Why the Reinflationists Are Failing to Understand the Costs of Recalculation?

|Peter Boettke|

Those re-entering the labor market are often finding that they have to accept a serious cut in their wages --- up to 40% less in some instances.  Is this the market adjusting to clean-out the previous mistakes, or is this additional evidence in favor of the deflationary spiral?

Gerald O'Driscoll has an excellent post on this issue that hopefully will make those who advocate reinflation reason to pause and rethink their position.

Comments

[Mario Rizzo]

When Keynesians are in full glory (that is, during recessions or depressions) anything that makes microeconomic sense is simply a collective irrationality: rational at the individual level but irrational or counterproductive at the aggregate level. Everything is topsy turvy.

[DG Lesvic]

Prof O'Driscoll,

Congratulations.

That's hitting the nail on the head.

Inflation had masked an underlying unemployment problem that deflation exposed.

A minimum wage law, for example, raised wages above market, equilibrium, full employment levels, inflation brought real wages back down to full employment levels, and deflation raised them again above those levels.

Reinflation could do that again, mask the problem for a while, but, as you pointed out, at the cost of an even more painful day of reckoning later on, which, of course, is just what the politicians want, delaying the day of reckoning, and, apres nous, le deluge.

The pain of recession is like that of withdrawal from drug addiction, not the problem but the cure. And, the more withdrawal and deflation, the quicker and stronger the recovery.

[Nikolaj]

Excellent article by O'Driscol and well summarized main point by Boettke.

I hope that advocates of reinflation as "quick recalculation", such as Horwitz or Selgin, who previously dismissed similar arguments made by couple of posters here including me, will now listen at least what professors O'Driscol and Boettke have to say. But, I am not sure...

[Steven Horwitz]

To be clear, I'm assuming Pete isn't aiming the "reflationist" label at my position. Under no circumstances do I think any monetary expansion is justified at the moment, and certainly not to offset the much-needed wage adjustments that O'Driscoll so nicely describes. This is indeed the needed "recalculation."

The argument for monetary expansion was only relevant 14 months ago in the face of bank failures and other issues at that time that might have been affecting velocity/money demand.

[DG Lesvic]

Prof Horwitz,

So you still want to counteract falling "velocity/money demand," which is still to counteract recovery.

The more saving, the more opportunity for recovery, the more deflation, the more recovery.

[Mario Rizzo]

Steve,

I'd love a split of views in the "mafia" here. But, alas, I don't think there is one. You are not a reflationist in Pete's meaning,.

[Nikolaj]

Hmmm. I just thought "sticky wages" and "unused capacity" (and even "underconsumption") were all conventional free bankers' arguments for "reinflating recalculation". Steve in his published works as well as in dozens of his comments here talked about these problems as being basically resolved or abolished by the free banking theory. Garrison also writes about sticky prices as a problem that will be alleviated by free banking responsiveness to changes in the demand for money.

Is it possible that O'Driscol provoked such a major rethinking of the theory? "Sticky wages" and "unused capacity" and even further deflationary pressures not an argument for a monetary expansion anymore? Vow! That's quite a revolution. All we are now a bunch of bloody liquidationists! :)

[Steven Horwitz]

Nikolaj:

Your juvenile sarcasm aside, if you'd READ any of that work carefully, you'd know (as Mario recognizes) that I've never argued for monetary expansion to offset prices being sticky in the face of REAL side changes. To the contrary, I've argued they should be allowed to fall. The whole argument for sticky prices has to do with their reaction to insufficient supplies of money, not to sectoral shifts or productivity changes.

I am increasingly convinced that you have not really read or understood my work and just wish to continue showing up here to be, frankly, a jerk.

[Richard Ebeling]

Following Jerry O'Driscoll's post, there was an exchange of views on "ThinkMarkets."

It was pointed out a difficulty for successful wage adjustment to restore full employment in the face of capital malinvestment is the fact that while workers in some sectors are having to accept significant money wage reductions to be reemployed, others (especially in unionized sectors) have the clout to more successfully resist wage reductions. This means that the wage adjustment burden falls more heavily on the more flexible sectors of the economy, and may delay recoordination across markets.

