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Inflation versus Deflation Argument Daryl Montgomery July 9, 2008 Copyright 2008, All Rights Reserved U.S. Inflation Background • U.S. government claims inflation is currently running at a 4.2% annual rate. • Methodology for calculating inflation was changed several times in the 1980s and 1990s. In every case the change resulted in a lower reported U.S. inflation rate. • In order to compare inflation numbers must use the same methodology (choose one). • If inflation is recalculated using 1970s methodology, current rate is about 12% (high in 1980 was 14%). U.S. CPI with 70s Methodology Our View on Inflation • Inflation is an increase in consumer prices. • We are entering a very high inflationary environment that will be much worse than the 1970s. • Currency valuations are a key component of inflation and the U.S dollar is in a long-term downtrend. • Prices for food and energy are set globally and analysis for price increases/decreases must be made on a global basis. • Increases in M3, MZM Money supply measures don’t have maximal inflation impact until at least 3 years after they take place (earliest possible U.S. inflation peak will be 2011). U.S. Dollar 7-Year Weekly International Inflation M3 Money Supply 1970-2008 Deflationist’s Argument • Claim we are entering an era of decreasing prices despite all evidence to the contrary. • Define Inflation as increase in money supply plus bank credit (Austrian School), NOT consumer price increases (but somehow this eventually affects consumer prices). • Admit that “printing” too much money causes inflation (Weimar Germany, Zimbabwe). • Claim interest rates below inflation rate aren’t inflationary if bank credit declining enough and inflation can’t exist without (national) wage increases. • Compare current credit crisis to the U.S during the 1930s and Japan in the 1990s. Problems with Deflationist View • Is theory-based instead of reality-based (starts with theory and if reality doesn’t match, claims reality is wrong). • They haven’t shown any relationship between their inflation measure and consumer price levels. • Doesn’t consider currency effects (there were none in the 1930s U.S and the value of the Yen was relatively flat during Japanese deflation). • Considers inflation to be local and not global. • Doesn’t consider inflation possible through expenditures of assets instead of income. • Based on mid-stage industrial economy, not a modern information-based economy. Is there a Relationship Between Money Supply + Bank Credit and Consumer Prices? • Consumer price deflation started in the U.S. by 1926, before the fall in money supply and bank credit in the 1930s. • CPI in Japan declined in 1986, just before the worst stage of their asset bubble. • Consistent consumer price deflation in Japan didn’t take hold until 1999, nine years after their bubble collapsed. • The inflation rate in the U.S. declined throughout the 1990s to the early 2000s even though bank credit was greatly expanded.