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Thursday, 11 April 2013 21:46

Inflation

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Politicians frequently blame inflation on greedy corporations, commodity or energy price increases, or on an “overheated” economy (a Keynesian concept).  However, prices should remain relatively stable as long as the amount of money in the system remains constant.  That is because an increase in one good means there is less money to spend, or less demand, for another good, thereby causing the price of the second good to fall.  Thus, the net effects will leave the general price level unchanged.

Such red herrings for inflation as “overheated” economies avoid the central fact: that money, like any other good, has a price set by supply and demand. So, what actually causes rising prices?    Milton Friedman correctly observed that “inflation is always and everywhere a monetary phenomenon.”  Since the demand for money does not typically change significantly, it must be money printing and the increase in supply of money itself that causes prices to rise.

In the United States, money creation is caused by both the Federal Reserve and the fractional reserve banking system.  Since its inception a century ago, The Federal Reserve has been increasing the money supply.  Banks further leverage this money supply by lending more money than they have in deposits.  The word “fractional” in fractional reserve means banks hold only a fraction of what can be demanded from them at any given time.

In the U.S., the last several years have witnessed a never before seen expansion of the money supply.  Although the timing of the emergence of price inflation can only be estimated, the correlation with money supply growth is indisputable.

Read 292217 times Last modified on Tuesday, 14 May 2013 19:19