This was seen before -- during the Great Depression.

Moritz J. Bonn was a well-known German free market economist (who after 1933 taught at the LSE). In April 1931 he delivered the annual Richard Cobden Lecture in London on, "The World Crisis and the Teaching of the Manchester School."

He pointed out:

"The free play of economic forces have been replaced everywhere, at least in part, by private monopoly or by Government monopoly, by tariffs, and by all sorts of price control, from wage fixing by arbitration boards to valorization by farm boards. . . .

"There is intervention now on a big scale, based on forecasting and bent on planning, and there is a crisis much bigger than any crisis the world has seen so far. . . .

"For in the present economic situation of the world half of its institutions are [politically] manipulated whilst the other half are supposed to be free. The prices of the goods subject to the play of free competition have fallen all over the world. . . .

"The other prices have remained fairly rigid. They are maintained by economic and political coercion, by combines of labor and capital, supported by tariffs and other manipulating legislation. . . .

"If selected prices and sheltered wages can be maintained whilst all other prices are declining, a new satisfactory level [of equilibrium] cannot be attained. . . .

"The conflict between the free play of economic forces and the manipulation by Governments and monopolies is the main cause of the long continuation of the crisis."

Let us only hope that in the present political and ideological environment, interventions do not become so pervasive that we experience a duration or depth of the current recession similar to the Depression conditions explained by Mortiz J. Bonn in the early 1930s.

We need to constantly remind people that, as Mises argued during the Great Depression, the current crisis is not a "crisis of the failure of capitalism," but the failure of the interventionist state and anti-capitalist policies.

Richard Ebeling

[DG Lesvic]

Prof Ebeling,

Before anyone again accuses me not knowing enough economics, they're accusing you, too, and Boettke, Mises and Rothbard, too, for all I'm doing is agreeing with you.

The capitalists losing their capital in the recession doesn't by itself translate into unemployment. Their displaced workers will just find other, lower paying jobs. The unemployment is a consequence of unemployment policies put in place before the recession, the effects of which were masked by inflation and then exposed by deflation. The minimum wage law, for example, raised wages above market, equilibrium, full employment levels. But the inflation brought real wages back down to those levels, and the deflation back up above them again.

So, Prof Horwitz' reflation would indeed alleviate the unemployment problem, but only until the next deflation, which would expose it again and even more painfully.

So, what would bring about a lasting reemployment of the unemployed, while the minimum wage law and other such impediments to full employment remained in place? Only one thing, more saving and investment, and the greater productivity of labor. So, ultimately, it is not Prof Horwitz's reinflation that is needed but Nik's deflation.

[Jerry O'Driscoll]

Thanks to Richard for his excellent comment. There is a related item in the Weekend Wall Street Journal. James Tarranto interviewed Seth Lipsky, who thinks we are at a "Constitutional Moment" in our country. He believes we will come out of the current situation for the better. I hope he is correct.

[Barkley Rosser]

Regarding this situation, let me note that during the last year or so, Germany has experienced a larger fall in GDP than has the US, however, its unemployment rate has barely increased, from 8.0 to 8.2%, whereas ours has risen quite substantially. Maybe there is something else going on here, like maybe the structure and operation of our respective labor markets (or possibly that Germany did not have a housing bubble, although few other countries have had as bad a ratio of lost jobs to lost GDP as has the US)?

[sheridan]

Steve Horwitz,

"The argument for monetary expansion was only relevant 14 months ago in the face of bank failures and other issues at that time that might have been affecting velocity/money demand."

Would you agree that the main difficulties with such a policy of stabilizing MV are:

1. it is impossible to know how to reflate correctly (Hayek’s knowledge problem);

2. the mechanisms by which you reflate are important, and that the Fed’s instruments are necessarily blunt

3. and that it is difficult to distinguish as to which constitutes a ‘primary’ and a ’secondary’ depression?

[DG Lesvic]

Sheridan,

You're still missing the point.

Deflation is the essential first step to recovery, and, the more of it, the better.

