[Update: I am not trying to make a normative argument. I am not arguing that since inflation can lead to a fall in real wages it is bad. This is simply a theoretical argurment that claims that inflation will lead to some becoming poorer than they were before.]

Superficially, Austrians and Monetarists agree on a wide palette of theoretical issues, including the fact that inflation (a general rise in prices — a rise in the prices of some goods, without an offsetting fall in the prices of others) is a monetary phenomenon. Thus, when market monetarist David Glasner argues that “rising prices necessarily put more dollars in people’s pockets” there is no disagreement on my part. A general increase in prices requires a rise in the supply of money, which necessarily means that certain people are holding these new monies; in other words, a general increase in prices requires that at least someone’s nominal income — income meant in the broadest possible sense — has risen, and that nobody else’s has fallen by an equal nominal amount. This is, however, as far as Austrians and Monetarists agree on this matter, as the discussion between Glasner and I goes to show.

It is pertinent to mention that the focus of debate — the effects of inflation on real wages, everything else being equal (that is, without considering the effects of monetary injections on productivity) — is a narrow one. My initial critique of Glasner, in fact, was on a very minor, even tangential, point made in his criticism of a piece by Jon Hilsenrath. Glaser’s objection to Hilsenrath’s claim that inflation will lead to a fall in real wages is that this is not necessarily true, given that nominal income must rise to make possible inflation in the first place. I rejected this conclusion, on the basis that since inflation does not affect all prices (including the price of labor) neither simultaneously nor proportionally, some must suffer from a fall in real income.

Glasner does not agree. Because Glasner’s post is structured in a fashion that makes it difficult to write a straight-forward reply, I have highlighted what I interpret as the four main points that shape his argument. These are,

“[E]xistence of inflation is predicated on an increase in total spending;” “[I]f money is being injected continuously or periodically, Catalan’s statement is erroneous, because once the cycle of injection and dispersal is repeated, it is no longer meaningful to identify a particular point of entry as prior to any other point in a continuing cycle;” “I don’t think that it’s possible to say much about how injections of money affect relative prices unless the monetary authorities are deliberately aiming to put money into the pockets of specific groups of people;” “[A]s a general proposition, we have little way of determining whether recent changes in relative prices (and wages) were caused by real forces affecting relative prices and wages or by the forces affecting inflation.”

Instead of responding point-by-point, I will instead revisit my original thesis — that inflation (a general rise in prices) will lead to a fall in real wages — and attempt to redesign my argument as to touch upon all four of Glasner’s objections. Points 1 and 4 can actually be put to rest by providing two preconditions.

First, I agree (and agreed) that the existence of inflation (a general rise in prices) can occur only as a result of an increase in total spending: as Milton Friedman put it, “Inflation is always and everywhere a monetary phenomenon.” That is not what I am contesting in Glasner’s criticism of Hilsenrath. Rather, I am commenting on what I consider to be a sloppy mistake on Glasner’s part: he argues that because spending (and thus, income) must necessarily rise before there can be a general rise in prices, it does not necessarily follow that real wages must fall. What I am bring attention to is the fact that inflation must necessarily leave some poorer than before, because wages (in general) do not rise proportionally or simultaneously with the price of goods; no less, prices (including wages) do not rise proportionally or simultaneously in relation with each other. If inflation is uneven, then there must be losers. (With that being said, I concede, of course, that there are also winners).

Hoping not to sound too hostile — as that is not my intention —, I feel that Glasner unfortunately falls into the trap of splitting hairs. Ultimately, I think he accepts the essence of my argument: in inflation, there are winners and losers. I am not arguing that all wages and profits suffer as a result of inflation (all else being equal), only that the wages and profits of some will. However, if the real wages of some fall then I am ultimately right; real wages (broadly considered) fall as a result of inflation, all else being the same.

Second, I am not interpreting history. My argument involves only the theoretical. Therefore, I am not sure how valid Glasner’s empirical objection is: I am not arguing that in recent history (whatever time period Glasner has in mind) recent changes in prices were caused by a rise in the supply of money. My point revolves only around the theory of inflation and the consequences of inflation on real wages, all else being equal (not considering the effects of monetary injections on production).

With these two things in mind, I can now proceed to consider the meat and bones of Glasner’s counter-argument: points 2 and 3. I reject both the idea than Cantillon Effects are irrelevant if money is injected at a continuous or periodic rate and that it is impossible to say how injections affect relative prices (and I think that here Glasner also errs in his interpretation of why Hayek’s theory of industrial fluctuations is not useful [if Hayek’s conclusions on the business cycle are wrong it is because of other, much more complicated, reasons]).

