastically to save the economy? Of legalizing things that people want to be legal? Not him. His thinking went like this. The govt’s high taxes are causing people to hide their money. This is bad for the economy. The solution is to tax everyone even more, not just those who hide their money. Duh, lower the taxes in the first place, Mr Vickrey.

You know, Columbia University is actually providing free copies of Vickrey’s paper on the internet. Have they no regard for his reputation? Does it not behoove them to hide this little work of his, to save the Vickreys from embarrassment?

[Just as an aside, Austrians say that hoarding is good for the economy, not bad, See this gem.]

The main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation.

In other words, with no inflation, there will be unemployment. Which is true. In an economy ruined by previous inflations, those people with unprofitable jobs will have to move on to profitable ones. And if the govt makes laws impeding employment, the unemployment will be chronic and high, as in some countries in Europe.

But inflation is at best a very temporary solution. The way it works is, the govt prints a lot of money to pay workers who should have moved on to other jobs long ago. These workers who make no money for their company, or for anyone else, are bottomless pits, requiring new paychecks constantly. So more money will have to be printed. [A typical case is Solyndra, which gobbled up $500 million dollars of govt money and then went bankrupt].

The problem is, every time money is printed, more unprofitable jobs are created. Each round of money printing has to be bigger than the one before. Mises said the rate of increase is exponential. Very very scary thought, because at the end of this rainbow of horror is total collapse of the value of the dollar.

Actually, unanticipated acceleration of inflation can reduce the real deficit relative to the nominal deficit by reducing the real value of the outstanding long-term debt.

Here Vickrey is explaining how wonderful inflation is. The govt, which can cause inflation by printing money, can use it to cheat those who lent it money, repaying them in money that has lost real value.

Vickrey family, where are you? Tell Columbia University to take Mr Vickrey’s paper off the internet. You don’t want him on record as saying stuff like that.

If a policy of limiting the nominal budget deficit is persisted in, this is likely to result in continued excessive unemployment due to reduction in effective demand.

We spoke about this before. By reduction in effective demand he means the govt won’t print money to pay workers who should have gotten real jobs, instead of jobs that rely on govt handouts.

The answer is not to decrease the nominal deficit to check inflation by increased unemployment,

Nobody said it was. The way to check inflation is to stop inflating the money supply. This will result in unemployment of people who have unprofitable or parasitic jobs, but that’s a good thing for the economy as a whole, and ultimately, for the workers themselves.

Here’s a little example from recent news about what happened when Greece did what Vickrey wanted, and worried about jobs instead of productivity:

The right to a permanent position once hired by the public sector had been protected by the Greek constitution before Sunday, and about one in four Greeks is on the public payroll.

The bill, which passed in a 168-123 vote, will allow for the first civil service layoffs in more than a century…A provision also aims to bypass, if needed, the notoriously slow and lenient disciplinary councils, which have refused to lay off even people convicted of felonies [= serious crimes]. More than 2,000 such cases are pending, nearly 600 on appeal.

Everyone had a job, nobody got fired ever, one fourth of the country was actively doing nothing, and the rest is history. The Greek situation is terrifying all Europe.

Vickrey continues with his ideas about how to fight inflation. Hint: By giving the govt more money.

but rather to increase the nominal deficit to maintain the real deficit,

At least he is being consistent here. You’ll remember how his first fallacy claimed that govt deficits are great for all of us. I hope you remember our rebuttal, too.

controlling inflation, if necessary, by direct means that do not involve increased unemployment.

Direct means such as what? He probably means wage and price controls, which are notorious for ruining an economy.

Bottom line, the reality is that inflation is terrible for everyone but the govt and its pals. Mr Vickrey loves the govt, as is clear from his article, so he thinks inflation is good. He tries to convince us that we won’t suffer from inflation, that only people the govt actively dislikes will lose. But he has to resort to such lies, and such open encouragement of the govt cheating those who lend it money, that I’m sure the Nobel Prize Committee is stripping him of his prize as we speak.

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