If you're not going to repeal the impediments to full employment, such as minimum wage laws, you must overcome them, and the only way to do that is by increasing the productivity of labor.

For that, you need investment, and, for that, savings, and its corollary, deflation.

[Niko]

Primary and secondary deflations are theoretical, mostly didactical, instruments. They can only be distinguished in hindsight, after the crises have passed. The mechanical model of money is broken beyond repair, so using it is proof of juvenile and backward thinking. Demand for money does not represent a demand to increase the supply of money, but a demand to hold more money, a decrease in the marginal utility of money.

[amv]

The German government pays firms not to release labor. While parts of the workforce have accepted an immense cut in working hours and thus a shrinked wage bill, government deficits fill the gap in income. Further, a lot of skilled labor in some sector is released but at the same time Germany finds new low-skilled (or better false-skilled) job opportunities. Our labor markets are not that bad anymore.

[sheridan]

DG Lesvic,

I perhaps should clarify that by deflation I refer to a contraction in the money supply, not a decrease in prices of goods and services.

To claim that deflation is desirable in itself is rather twisted. It's akin to claiming it's better to have debtors wiped out and all companies go bankrupt to replenish the pool of savings/capital.

[DG Lesvic]

Sheridan,

Recession is not the cause of unemployment. If the inflation that caused the boom/bust cycle were the only intervention in the market, capitalists would lose their investments but their displaced workers would just move on to other, lower paying jobs.

But even before any recession, there were interventionist impediments to full employment, such as minimum wage laws, forcing wages above free market, equilibrium, full employment levels.

Their effect was masked by inflation, bringing real wages back down to market clearing levels.

But then, deflation, forcing them back up, exposed the unemployment effect of the interventionist policy again.

But exposing it was not the same thing as causing it. It was still the interventionist policy that caused it.

And while Prof Horwitz’s reinflation would mask its unemployment effect again, it could not do so permanently. Eventually, deflation must again follow inflation, and with even more painful consequences than before.

Without repeal of the policies that are the real underlying cause of unemployment, or reinflation to mask their effect, how could the unemployed ever get employed again?

Only through more saving and investment, raising the productivity of labor.

But, the Keynesian bias for spending over saving, and reinflation to keep spending up, deprives the market of just what it most needs, saving, and its corollary, deflation.

The more saving, the more opportunity for recovery, and the more pain, the more gain. For the recession is like withdrawal from drug addiction, however painful, not the problem but the only cure, liquidating malinvestments and reestablishing the preferences of the consumers.

Since there cannot be a recovery until that has occurred, the recession must be allowed to run its course and the market find its bottom.

Keeping it from hitting bottom just keeps it from starting back up again, prolonging and deepening the agony, and turning a recession into a depression.

[Niko]

@DG Lesvic:
Saving does not mean deflation. It is a move from consuming consumer goods to consuming things further from the consumer.

The classical example: a fisherman catches an amount of fish that would last him for 1 week in order to make a bout. The fish is saved capital, since the amount of labor and time freed will be spend on other things, not destined for immediate consumption, but which will help in the future to increase production.

The deflation that we are seeing now is a mark to market of products which could not found another fool and restriction of credit caused by people getting the money out of the bank. It is mostly an accounting gimmick and it is not caused by increased savings.

That aside, Mr. Horwitz is still very wrong.

[Steven Horwitz]

Sherdian:

I agree that all three of those are concerns. I'm not sure it's "impossible" to know when/how to expand the money supply in the face of an increase in money demand, but there are no doubt challenges there. As I've argued all along, the question is simply whether attempting to do so in the face of a major increase in MD is better or worse than doing nothing and risking a major deflationary spiral.

To repeat: I am NOT arguing for reflation to offset real-side decreases in prices or real-side recalculations. I am only arguing for increasing the MS in the face of an increase in MD. These are two different things. If people wish to continue to argue against reflation to reduce unemployment, I wish they would please stop referring to me in this context as that is NOT my position.

Of course someone who had actually read my book would know that, as I explicitly argue to the contrary in the chapter on Hutt.

