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Inflation: The Reality of Modern Economic Life

Inflation: The Reality of Modern Economic Life

Like the need for separation of church and state, we need the separation of the central bank and state if freedom is to be preserved.

As economies around the world suffer from levels of inflation not seen in decades, a deadly disease plagues the entire world, rejuvenating itself like the nine-headed hydra. But while the origins of COVID-19 are debatable, the causes of inflation are not. They lie in undisputed human actions, actions not of everyday economic participants but of special institutions which exert their control over economic affairs in our everyday life, stifling the freedom and lives of millions of its constituents. It is the wolf which we have brought willingly into our homes, and we have become sacrificial lambs in the process.

Inflation, a modern phenomenon

Inflation is not some abstract economic concept devised by economists to act as an analytical device; it affects the lives of even those who hardly know about it. So embedded has it become in our expectations that we forget that inflation wasn’t always a permanent part of our lives. Inflation is seldom mentioned in the great works of past masters like Adam Smith. It was rather in the debates between the British Currency School and the British Banking School (and later with David Ricardo) that the problem of inflation came to the forefront of economic discussions. Yet even then, inflation was treated as a special case and not the general state of affairs.

Moreover, inflation was always traditionally associated with economic disarray. When despotic sovereign rulers went to war with money they didn’t have, they depended on the artificial creation of money to cover their costs. During the long war that broke out between Great Britain and Revolutionary France, the British government’s war costs had grown exponentially. While the British economy was left in shambles, devoid of growth, 70% of the debt was financed by the Bank of England. So when scholars argue that the nationalization of the Bank of England took place for the very purpose of assisting the government, thereby giving it the control of one of the most important pillars of economic life – money – they are not wrong.

And then something extraordinary happened in the midst of the Great Depression. John Maynard Keynes’ General Theory of Employment, Interest and Money provided the government of its time both the legitimacy of expanding its control over economic affairs as well as the sledgehammer with which to execute it. A few decades later, in the 1970s, inflation soared to levels that were unfathomable even by the most astute supporters of interventionism, and we got stagflation. Stagflation proved what classical liberal economists had always argued, that is, that you cannot create wealth and prosperity by artificially creating money and putting chains on the market.

A unique crisis that arose from political disarray and resulted in economic stagnation has now become a never-ending state of affairs, something which we have internalized and have deemed to be normal. The role of the central banks around the world has evolved from ‘safeguarding the economy’ into ‘managing the economy’, fundamentally distorting the workings of the market in the process.

The role prices play in society

The market process is a process of coordination where order appears spontaneously out of the voluntary interactions of millions of economic agents each pursuing their own private good. Prices in the market process act as coordinating signals conveying important information about economic data that are scattered among millions in a decentralized manner. The role prices play in coordinating actions in the market was one of the core arguments advanced by Friedrich Hayek on why central planning could never allocate resources as effectively as markets do.

As central banks, in their attempt to dictate the course of the economy based on their respective political leanings, inflate the economy with liquidity, it leads to distortions of prices in the structure of production. But the rise in prices in itself is not the problem. In a well-functioning market, it has a specific role. When an object becomes scarce in the market, it sends a signal to consumers to economize on it. At the same time, it instructs producers to employ their resources on increasing supply and realizing the additional profits until the profits are brought back down to normal. It is the artificially created rise in prices which destroys the efficient allocating mechanism of markets. It is a tax levied on consumers which reduces the purchasing power of their money as well as their saved-up wealth. It acts as a signal which misdirects the employment of resources leading producers to make inefficient choices and allocate resources erroneously. It undermines trust on all sides in the price mechanism.

Conclusion

The claim that central banks in their efforts to manage and dictate the course of affairs not only dampens but essentially distorts the role of prices in the market isn’t revolutionary or surprising. The workings of the markets in such a state of affairs can be adequately captured by imagining a busy street without traffic signals. It would be a chaotic mess, which is the case with our present economies.

We need stable rules and real market prices so that prosperity can finally emerge and cut short this crisis. With a central bank in charge of the economic affairs of citizens that is not possible. Like the need for separation of church and state, we need the separation of the central bank and state if freedom is to be preserved.

Author

  • Inflation: The Reality of Modern Economic Life

    Vibhu Vikramaditya is an economics and a libertarian scholar with research interests in capital theory, monetary theory, and business cycles. He writes on modern events in the economy from a legal and economic standpoint.

The views expressed on austriancenter.com are not necessarily those of the Austrian Economics Center.

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