Firstly, please note that Austrian School’s definition of inflation is different from the mainstream definition. Austrian School define inflation as the growth in money supply (i.e. debasement of the currency). In other words, according to the Austrian School’s definition, inflation is purely a monetary phenomena.

A clear understanding of the different definitions is essential to avoid miscommunication in discussions.

Are you saying that high wage and general inflation and little to no (real) debt growth would lead to mass unemployment?

Not exactly. Let me quote the book, What You Should Know About Inflation by Henry Hazlitt (an Austrian School economist):

The same chain of causation applies to all the so-called “inflationary pressures”—particularly the so-called “wage price spiral.” If it were not preceded, accompanied, or quickly followed by an increase in the supply of money, an increase in wages above the “equilibrium level” would not cause inflation; it would merely cause unemployment. And an increase in prices without an increase of cash in people’s pockets would merely cause a falling off in sales. Wage and price rises, in brief, are usually a consequence of inflation. They can cause it only to the extent that they force an increase in the money supply.

I don’t have much to add here, except to say I can understand that there are arguments both for and against trying to inflate our way out of the mess we’re in. I’m not informed enough to comment on the problems that might eventuate. I just see a continuation along our current path taking us further toward an unpleasant outcome.

“How is it possible to engineer an inflation whereby only goods prices rises and asset price remain stagnant? Any policy of deliberate inflation runs the risk of misfiring and thereby further inflating asset prices.”

I would have thought some combination of credit controls (restrictions or tax on equity withdrawal for starters) would do the trick in keeping asset prices in check. Are you saying that high wage and general inflation and little to no (real) debt growth would lead to mass unemployment?

Rather than simply agreeing to disagree on “monetary dynamics and the causes of inflation” would it be too much to ask for a brief explanation of the differences of opinion? Just the key points as they relate to the argument? And no big words, okay? ;-P

I would also see credit contraction and asset price deflation as part of the process, but I take the causal mechanism back one stage further to the excessive accumulation of debt–on the basis of “euphoric expectations” about asset price inflation–over the preceding decade.

See the November 2006 Debtwatch report, page 12, Figure 14 for a nice empirical statement of this. While I don’t believe that the OECD debt figures can be directly mapped to the RBA and US FRB debt figures I use elsewhere in the report ( I expect the OECD’s classification drastically understates Japan’s actual domestic debt levels), the dynamic between accelerating debt and economic performance is quite clearly shown in the data.

So I see the root cause as debt accumulation during a boom–which is what we are experiencing now. Once that reaches excessive levels–which means once the debt servicing commitments become extreme compared to cash flows from actual productive investments–then the system can tip over into a debt-induced downturn. This is Minsky’s thesis, which I’m attempting to develop further.

… Japan’s deflation was caused by credit contraction that was caused by the collapse of asset prices.

To be more precise, I meant that there was a vicious cycle of credit contraction and asset price collapse. Which of the two was the root cause of this vicious cycle would better be a separate discussion for another day.

I agree that the philosophical base of our schools of economic thoughts (mine is Austrian School) are different. So, there is no point in furthering the debate.

Just a clarification on my view regarding the Japan example that you gave. My belief is that (and I’m aware you may not share my belief) Japan’s deflation was caused by credit contraction that was caused by the collapse of asset prices. Therefore, I would not advocate monetary inflation as a cure because all that would do was to inflate the base money supply, which will hardly re-inflate broad money (in which its inflation caused the asset price bubble in the first place). Japan did precisely that and the result was the rise of the yen carry trade in which among other things, Japanese banks extended credit to Asian countries.

Therefore, in Japan’s case, I would not recommend monetary inflation to solve deflation problems.

Here we part company on our analysis of monetary dynamics and the causes of inflation. We could debate from one theoretical perspective (Austrian) to another (Post Keynesian, Circuitist), but my experience of such debates is that they convince neither side. Therefore I suggest you take a look at the following paper, written by two economists with impeccable conservative neoclassical credentials (ie, a Nobel Prize) on the actual dynamics of monetary creation in the USA. They conclude that credit money creation precedes fiat money creation:

http://www.minneapolisfed.org/research/common/pub_detail.cfm?pb_autonum_id=225

Hyper-inflation is indeed an economic disease in its own right–I’d never deny that–but in the context of deflation, inflation can be desirable. That was Japan’s position for the 15 years it was in a debt deflation recently, and conventional means to cause inflation (”printing money”) failed abjectly–which indicates amongst other things that the conventional theories, like the one you propose above, are not correct.

Please remember that I think a wage-increase-by-decree policy has zero chance of being implemented–whether I think it might work or not. But I simply want to propose it because I expect the opposite policy will be pushed if a debt deflation actually ensues–and that would be an unmitigated disaster.

I’m sorry that this is a rather tangential reply to your post, but I’m busy with other work at the moment, and the difference in our philosophies on this point is rather too extreme to make sensible debate on a blog feasible. However I suggest that if you’d like to know where I’m coming from on some of my analysis on this point, you search out articles on Hyman Minsky’s “Financial Instability Hypothesis”–some of which I have linked from this blog, and from my website http://www.debunkingeconomics.com.