[Nikolaj]

Niko,
I asked Steve maybe ten times during the last 6 months questions very similar in substance to your three-point question posed above - how to distinguish ex ante between the primary and secondary recession, how to identify the agents whose demand for money has increased and so on, citing Hayek who said directly that was impossible, and never got an answer. Or, at least nothing more than you've got: "I agree that all three of those are concerns. I'm not sure it's "impossible" to know when/how to expand the money supply in the face of an increase in money demand, but there are no doubt challenges there."

So, it is not impossible just we don't have a clue how to do that.

Steve,
your knee-jerk reaction to my sarcasm is not very helpful. Garrison is a major figure in ABCT and he considers sticky prices to be a problem that will be alleviated by free banking. You yourself cite in your book "idle resources" as the "biggest welfare cost" of deflation that can be addressed by monetary measures of free banks. Both of these conceptions are clearly wrong from Hayek-O'Driscol perspective. Hayek says that
"The only way permanently to “mobilize” all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes."

This is a direct critique of your position (or rather, a critique of the position of the people in 1930s who shared your views on "idle resources", such as Keynes)

O'Driscol says that: "The problem with “sticky” price models is they prove too much. We would constantly be in depression if they had universal application."

For O'Driscoll, falling wages during the depression are just a sign of a recovery. You say that you would allow to the people to hold as much of cash as they wish "at the current price level" which means that you advocate stabilization of prices during the depression. If the deflation is a natural, or at least possible development during depression, and you want to prevent deflation at every cost, what is your ideal if not the "recalculation by reflation"?

[Niko]

@Nikolaj:
I agree with you. I also think it is impossible. Even in hindsight it is very hard to determine them, it is mostly a waste of time and energy, since the reasons they will discover, or think they discovered, only apply to that recession and a repeat of those circumstances would probably make for different results, the only common thing being misery in both situations.

As I’ve said, this description of deflation is a great didactic tool, but it is not a real tool. You can use it to explain theory, but it does not explain reality very well. The persons you’ve asked are mostly professors, so they are unlikely to provide a workable answer.

In the end, if you call yourself Austrian, doesn’t mean you actually know what you are talking about.

[DG Lesvic]

Niko,

You wrote,

“Saving does not mean deflation. It is a move from consuming consumer goods to consuming things further from the consumer.”

You’re assuming investment in place of consumption. But what if there were neither consumption nor investment, but saving money in a mattress? Wouldn’t that mean deflation? And, if you saw a hostile climate for investment, wouldn’t that be the best thing to do with your money? And, if that was the best thing to do with it, why should we, in effect, take your money from you and give it to someone else who would throw it in the path of an avalanche?

Prof Horwitz,

It appears to me that you are confusing marginal with total demand for money. The greater demand for money is for each dollar, not for more dollars.

The greater demand for money is really for more saving. So, "increasing liquidity" and reducing the value of savings would not be "meeting" but thwarting the real demand, for a reliable means of saving.

[Nikolaj]

The first sentence of Pete's post is the most important for the present discussion:

"Those re-entering the labor market are often finding that they have to accept a serious cut in their wages --- up to 40% less in some instances. Is this the market adjusting to clean-out the previous mistakes, or is this additional evidence in favor of the deflationary spiral?"

This is a critical issue. What evidence we have that the occurrence described in the previous passage is not a fatal "secondary recession" or unstoppable "deflationary spiral" that must be counteracted by all means? How we can empirically to distinguish between the "supply side" cleaning up that monetary equilibrium theorists support and detrimental demand-side deflationary spiral (since decrease in the wage-rates would occur both cases)?

[DG Lesvic]

Nik,

The fear of an ever downward, deflationary spiral is groundless. If there could really be such a thing in the market itself, it would occur every time a donut shop went out of business, setting off an endless cascade of falling businesses. In fact, the market has withstood the failure of a good many donut shops, and financial institutions, as well, for, no matter how many failed, there were just as many eager buyers and sellers as ever.

