Gold Core

Inflation of the money supply

Published by Marc Westlake under Economics |

"Fiscal policy!" whooped Ford.  "Fiscal policy!"

The management consultant gave him a look that only a lungfish could have copied.

"Fiscal policy..." he repeated, "that is what I said."
 “How can you have money,” demanded Ford, “if none of you actually produces anything? It doesn’t grow on trees you know.”
“If you would allow me to continue …”
Ford nodded dejectedly.
“Thank you. Since we decided a few weeks ago to adopt the leaf as legal tender, we have, of course, all become immensely rich.”

Ford stared in disbelief at the crowd who were murmuring appreciatively at this and greedily fingering the wads of leaves with which their track suits were stuffed.

“But we have also,” continued the Management Consultant, “run into a small inflation problem on account of the high level of leaf availability, which means that, I gather, the current going rate has something like three deciduous forests buying one ship’s peanut.”

Murmurs of alarm came from the crowd. The Management Consultant waved them down.

“So in order to obviate this problem,” he continued, “and effectively revaluate the leaf, we are about to embark on a massive defoliation campaign, and … er, burn down all the forests. I think you’ll all agree that’s a sensible move under the circumstances.”

The crowd seemed a little uncertain about this for a second or two until someone pointed out how much this would increase the value of the leaves in their pockets whereupon they let out whoops of delight and gave the Management Consultant a standing ovation. The accountants amongst them looked forward to a profitable Autumn.

from The Restaurant at the End of the Universe by Douglas Adams

The question many investors are now asking is this; is the fear of inflation arising from the response of the monetary authorities printing money to address the credit crunch going to be realised?
 
This fear is based upon a classical Monetarist view based on a definition of inflation; “too much money chasing too few goods”.

However, a recent study by Credit Suisse has questioned the extent to which printing money might be inflationary given the other changes observed in the “shadow money” system. This is the other side of the Monetarist view and postulates that given the slowdown in credit availability, combined with the reduction in aggregate wealth arising from the recent falls in the value of real assets, our preference for holding cash has changed and therefore the monetary authorities are acting appropriately to fend off the risk of significant deflation.

The actual rate of inflation is as much a reaction to expectations of the cost of future goods and services as it is to changes in input costs such as raw materials or commodities.

Economists describe this as “expectations augmented inflation” and is reflected in, for example, employees negotiating pay increases to reflect an expection of higher prices in the future. This feeds into the costs of production, higher output costs of goods and services and therefore higher realised inflation.

Since our expectations of the future rate of inflation are therefore relevant to the realised rate of inflation, it is clearly beneficial to consider all the possible scenarios.

 
The original research from Credit Suisse can be found here.
 
Or listen to a Bloomberg interview