The basis of my rejection lies in that if the expenditure — distribution — of money occurs over time, then this temporal lag in the effects of inflation will lead to a change in income (as it relates to the various individuals who make up a market) regardless of whether the injection takes place once or continuously. It is true that the effects of monetary injection will continue to manifest themselves throughout the market as the injections continue to take place, but as the later recipients of new monies begin to feel the effects the original recipients will now receive even more new monies. Whether or not prices are now changing continuously, the recipient of new monies will still be bidding a higher income on the prices of the recent past (i.e. of the present), and thus they will still be at an advantage as compared to others. No less, that monetary injection take place continuously does not invalidate the fact that changes in prices as a result of an increase in the supply of money in circulation do not occur simultaneously or proportionally amongst the prices of all economic goods — what this means, most importantly, is that all wages will not rise proportionally to all goods, meaning whatever wages lag behind changes in the price of goods will see a fall in real purchasing power.

All action takes place towards time. The act of bidding money towards a good is one that requires a certain amount of time, just like the act of the seller to raise prices in light of an increase in nominal demand for his product. It follows that actions that follow previous, prerequisite actions (the use of that money by the seller to bid towards other goods) also requires time, and therefore we establish an intertemporal schedule to the movement of relative prices resulting from monetary injection. Even if money is injected continuously or periodically (this also implying the passage of time), it is impossible for the intertemporal consequences of something that follows an intertemporal schedule — a staggered effect on prices — not to manifest. So, even if new monies has been injected into the economy in the recent past, intertemporal lag means that the effects of the subsequent injection of new monies will still fall behind the effects of the previous injection. I do not see any theoretical basis for the belief that a continuous or periodic injection of money negates this intertemporal aspect of the circulation of money, as Glasner wants us to believe.

For the sake of providing a simple example, if Glasner were correct then it would not make sense to reduce the value of currency to stimulate exports. If the intertemporal aspect of the money circulation was absent, then exchange ratios between different currencies (all suffering from continuous tempering) would remain constant. This is not the case, though: a continuous devaluation of currency is necessary to continuously artificially stimulate exports, because at some point relative prices (the price of one currency to another) fall back into place —, reality is the exact opposite of what Glasner proposes. The example is imperfect and very simple (it does not have anything to do with the prices between different goods amongst different international markets), but I think it illustrates my point convincingly.

Can we pinpoint specific points of injection? It is true that this is (mostly) a historical endeavor — how a monetary injection actually affects an economy requires historical analysis (i.e. looking at the data). However, if the monetary authorities are looking to implement a certain program, we can ascertain the general effect of this program on relative prices theoretically. My point is that if we know how the authorities plan to inject new money, we can successfully predict the general pattern of change that will occur. So, if the monetary authorities inject new money by allowing banks to lower interest rates by increasing the supply of credit, then we know that the monetary injection is taking place through the loanable funds market — going back to a tangential comment on Hayek’s business cycle theory, this is exactly how Hayek came to his conclusions (Hayek’s theory would be invalid only if new monies did not enter the system through loans that were used to bid these new monies towards capital goods). Of course, though, the effects of new monies are not equal amongst the different possible points of injection, but this was never in contention.

The broader point remains, though: since inflation does not occur simultaneously or proportionally amongst all prices, there are winners and losers. Those who do not see a rise in wages that are the same or greater than the rise in the prices of the goods they buy will see a fall in purchasing power (a fall in real wages); those who see a rise in real wages will see a rise in purchasing power. Whatever be the case, it is undeniable that there are losers; thus, Hilsenrath (and myself) was right all along (on this very specific point, that is tangential to his [fallacious] general argument).

In the grand scope of things, though, I think Glasner and I would agree that this argument is really about something that does not really matter. We know that “everything else” cannot and does not stay equal in the event of monetary injections. Changes in the data force changes in expectations, or further changes in the data, and thus changes in the supply of money will have effects on the real economy (distribution of economic goods). If monetary injections, in specific occasions, can lead to a rise in productivity, then that some wages suffer from changes in relative prices will be offset by the fact that in general all wages have risen (as a result of greater productivity). However, if monetary injections do not lead to greater productivity — or even, a fall in productivity — then we know that real wages, and the real economy, will suffer from it.

The aspect of this minute debate that stands out as excruciatingly important, though, is in highlighting how different economists approach the topic of price formation in relation to the individual and money. While on-the-whole the debate on the effects of inflation, all else being equal, may be not so important, how economists look at (relative) prices still plays a very large role in the conclusions they derive on more important topics (such as the business cycle). I agree with Hayek when he lamented the lack of focus on the consequences of a change in prices of certain goods relative to others, in Prices and Production. Whether you agree with his conclusions or not, I think that it is unacceptable that many economists consider an aggregated approach to price formation as superior to an individualistic approach — if an aggregated approach led Glasner to an erroneous position (or what I consider to be erroneous) on such a simple and inconsequential topic, then what kind of errors can it lead him to make on more serious topics?

I realize that the above paragraph is extremely loaded and accusative. I do not mean it to be controversial, so I hope that all dissenting readers give me the benefit of the doubt. I honestly believe that it is the differences in approach to price formation that leads to quite a bit of divergence of the quality of the conclusions wrought.