If something is keeping them apart, it isn't the market. For, it is nothing but buyers and sellers. The only thing coming between them was the agency designed for that very purpose, “the government." What is needed is not more but less and ideally no more of its interference.

Just get it out of their way, and eager buyers and sellers will instantaneously come together again.

They will have to do so at lower wages than before. How much lower depends on the amount of saving still available for investment. The more saving, the less painful the readjustment.

So, what is needed is not a reinflation to prop up spending, but deflation to encourage saving.

[Barkley Rosser]

amv,

So how is it "better" in the US that we throw people out of jobs who then get rehired at 40% lower wages, while in Germany workers except temporary wage cuts through the kurzrabeit system without being laid off? Last time I checked, despite the strong euro, Germany had a bilateral trade surplus with the US, with many of their industries more productive than ours.

[Barkley Rosser]

"...workers accept..."

[Niko]

@Lesvic:

"You’re assuming investment in place of consumption. But what if there were neither consumption nor investment, but saving money in a mattress? Wouldn’t that mean deflation?"

Investment is another form of consumption. When you consume bred, you consume bred. When you invest in a mill, you still consume other things. Saving money in a mattress is a form of savings and it means a decrease in the marginal utility of money. It means that the interest is not good enough (score zero for the monetarists and their deflation theory, very stupid) and that you have a lower range of things you want to consume. It is not deflation in the mechanical sense, it is a smaller set of things you want to spend money on. From the price perspective it is deflation for the things that remain on the margins of demand. It is not deflation from the perspective regarding the supply of money.

No one saves money unless he wants to consume them. That is what money is: ability to consume real goods. Savings of money is future consumption and always was and always will be. It is the very essence of money: demand for real goods. It is basic economics.

[DG Lesvic]

Niko,

You make the Oracle of Delphi appear positively transparent.

[DG Lesvic]

Barkley,

Previously you and your pal took me to task for having taken you seriously.

So I'm not making that mistake again.

[DG Lesvic]

But, for anyone else who might take you seriously, the issue is not what is the best way to manage a business, but who best to manage it, the businessmen themselves or college professors?

[sheridan]

Thanks for the replies.

I hope I'm not straying too far by soliciting views on:

1. The Japanese experience during the '90s.

I think we can all agree on the causes behind the boom and subsequent bust - but how has the Bank of Japan fared, and what kind of policies should have been pursued?

Some have argued (e.g. http://www.safehaven.com/article-4908.htm , http://www.safehaven.com/article-13964.htm ) that in fact the money supply has been expanding but slowly in Japan. Meanwhile they also have an ongoing giant debt bubble.

2. The Great Depression experience of other countries, especially those who rigidly adhered to a gold standard (Switzerland, France, the Netherlands etc.). The deflation experience was especially painful for them which led to the slapping on off tariffs - eventually all of them devalued.

The most popular view (among mainstream circles, anyway) is that advanced by Barry Eichengreen (c.f. http://www.dartmouth.edu/~dirwin/w15142.pdf ).

[Niko]

@DG Lasvic:
Should I understand you have no idea what I was talking about?

Read Rothbard, America's Great Depression and look for the chapter where he criticizes the liquidity trap.Better: the hole chapter on Keynes.

[DG Lesvic]

Niko,

No, you have no idea what you were talking about.

You had better reread Rothbard's America's Great Depression, if you think he was on the side of reinflation.

[Niko]

I'm not on the side of reflation and certainly Rothbard wasn't either. I'm just saying that savings does not mean deflation, which is your point and which shows that you didn't get it. And in that chapter you may find the answer why.

[DG Lesvic]

Niko,

I have no idea what you mean by deflation.

To me it means a contraction of the money supply and falling prices.

With money saved in a mattress, how could prices not fall?

[Steve Horwitz]

"You say that you would allow to the people to hold as much of cash as they wish "at the current price level" which means that you advocate stabilization of prices during the depression. If the deflation is a natural, or at least possible development during depression, and you want to prevent deflation at every cost, what is your ideal if not the "recalculation by reflation"?"

