Your Basic Free Market Economics Quiz (Part 2-Inflation)

Here's part two of your basic economics quiz. The five questions below deal with inflation and deflation. When you come out on the other end, you might find that your definitions of these terms have changed.

1. True or False: Inflation is a general rise in prices?

Answer: Not exactly.

Inflation is only that general rise in prices that is caused by an increase in the money supply without a corresponding increase in productivity (goods and services). Any other rise in prices--caused by a reduction in productivity caused by ravages of war, natural calamity, etc.--does not constitute inflation. Non-inflationary rises in prices are much more likely to correct themselves (i.e. when the crisis is past). It is much less likely that inflation will occur if a country is on a commodity standard, such as gold. Higher prices that people generally describe as "inflation" are actually a consequence of the actual inflation, or increase of the money supply. In today's America, this is the fault of our central economic planning bureaucracy, known as the Federal Reserve.

2. True or False: The American economy has always experienced inflation?

Answer: False

Due to a relatively constant money supply at the time, coupled with ever increasing productivity, something that cost $100 in 1820 cost only $63.02 in 1913. But this is where the wheels began to fall off the American economy. What happened in 1913? We have experienced inflation for almost all of the time since 1913, when the Federal Reserve was created. The tendency of living Americans to claim that America has always had inflation is similar to the claim of living, former Soviet citizens that Russia had always lived under Communism. If what you know is all you have ever known, it's hard to imagine anything else. However, there really was a time when you could put away something for your future and expect it to not have been ravaged by central economic planning by the time you needed it.

3. True or False: Central Planning encourages saving and investment?

Answer: False

Central planners, having the hubris that they can manage all by themselves something as large as an economy, invariably cause more problems. Some of this is intentional, as the central planners usually benefit from their mismanagement (they get first crack at the inflated money supply before prices generally start to rise). Very seldom has central planning not corresponded to inflation. During inflationary times, people are much less likely to save and invest, because the value of their money declines over time as it is destroyed by the negative effects (inflation) of an inept central planning bureaucracy.

4. True or False: It is possible for a well-functioning economy to experience zero inflation?

Answer: True, but not entirely probable.

Economies are apt to function much better if they are not controlled by central economic planners. Human foibles being what they are, it's not likely that we'll live without any inflation, though, because it's hard to correctly quantify the goods and services in an economy on a continual basis. However, inflation would be much less in an economy that is (a) on a commodity standard, and (b) not controlled by a behemoth such as the Federal Reserve. However, if the money supply were to remain relatively constant, the effect in a healthy economy would be falling prices.

5. True or False: Deflation is a decline in consumer prices? Falling prices are a bad thing?

Answer: Not exactly and not necessarily.

Just as most people are apt to mis-define inflation, they are apt to give the wrong definition to deflation. Deflation is only that decline in consumer prices that results from a decrease in the money supply. Prices also go down as a result of efficiencies of production, or as a result of overproduction (supply exceeds demand). This is not deflation. This is a good thing. When inflation (increase in money supply) is mixed with efficiencies of production, prices do not go down as much as they would have. Imagine, for example, what the cost of a personal computer would be if there hadn't been nearly 100% inflation of our currency since PCs came out in the early 1980's.

. . .


Life without the Federal Reserve would likely have been so much sweeter. Without the inflation that the Fed has caused, you would still be living on a much lower salary, but your home would have a cost not much higher, unlike today. Without our "friend", The Fed, you'd be paying about 27 cents for a gallon of gas, 10 cents for a loaf of bread, and $200 for college tuition. Instead it seems that the cost of living goes up each year more than the increase in our salaries. It kind of makes you feel like a rat in a cage, doesn't it?

You know what? You are.




Comments

  1. Thanks for a very informative article - makes perfect sense!!! Thanks! :-)

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  2. well, you seemed to have gone downhill since part 1.

    1 - well, no, that's not the definition of inflation, it is just a general rise in prices. also money supply isn't the only factor (MV = PQ, don't forget the V) thus commodity backing doesn't prevent inflation either.

    5 - again with the redefining, i mean i realize you've got it out for central banks but you don't have anything better than this??? also deflation being a good thing, well, no, if currency is devaluing what happens to the credit market?

