Wednesday, November 7, 2012

Fatal Fallacy 4

I posted #3 a while back, but wanted to pick up the series again. I'm posting #4 for the sake of completeness, but I would be lying if I told you I really understand this one. Focus on the last, italicized (mine), part.

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.

 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. 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.
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. 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. 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 main difficulty with inflation, indeed, is not with the effects of inflation itself, but the unemployment produced by inappropriate attempts to control the inflation. 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. 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. The answer is not to decrease the nominal deficit to check inflation by increased unemployment, but rather to increase the nominal deficit to maintain the real deficit, controlling inflation, if necessary, by direct means that do not involve increased unemployment.

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