The benefits of moderate inflation in a currency union: lessons from the gold standard

This post is well worth a read, if necessary using google translate. It essentially takes the well-known point that moderate inflation can be beneficial in that it helps downward real wage adjustment, in circumstances when this is necessary; and extends this to the context of real exchange rate adjustments in a diverse currency union. It also cites some supportive evidence from the history of the classical gold standard, courtesy of Flandreau, Le Chacheux and Zumer.

15 replies on “The benefits of moderate inflation in a currency union: lessons from the gold standard”

I would go further than referring to wage moderation. I think a small amount of inflation is healthy independent of wage adjustments. It is a stimulus to investment and spending.

Without inflation, the temptation to simply put money under the bed is not penalised. Inflation forces wealth to take risks, consume, invest and be economically active. It is the surest way to get wealth to commit to long term programs of investment, because earning a return on capital is the only way to preserve wealth.

In an inflation free economy, the wealthy can simply hoard their capital, becoming economically dormant for decades at a time. Capital becomes lazy in an inflation free economy and savings simply become a blackhole sucking liquidity out of an economy. Savings become a drain on an economy in such a scenario, rather than a force for productive investment.

The FT did a hagiography of Super Mario Squid Draghi on Saturday. He managed to pull Italy out of a default. But how did he do it ?

“Yet it was a very Italian crisis in the 1990s that established him as the man of the moment when heading the Treasury in a battle against soaring public debts, a budget deficit and inflation. “We came within an inch of defaulting,” recalls Francesco Giavazzi, a Massachusetts Institute of Technology economics professor who has known Mr Draghi for 40 years and was then also at the Treasury. “He is extremely cool in situations where normal people are freaking out. ‘Providing we do the right thing we will get out,’ he said. I didn’t sleep well at night but Mario slept very well.”

Through cuts in public spending, a DEVALUATION of the lira and one of Europe’s largest privatisation programmes, Italy did get out”

If you have no real wage inflation (remember the Euro inflation targets use a euro as a metric not real inflation expressed in relation to individual buying power) – if you cannot provide credit , and yet the economy is improving in productivity the surplus will have to flow to the free gold on the asset side of the Euro balance sheet.
The euro is a conspiracy of the rich to extract wealth while claiming quite rightly there is very moderate inflation of the euro.
Its a beautiful construct.
If the Euro is to succeed Gold will continue to rise until it rises to a new equiliberium (possibly at a much higher price)
Therefore responsible elements of society if they are in favour of the Euro should advocate allocated gold ownership amongest the lower and middleclasses.
If the euro should fail and we once again have a rise of sovergin entities then goverment securities will have a claim on these juristictions.
Therefore a mix of ownership of these two liquid wealth batteries is needed for whatever poltical events unfold.
But don’t take my advice I am just a Dork.

I remember reading the first war war tome -“A call to arms” that you could cash a Sterling cheque in Berlin up to 1916.
I assume there was quite close linkages with the CBs during the Great War.

@ Ger:

Inflation*: a la The Great Milton, be lotsa money!

If you have only one diamond – its kinda rare. You have a skipload: who care? Same with money. Now credit and debt are BOTH money! Well, credit is money, whilst debt is anti-money: like matter and anti-matter. You got to keep them apart, or POOFF! goes your money. That’s Deflation.

What we have had for 40-odd years – courtesy the FIRE economy, is a truely massive increase in the money supply (digital, electronic, virtual). Money is no use on its own. It may sit, as you correctly describe it, beneath the mattress. However …

…. if you loan out money (not the cash stuff) it just grows and grows and grows. No nutrients required. In fact the whole thing is so magical, you can even create your own! Result: you get a toxic, tarry, swampy, sinkhole of fermenting, stinking debt. You could be overcome by fumes, and in imminent danger of falling in!

Corrective: Drain that swamp, like ASAP! This action only affects terrain. Sky is unaffected. There are consequences, but unlike debt, they are unable to grow.