    2-4 seem to be trivia thrown in to take another jab at the idea of a central bank, so i'll try to remember them while playing trivial pursuit, but i don't see how they advance your down with the fed position.

    as was pointed out in the comments of part 1, you seem to have put your opinions out here without much backing. i see that you're against the fed, but you haven't given me a reason to change my mind, since some of your arguments seem to be, at best, a bit of a stretch.

    seriously, where'd you find those definitions of inflation and deflation?

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  3. Kannie,

    I'm glad you liked it. Did it change your definitions of inflation and deflation?

    Craig,

    No. I was already at the bottom of your hill.

    ;-)

    I get my definitions from the Austrian economists, who were the only ones who predicted the 1929 stock market crash and Great Depression, as well as predicting the economic collapse of 2008. Icons of finance like Ben Bernanke, Robert Rubin, and Henry Paulsen claimed to have been so board-dumb that they didn't see it coming.

    Have you studied MV = PQ? Or are you just throwing equations around so you can look smart? In the quantity theory of money, inflation is largely based on the growth rate of the supply of money. Also, you say that I said that there would be no inflation if we were on a commodity standard. I didn't. I said that there would be less likelihood of it.

    It's interesting that you like the Central Bank idea. Did you like it when Bush was in office helping Henry Paulson and Ben Bernanke to make the same mistakes that Barack Obama and Timothy Geithner are helping Bernanke make? Explain to me how the Fed is NOT responsible for the problems that we have?

    The facts in items 2-4 (and items 1 and 5, as well as the last quiz) can be found by reading the new book "Meltdown" by Thomas Woods.

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  4. yes, i actually have studied the equation, that's why i was pointing it out. you point to the fed's control of money supply as the only thing that could be causing inflationary/deflationary pressures, but if velocity increases or decreases then you could find yourself in inflation or deflation without the central bank even existing. this is where the gold standard argument falls down for me, how does a commodity backed currency even decrease the likelyhood of a change in value of a currency?

    and yes, i did support the concept of central banking when bush co. was running the show (though it was greenspan and bernanke, not paulson since he was in the treasury department, not the fed). this gets back to your question in the comments of part 1, do i blame the free markets for our current situation, in a way, yes.

    corporate greed, which can unbalance a free market led us to where we are. but that's not really a free market, free markets hinge on informed optimizing decisions, when large entities are out to make profits regardless of the risk involved, while creatively keeping thier books in order to appear to have little risk then how can even their stock holders hold them accountable? so if you have corporate greed, how can you have a free market? so if by free market you mean lack of regulations then yes, i blame the free market, since the corporations won't keep themselves in check, and their shareholders can't (due to lack of information) then someone or something has to step in and regulate. notice how none of that has anything to do with the fed.

    and then the book, maybe stop reading books by historians about the economy. he also works for a think tank that "works to advance the Austrian School of economics and the Misesian tradition, and, in application, defends the market economy, private property, sound money, and peaceful international relations, while opposing government intervention as economically and socially destructive." austria, ironically, is in the EU, which has a central bank.

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  5. Frank - It did indeed. I'm still mentally processing through it, of course, but the Austrian school of economics seems to claim and operate on much sounder principles - not to mention principles much more respectful of natural, individual rights.

    To craig41's last point, I'm not sure how one discounts an entire (minority) school of thought simply because a majority of the populace in that country has yielded to the temptation of collectivism...

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  6. Craig,

    It's ironic that Austria is in the EU only from the point that the Austrian government is not as smart as economists who espouse the economic principles originated in their country.

    I did NOT say that we couldn't have inflation without a central bank. I only said it would be much less likely.

    You said:

    corporate greed, which can unbalance a free market led us to where we are.

    You're correct. However, if you blame the current economic fiasco only on corporate greed, you are being very short-sighted. It was the free-for-all money-creation philosophy of the Fed (mixed with silly government requirements, such as affordable housing for people who couldn't really afford it) for the past 10 years that gave a false indication to the market that now was a great time to buy homes. Without the Fed, there would have been very little outlet for the greed that has ultimately gotten us into trouble.

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  7. Kannie,

    Your recent comment showed up just ahead of mine...

