BloombergView's McArdle Repeats Typical Keynesian Falsehood

Megan McArdle recently wrote a column over at BloombergView, "Printing Money Goes Haywire in Venezuela" that contained a dangerous falsehood that seems to be accepted as common wisdom by too many economists these days. Dangerous in that it leads policymakers to do stupid things such as manipulate interest rates or currency values.

McArdle writes:

"The core thing to understand about inflation as a policy tool is that in general, steady-state inflation doesn't do you any good; what you need is accelerating inflation. A little bit of inflation is actually OK -- it allows the economy to naturally cushion economic shocks that would otherwise lead to unemployment."

Like some kind of creature in a bad horror movie the long discredited Phillips Curve, which McArdle implicitly references in the quote, simply won't die. To review, the Phillips Curve purports to show an inverse relationship between the rate of inflation and the rate of unemployment. In order to lower the unemployment rate, central bankers need to allow inflation to rise. And vice-versa. To bring down inflation you need to have more people thrown out of work.

The Keynesians believe in something called "NAIRU" or the "non-accelerating inflation rate of unemployment". When the actual unemployment rate falls below this nonexistent measure, Keynesians worry about the economy "overheating". To their way of thinking, inflation is a function of too much economic growth which eventually leads to labor and capacity shortages.

However, for whatever reason these economists ignore the stagflation era of the late 1970s/early 1980s when the U.S. economy had both high unemployment AND high inflation, something the Phillips Curve says cannot occur because of the aforementioned inverse relationship.

The bottom line is that faster economic growth (and wage growth for that matter) is never a reason for inflation to accelerate. In a market economy, price signals work their magic to help alleviate any shortage of labor or capacity.

If a local factory in the U.S. is facing a shortage of skilled workers, higher wages serve as a lure for labor to migrate into that market. Also, a company can access labor from around the world if there is a shortage of workers with particular skills. Price signals are powerful and work extremely well when government doesn't interfere with them by creating artificial barriers to the movement of labor and capital across borders (both nationally and internationally).

The Fed also doesn't even recognize true inflation, which is not an increase in some statistical measure of inflation such as the consumer price index (CPI) or GDP price deflator.  Those are crude concepts at best and almost meaningless at worst.

True inflation is a decline in the value of the dollar from a previously stable level. The best measure of that value is gold (or alternatively a broad basket of commodities). Gold is far and away the preferred measure because is not consumed the way wheat, crude oil, or pork bellies are. Every ounce of gold ever mined is essentially still in existence today. When we see the price of gold moving in value, in reality it is not the gold price that is moving as much is it the value of the currencies in which it’s priced that is changing. Therefore, when gold's price in any currency rises substantially, that signals the unit of account is weakening and inflation is on the rise.

A "little bit of inflation", such as a 2% target (something the Fed defines as "price stability"), is very destructive to savings and capital formation. Inflation at 2% represents a halving of purchasing power within a generation. That can hardly be considered stable.

Any unit of measurement, such as the minute, foot, or pound, must be stable if it is to be useful. What good is the foot as a measure of distance if is allowed to "float" in value? One day it represents 12 inches, the next day 8 inches, and perhaps 15 inches next week. You might still be able to construct a building with a floating "foot" but you'll build fewer of them and the quality of the ones you do manage to build will be suspect.

The same concept applies to money. Quality money is that which is defined relative to something stable such as gold. A gold-defined dollar provides the market with a stable unit of measure, free from harmful fluctuations that we define as inflation or deflation. Therefore it is most conducive to capital formation and long-term investment.

Since job creation requires capital investment, a return to the gold standard system is the surest path out of the economic rut that plagues the economy.

It can be done and fortunately Nathan Lewis shows the way here and here.