I am simply not going to respond to comments and questions that are either deliberate misrepresentations of my position or reflect a refusal to try to understand my attempts to clarify my position over the last few months. The quoted material above is just such an example. If the author of the above thinks that monetary equilibrium theory means stabilizing the price level or preventing ANY form of deflation at any cost, he or she has not been paying attention or is deliberately distorting my view. Hence no response will be forthcoming.

[DG Lesvic]

Prof Horwitz,

But you are in favor of preventing some form of deflation at some cost, aren't you, and, in some circumstances, promoting the spending you preferred over the saving the market preferred.

[Barkley Rosser]

DG,

So, are businesses in Germany being run by "college professors"?

[Steve Horwitz]

I am in favor of a free banking system in which the supply of bank liabilities would respond to changes in the demand to hold them. Both monetary inflation and monetary deflation are bad and such a system will prevent them.

In a second best world of central banking, I am in favor of central banks not allowing major decreases in the money supply and I am in favor of central banks expanding the monetary base in the face of a significant increase in the demand for money. Both of these will prevent declines in MV and corresponding problematic and avoidable declines in both P and Y.

Price deflation due to increases in productivity are good. Falling prices (and wages) due to sectoral shifts in demand and supply are good. Neither of these forms of price deflation should be offset by increases in the money supply.

Maintaining MV during a bust should not interfere with the corrective recalculation and sectoral shifts that need to take place. Not maintaining MV can turn such necessary sectoral shifts into much more problematic overall declines in economic activity.

The problems facing the US economy right now are NOT due to excess demands for money and there is NO reason WHATSOEVER to increase the MS ("reflate"). Doing so would only prevent the needed adjustments from taking place. I have said nothing in print or elsewhere to suggest otherwise.

Anyone who thinks I favor price level stabilization is either intentionally distorting my views or has not read my work with any degree of care.

I hope that clarifies where I stand on these issues and I hope that the discussion can continue with an accurate rendering of my views. Disagreement is, of course, fine. Misrepresenting my views is not.

[Barkley Rosser]

OK, here is the hard question. Why would bubbles not happen under free banking? Is there any reason to believe that free banks in a free banking system would not have lent to the realtors selling homes for overly high price-to-rent ratios, and even eventually to ones with subprime mortgages and the like?

I realize that part of the answer to that is whether or not there is a secondary market for mortgages, allowing mortgage issuers to offload them onto somebody else, and, yes, it was government set-up Fannie Mae that set up that market in the US back in the 1930s. But, is there any reason to believe a free banking system would not also set up such a market, or if it were to be introduced now into an economy such as the US that has such a market it would shut it down?

[Steve Horwitz]

Quick response Barkley:

There are two question in play. 1) Could asset bubbles happen under free banking? 2) Would the particular asset bubble associated with the last few years in the housing market happen under free banking?

If a free banking system would prevent inflationary monetary expansions, then one has to explain how asset bubbles would emerge in the absence of the credit fuel for the fire. In the case of the housing bubble, many of the market checks on bad investments were absent, even above and beyond the inflationary fuel. Could it have happened under free banking? Possibly, given all the other ways government distorted the incentives and payoffs.

But whether such a bubble could have occurred under free banking *and* in the absence of those other interventions, of that I'm not convinced. I need an explanation of how the credit fuel for the fire will be created that is consistent with the incentives/knowledge facing genuinely competitive markets. I'd guess that smaller bubbles are possible but more likely to be quickly corrected than in the current world.

[Lee Kelly]

Barkley,

I do not think anyone has (or would) claim that bubbles cannot happen with free banking.

The claim, I think, is that if issuers of banknotes are at the mercy of market forces, and risks are not being subsidised by government, then the *propensity* for bubbles will be reduced.

[DG Lesvic]

Prof Horwitz,

You wrote,

"I am in favor of a free banking system in which the supply of bank liabilities would respond to changes in the demand to hold them."

How would it respond? If there was an increase in savings, would the banks respond by increasing the supply of their currencies? Not if they wanted to stay in business. For, by reducing the value of savings, they would defeat their purpose, and drive their depositers to their competitors.