It would be possible by increasing wages.

One question: how would that be done in practice?

Say, we increase wages by decree without a accompanying monetary inflation (i.e. increase in the quantity of money). It will lead to mass unemployment, which in turn will hasten deflation that is led by mass debt defaults (see the 2nd last paragraph of our article: Can Australia’s deflating property bubble deflate even further?).

Say, we increase wages through monetary inflation. We would agree with you that the first round of impact will be on consumer prices. But this is highly risky. Firstly, with this measure, businesses will know in advance that their wage cost will increase. Therefore, they will respond by increasing prices perhaps even beforehand. Politically, once you increase wages once that way, the mob will demand more increase in wages to ‘combat’ the increase in prices. This runs the risk of an upward spiral of general price level. In Murray Rothbard’s (an Austrian economist from the Mises Institute) excellent book: What Has Government Done to Our Money? (page 31-32), it mentioned that

At first, when prices rise, people say: “Well, this is abnormal, the product of some emergency. I will postpone my purchases and wait until prices go back down.” This is the [59] common attitude during the first phase of an inflation. This notion moderates the price rise itself, and conceals the inflation further, since the demand for money is thereby increased. But, as inflation proceeds, people begin to realize that prices are going up perpetually as a result of perpetual inflation. Now people will say: “I will buy now, though prices are `high,’ because if I wait, prices will go up still further.” As a result, the demand for money now falls and prices go up more, proportionately, than the increase in the money supply. At this point, the government is often called upon to “relieve the money shortage” caused by the accelerated price rise, and it inflates even faster. Soon, the country reaches the stage of the “crack-up boom,” when people say: “I must buy anything now—anything to get rid of money which depreciates on my hands.” The supply of money skyrockets, the demand plummets, and prices rise astronomically. Production falls sharply, as people spend more and more of their time finding ways to get rid of their money. The monetary system has, in effect, broken down completely, and the economy reverts to other moneys, if they are attainable—other metal, foreign currencies if this is a one-country inflation, or even a return to barter conditions. The monetary system has broken down under the impact of inflation.

In my humble opinion, I believe your opinion (that is if I understand it correctly as increasing wages by decree with monetary inflation) may run the risk of losing control, resulting in hyper-inflation.

It would be possible by increasing wages.

Of course, in practice, that is highly unlikely to happen, given the attitude of conventional economists to both inflation, and wages. I’d give the odds of this actually being tried by policy makers as zero.

However, I flag it as a possible remedy because what they are far more likely to propose is something that would make the situation worse: reducing wages. This was of course attempted as a “cure” during the Great Depression–a 10% across the board cut in wages. And Australia was even more mired in Depression afterwards.

From the point of view of neoclassical economics, unemployment–one, but far from the only, symptom of a debt deflation–can be cured by cutting REAL wages. As Keynes argued against this policy, cutting MONEY wages won’t necessarily cause real wages to fall, because the cut in wages will be passed on (in the environment of a Depression) to a fall in prices, leaving real wages at much the same level.

Though I disagree with Keynes about part of the following (causing inflation by “increasing the quantity of money”), I think he puts the dangers in reducing money wages well:

“The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt;
whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage-unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former.” (1936: 268-69)

His comment about “inexperienced person” I read as a jibe at his conventional economic rivals.

So partly, I’m proposing deliberate wage inflation as a potential cure, because I don’t want to see the descendants of Keynes’s rivals in the 1930s–who now dominate economic policy once again–getting away with the same stupidity a second time.

As for your suggestions, they would work to delay getting into a Depression; once in one though, they would have little effect (very few people would be buying assets at the time in any case).

Ultimately, the only way to prevent what seems an inexorable trend towards a debt crisis, is to make structural changes that, as near as possible, eliminate the belief that the road to riches is via speculation in the secondary market on assets. Your proposals are directed at that end,but they’re the sort of reform that market fundamentalists would aim to abolish when the crisis was over.

But now that our property prices is already inflated, how do we deflate the property bubble? We have an idea, but we don’t know whether it will work:

1. First, remove all negative gearing loophole.
2. Next, for every property transaction that involves a non-first home owner (i.e. investor) as a buyer, impose a purchase tax on the buyer which is a certain percentage of the price of the property being transacted. Also, increase the government stamp duty, and fees for buyers who are investors.
3. For all sellers of property, scrap all government stamp duty, taxes and fees with regards to the property transaction.

But we disagree with Steve Keen on:

Policy-generated inflation would redress the balance, by driving goods prices up while keeping asset prices where they are.

How is it possible to engineer an inflation whereby only goods prices rises and asset price remain stagnant? Any policy of deliberate inflation runs the risk of misfiring and thereby further inflating asset prices.

What are the citizens to do but play the markets and sell services and imports to each other when manufacturing can not compete with imports and export industries of mining and agriculture are capital intensive and labour non-intensive?

Turning a blind eye and keeping hush to the rapid creation non-cash money by monetizing assets, through creation of debt and credit over those assets, the created money being used to monetize more assets, keeps the citizenry happily employed in record numbers.