I know about sticky wage theory and it's supposed effect, but I don't buy it entirely. First of all, the major reason why they exist to some extend in the first place, is because of governmental intervention in the labor market, special privileges for unions, etc. In a free market, inefficient behaviour of wage earners will put them out of business and people will learn that a 2% nominal wage cut is better than a 100% real wage cut if the firm goes out of business. Besides, why aren't wages sticky in both directions? You could also argue that with high inflation, businesses are going to increase wages at a lower rate than inflation, because workers will be satisfied with a 2-3% increase, even if inflation is at 10%, because they are to stupid to realize what real wages are. Thus creating the same inefficiency the other way around.
First of all, the foreclosure and default argument is a mood point. If it is indeed better for banks to lower the debt of it's debtors, then they don't need price inflation for it. They could simply offer a "haircut".
Don't say that savers are not going to be hurt under higher price inflation if you make the point that the return will be devalued, thus helping debters. You can't have it both ways. It's a zero-sum game.
Of course you could delay recessions by increasing the money supply. Nobody says that this won't increase total output. In fact, that's a core assumption of the Austrian Business Cycle Theory. But you don't see recessions as what they are. A necessary evil to reallocate badly allocated ressources (most times because of bad monetary policy in the past). You're not doing society a big favour if you artificially stimulate the economy to continue in an inefficient way. In fact the same problem will come back later, only larger this time. History shows that those recessions that got the most political response have been the most severe and long lasting ones, while those where the economy was "left alone" restructured very quickly, even though the initial shock was just as hard. And that's not that hard to understand, once you realize what a recession really is. Of course if you blame everything on "animal spirits" rather than on systemic reasons, you won't be able to draw many conclusions out of it.
(Have you ever heard of the Great Depression of 1920?
http://www.youtube.com/watch?v=czcUmnsprQI)
That's exactly what I've said. I did point out that the Feds actions represent a shift in the money supply curve. Maybe what confused you was my point about the liquidity trap situation you mentioned earlier?
Again, in a free market people save (and let's for the sake of the argument assume that savings=lendings=investments) and people borrow. When people suddenly decide to save more (higher savings rate represents a shift in the money supply to the right on the loanable funds market) more money at a lower price is being lent out, if the money demand curve remains unchanged (ceteris paribus).
What happens in the economy? Well, borrowers are taking that additional money in order to built capital goods so that they can increase their production in the future. The savers on the other hand are going to spend less today. Why? Because they save more. They can't use money twice. Y=C+I
Now Keynes would have (wrongly) argued that this situation would result in a recession. His reasoning was that if consumption goes down now, nobody is going to invest in the future (paradox of swift). That argument is really bad on a number of grounds. First of all, yes, retailers had to lay of workers if consumption goes down, no question about that. But the problem of Keynesian/neo-classical economics is that in those schools of thought Y equals Y equals Y... and K equals K equals K.
Just because some people lose their jobs and the economy restructers a little bit, doesn't necessarily mean that it's a bad thing. Also, the firms who want to borrow the higher amount of capital at lower interest rates, are certainly not retailers. They are companies in mining, housing, R&D, etc. with long term strategies at the earliest stages of production. These entrepreneurs are perfectly able to understand that low costs of borrowing money are great for them and that the demand for their product is not going to be affected by the current lower demand for consumption goods, because their goods are going to enter the shelves in 10, 20 or 30 years. And they also know that there
has to be demand in the future, since they borrowed money from others who are going to want to consume eventually. Nobody invests for the sake of investing. In the end, for every salesman laid of, a miner or researcher is going to be employed.
So we see that in an unhampered market, the path to sustainable growth in the future is to save today. And that's perfectly sustainable because the payback of borrowed money with interest represents excess demand later, exactly at the time the exess supply of goods is occuring.
Now what happens if the central bank increases the money supply, not private savers? Again, the supply curve of loanable funds shifts to the right, but the amount of money that is actually being saved by market actors is still where it was before. The excess money does not represent savings.
How could that be? Because what the newly created money does is syphoning purchasing power from all currency holders. In a perfectly adjusting economy prices would rise instantaneously across the board, if the money supply where to be increased evenly. Since that new money mostly goes to the government via bonds it would in effect be equal to a lump sum tax.
But the economy is not perfectly adjusting and we do not have perfect information. Lenders are suddenly confronted with a lower interest rate, thus fewer people are going to save today and thus current consumption is going to go
up (as opposed to the situation where lower consumption resulted in lower interest rates, because of higher savings). At the same time borrowers are confronted with lower interest rates too, which will result in a
higher amount of investment. So I and C are both trying to increase at the same time. But since resources are scarce, this will result in prices being bid up - but not instantaneously, it will take time (Friedman's famous "time lag" he couldn't really figure out). For a short amount of time we will see zero unemployment (or rates below the natural rate, because of excess work force wanting to work in the boom economy) and higher total output. Everything seems to be great until inflation finaly kicks in and increases the prices of goods. To combat this the central bank increases the money supply again year after year, only delaying the inevitable. Eventually those investments will result in even more goods being produced. But (as opposed to the free market growth situation) there is no excess demand (desire
and ability to purchase at prices X).
In no situation can a central bank know better what an economy needs than the actions of millions of individuals responding to other individuals' actions displayed by prices, profits and losses.
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