You wrote,

"I am in favor of central banks not allowing major decreases in the money supply and I am in favor of central banks expanding the monetary base in the face of a significant increase in the demand for money."

But the money supply has decreased because the market foresees an increasingly hostile climate for investment, and the need to keep their money out of the path of an oncoming avalanche and provide for rainier days.

Why would you take it from those who had earned it to give it to those who hadn’t, from the prudent to give to the imprudent, from those who would conserve it for the rainier days and the opportunities for recovery where they appeared, to give it to those who would throw it into the path of an oncoming avalanche?

You wrote,

"Maintaining MV during a bust should not interfere with the corrective recalculation and sectoral shifts that need to take place."

It would interfere with the saving that needs to take place and send the same false signals that any meddling in the market would send.

You wrote,

"Not maintaining MV can turn such necessary sectoral shifts into much more problematic overall declines in economic activity."

The fear of such problematic declines is groundless. It is the fear that any business failure would set off an endless cascade of business failures, and that we mustn’t even allow a donut shop to fail.

You wrote,

"The problems facing the US economy right now are NOT due to excess demands for money."

There is no such thing as an excess demand for money, except in the mind of a dictator. For, unless the dictator knows best, the individual himself is the best judge of how much he needs to save.

[bill woolsey]

I support reflation. Nominal expenditure is well below its previous 5% growth path, and even well below an adjusted 3% consistent with price stability going forward.

I don't really have any interest in seeing price inflation, but I wouldn't be surprised if a return of nominal expenditure to its previous growth path (or even a new one consistent with stable prices in the future) would involve price inflation.

When there is a reduction in productive capacity of the economy, there should be price inflation. In fact, I think that just slower than normal increases in productivity should result in price inflation. While I favor a stable price level trend, exceptionally large increases in productivity should result in deflation.

A background of slow steady growth in nominal expenditure, including a prompt reversal of deviations, is consistent with decreases in the prices of some assets, all assets, reallocations of labor, or any number of things.

The notion that an increase in the purchasing power of money is somehow essential to these processes is very much mistaken.

Further, the notion that a temporary increase in money demand being corrected by temporary reduced production or a temporary reduced price level is going to great sound price signals--including nominal interest rates, wages, or relative prices, for long run investment decisions is blindness.

Do any of you every pay attention to discussions of structural unemployment? It comes up all the time in discussion of international trade. Yes, the continued collapse of UAW unionized domestic car manufacturing many former employees of those firms taking new jobs at lower wages.

There is no reason why these adjustments cannot take place in an environment of slow stable groth in nominal expenditure.

[DG Lesvic]

Mr Woolsey,

All of your interventionist measures designed to bring the market back to health are just more of the poison that made it sick in the first place.

It all begins with inflation of the money supply, lowering interest rates and encouraging longer term investment, but without increasing the supply of goods to sustain it. And when it finally collapses, for want of the goods and real demand, the monetary meddlers prop it up with more funny money. But they can not do so indefinitely. Eventually their house of false expectations must fall, and, the bigger the house, the harder the fall.

All of you people are confusing the medium with the objects of exchange and marginal with total demand for money. Whereas oil is an object of exchange, money is the medium of it. And while the supply of its objects, oil, apples, and oranges, determines our wealth, the supply of its medium, money, does not. We are richer with 100 than with 50 barrels of oil, but no richer with oil at $100 than at $50 a barrel. What matters is not the total number of dollars but the ratio of one dollar price to another, not that apples go for 10 dollars a box and oranges for 5, but that apples go for twice as much as oranges, whether at 10 to 5 or 2 to 1.

While a greater supply of oil renders a greater service than a lesser supply of it, the greater supply of money renders no greater service. So there cannot be a market demand for any greater number of dollars. The greater demand for money in the market means something entirely different, a greater marginal rather than greater total demand for money. With more goods chasing the same number of dollars, there will be a greater demand for each dollar, but not for more dollars.

The greater demand for money is really for more savings. So "increasing liquidity" and reducing the value of savings would not be meeting but thwarting the real demand, for a reliable means of saving.