Today, I received an e-mail as a reaction to an interview which I had given the left-leaning German daily “taz” last week (see here for the German text). In this interview, I had claimed that the recent actions by the US Fed to calm markets do not create inflationary pressure. My argument was that the US economy will most likely go into recession and banks will not extend their credit portfolios, so aggregate demand will remain weak which will put downward pressure on wages and prices.
The reader of my interview, however, was quite angry. He claimed that I obviously did not know much economics and that I was part of “a brainwashing scheme of mainstream media”. According to him, a rise in the money supply already is inflation as it always leads to higher prices. At least, so he said, that is what he was taught when he was studying economics at the University in Essen. As a proof, he also cited the German Wikipedia site.
When I looked at the German Wikipedia Website on inflation (which incidently is blocked for editing for new users, so I could only leave plead to have it changed), I was quite surprises by the definition I found there (the quote is the first sentence, hence the central definition) which read:
“Inflation (von lat.: „das Sich-Aufblasen; das Aufschwellen“) bezeichnet in der Volkswirtschaftslehre einen andauernden, „signifikanten“ Anstieg der Geldmenge und damit des Preisniveaus”
For non-German speakers (my translation):
“Inflation (from latin: “balloing”) denotes in economics a continous ‘significant’ increase in the money supply and hence in the price level.”
Interestingly, in Germany, monetarism seems to be so much accepted that for the definition of inflation, people put the increase in the money supply before the increase in prices!
Compare this to the definition of inflation from the English language version of Wikipedia:
“Inflation is a rise in the general level of prices over time. It may also refer to a rise in the prices of a specific set of goods or services. In either case, it is measured as the percentage rate of change of a price index.”
Or to the definition from the New Palgrave’s which cite David Laidler and Michael Parkin (not necessarily known as anti-monetarists):
“Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value in money.”
The definition of the German entry to Wikipedia has several problems – both in relation with historical evidence, but also against modern mainstream monetary theory: First, as we know since the Volcker experiment and Goodhart’s law, the velocity of money is far from stable. There might be periods of rapidly rising money supply without inflation.
And as we know from the time of German hyperinflation, inflation can continue even without a rapid increase in the money supply: During the German hyperinflation, there was one episode when the money printers went on strike. Nevertheless, the price increases continued. In fact, in most periods of high inflation, the real money supply falls. When Hjalmar Schacht introduced the new currency, the Rentenmark (which was backed by claims on mortgages decreed by the German government on private property), people had confidence that the new Mark would be stable. After a short while, money supply started growing quite briskly again – but without a coincident increase in prices. Instead, people started to hold their wealth in money again.
This is also what modern textbooks tell you: In most modern mainstream models, what is important for inflation is inflation expectations plus the deviation of current demand from potential output. Money supply is endogenous and a consequence of developments in the financial sector and portfolio decisions by private households.
While one can sensibly argue that data on money supply might help you to spot excesses in bank lending, it is less clear whether this might lead to inflation in the end. This is why even the ECB has moved away from putting M3 first as a intermediary target for monetary policy.
However, as we see from my reader’s e-mail and the Wikipedia entry, it will take a long time until Germans will widely accept an inflation targeting framework. Being sceptical of the financial sector as a part of “capitalist economy”, many Germans still believe money should best be backed by gold. If this is not possible, it should at least be run by the Bundesbank with a strict monetary targeting (even if this was never what the Bundesbank empirically did). And obviously, this view is also still taught in universities across the country.
This post has been co-posted at Eurozone Watch.