    You answered his concern about Austrian government vs. Austrian Economics better than I did!!

    Thanks.

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  8. it's kind of funny that you both went after the part where i was just being funny (i mean there was more in the comment than that!). i guess it wasn't. but really, if these anti central bank austrians are so right they'd be winning over hearts and minds in thier own country right? or at least somewhere? i mean other than you two. but i digress, it was really just a joke, the funny ha ha type of comment.

    anyways, frank, yes i know what you said, that's why i said "how does a commodity backed currency even decrease the likelyhood of a change in value of a currency?" and you said "I did NOT say that we couldn't have inflation without a central bank. I only said it would be much less likely." and i'm still wondering what the answer to my question was. i know, it doesn't make it impossible, you seem to be saying it decreases the chances, i disagree, what are you understanding that i'm not?

    and then there's this " It was the free-for-all money-creation philosophy of the Fed (mixed with silly government requirements, such as affordable housing for people who couldn't really afford it) for the past 10 years that gave a false indication to the market that now was a great time to buy homes. Without the Fed, there would have been very little outlet for the greed that has ultimately gotten us into trouble."

    how so? in all realitiy the free market (ish, i mean we've already established it's not a free market) of investors looked to rebound from the .com bubble burst by inflating a new bubble, this time in housing. it worked, for a while, and really isn't to far from going all madoff if you think about it.

    the bubble popped, and the banks were in trouble since the were effectivly doubling down on the bubble. they had to though, cuz they had to keep it growing to be able to sell off the loans and/or refinance the loans. that was their racket. it wasn't the fed, it wasn't the "silly government requirements, such as affordable housing for people who couldn't really afford it" it was the banks, and investors looking to make back the money they lost when .com went down and more.

    or at least that's my opinion, yours seems to be i read a book by a historian who likes what these austrian economists are saying and it says that isn't it (and i'm the one that's being short sighted, lol). it's gonna take more than that to convince me.

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  9. Craig,

    I meant to respond a few days ago...

    You're right about the free "ish" market. It's not free. How then, did it become not free? By the machinations of government.

    Where did the .com bubble come from? The same place as the housing bubble. By the machinations of government. If government hadn't created excess money in the economy (i.e. if there were a truly free market), there would have been NO BUBBLE.

    By the way, my perspective is that free market principles are innately common-sensical (not non-sensical like socialistic economic theory) and that I found a book that confirms my common sense with practical experiences.

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  10. Where did the .com bubble come from? The same place as the housing bubble. By the machinations of government. If government hadn't created excess money in the economy (i.e. if there were a truly free market), there would have been NO BUBBLE.

    this is where we disagree, the bubble came from the investors, looking to make bigger and bigger profits. the stock market was the arena for the bubble action in the 90's this decade it was housing. one wonders where it will be next. the problem is that no matter what the money supply is, there are always those willing to bend or break the rules to make money. it's a dog eat dog world in investing, and the investors won't hit the brakes while they're making money, they won't stop until the bubble bursts.

    if we've learned anything from the last two bubble cycles it's that. the fundamentals of the market don't matter anymore, you just have to be able to sell something for more than you bought it for.

    this is the free market at work, and again, it doesn't have anything to do with the money supply, if there were only a million dollars in the economy we'd just find ways to turn it over faster (although it's already moving really fast). i agree, it's common sensical, but that doesn't make it perfect, or ideal, or even the best option. we are seeing the downside of free markets now. what to do next is open to debate, but blaming it solely on the fed isn't accurate.

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  11. You may think it straining at gnats, but I did not blame it "solely" on the fed. I blamed it primarily on them. I agree that the capitalists got too greedy. I'm surprised, though, that you can't see how they couldn't possibly have sold homes for ever higher and higher prices without there having been more money in circulation.

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  12. hypothetically, doesn't extending credit to those that wouldn't normally be considered a safe risk, for the sake of continuing a housing market bubble, increase the money supply?

    in that hypothetical situation wouldn't it be good to have an entity that could take action to contract the supply of money in some way?

    it's not straining at gnats, more money in the system means more money spent (generally, savings aside). however, it doesn't mean more money spent in housing, nor does it mean more money spent on credit. i see the argument you're trying to make, i just disagree.

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