The Dangers of “just a little inflation”

Good reminder from Henry Hazlitt’s classic. Bernanke and other Keynesian economists believe they can finesse this danger. Like they finessed the housing bubble, I suppose. All inflations end with some form of contraction – the greater the inflation, the greater the contraction.

From “Economics in One Lesson,” by Henry Hazlitt (1946):

Even a relatively mild inflation distorts the structure of production. It leads to the over-expansion of some industries at the expense of others. This involves a misapplication and waste of capital. When the inflation collapses, or is brought to a halt, the misdirected capital investment—whether in the form of machines, factories or office buildings—cannot yield an adequate return and loses the greater part of its value.

Nor is it possible to bring inflation to a smooth and gentle stop, and so avert a subsequent depression. It is not even possible to halt an inflation, once embarked upon, at some preconceived point, or when prices have achieved a previously-agreed-upon level; for both political and economic forces, will have got out of hand. . . .

For . . . the causation is never a merely mechanical one. You cannot, for example, say in advance that a 100 per cent increase in the quantity of money will mean a 50 per cent fall in the value of the monetary unit. The value of money, as we have seen, depends upon the subjective valuations of the people who hold it. And those valuations do not depend solely on the quantity of it that each person holds. They depend also on the quality of the money. In wartime the value of a nation’s monetary unit, not on the gold standard, will rise on the foreign exchanges with victory and fall with defeat, regardless of changes in its quantity. The present valuation will often depend upon what people expect the future quantity of money to be. And, as with commodities on the speculative exchanges, each person’s valuation of money is affected not only by what he thinks its value is but by what he thinks is going to be everybody else’s valuation of money. [This is impossible to model.]

All this explains why, when super-inflation has once set in, the value of the monetary unit drops at a far faster rate than the quantity of money either is or can be increased.


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