@ DoC: Please stop encouraging folk to gofer Gold – it’ll only put the price up! :-). 🙂


* VIP: Not to confuse increase in real and virtual money supply with price increases and wage increases. Separate, but sequential.

@Brian Woods
In a goverment money system without credit the money must flow to wages / benefits – it has no choice as there is no demand without this.
In a freegold system without credit the money must flow to gold.

Its really very simple – once there is a surplus – its all about the flow.

The euro masters saw the crunch coming decades ago as they knew the post 1971 dollar system was unsustainable, so they designed the Euro to protect their wealth.

The men who designed the Euro were some of the most sophisticated monetory scientists in the world – they knew exactly what they were doing.
At the end of the day you are either a dollar bitch in its new monetized form or a euro bitch – there is no in between

@DoC: “…its all about the flow.”

Thanks for reminding me about this. It is a common meme in biological systems. I did read something about ‘stocks v flows’ some while back, but I cannot recall what it was. Struck me as odd at the time, but that’s how systems are created, wax and wane.


you make my point perfectly for me. The purchase of gold is just the sort of activity we want to discourage. If wealth simply withdraws from economic activity, by (among other things) flight to gold, then society is losing productive capital and hence output.

There is no inherent connection between investment and debt. Although we have recently had an economy that rewarded creditors so much that the best place for wealth to invest was in the debt markets. Investment and lending have become a bit conflated in many minds. But that doesn’t mean there are no other productive investment options, or that we would be better off if wealth withdrew its money from circulation altogether.

On the contrary, we need to terrorise wealth out of sitting idle and force it into productivity (ideally in the real economy, rather than lending). A long term commitment to steady, controlled inflation must be a part of this.

It’s Economics 101 -less of the factors of production, means less production.

Surely the key issue is still that which the ECB always talks about, i.e. “inflation expectations”.

Excuse the simplifications, but let’s take a couple of cases.
1. If you expect high or particularly increasing inflation, you should borrow as much as you can. You’ll never really have to pay it back.
2. If you expect low inflation, you should borrow a lot less since you’ll actually have to repay the money.
3. If you expect high or increasing inflation, you should not lend…you should buy assets.
4. If you expect low inflation you might be able to lend but you need to lend carefully since the borrower might get caught out.

In all cases (and there are more), the key issue is expectations and the winner or loser is determined by who can best align reality with expectations.

In the example article, countries that had high debt were caught out by low (negative) inflation. There were a number of inflations and deflations throughout the 19th century. I’m not sure that one example can be used to create a general case for higher inflation as a better solution than stable money.

If I quote the Keynes/Hayek rap.. “ data point and you’re jumping for joy”.

How can we define such a nebulous term as inflation.

Surely the most dramatic inflation in Ireland over the last 3 years at least has been wage deflation which is just inverse inflation measured against real goods.
Again our policey makers are locked into 1980s thinking – they must decrease the fiscal debt to eventually drive credit creation – but what if credit creation is impossible now ?
Do you reduce wages ? – who pays for the rising interest cost then ? – I suggest nobody.
We have lived through a post war series of bubbles where the dollar inflates first to Europe , then Japan and now the Asian landmass.

It has come full circle now – this phase of globalisation through a combination of wage deflation and credit creation to drive demand is over.

The credit created can only flow back to gold and or wages unless the liabilties are defaulted under a global bank run.

I would suggest the authorties will not allow this to happen and will openly buy physical gold through the open market with the BIS as the dealer.

I first started paying attention to ecomics around 1979-1980 when inflation was the “bete-noir”.

If I remember correctly inflation was around 18% in Ireland at the the time and I believe equally as high throughout Western Europe and the US with countries like Israel and Argentina reporting figures which would easily compare with Zimbabwe today. At the same time I believe Switzerland had inflation of around 4% which was considered very good.

I know the discussion here concerns “moderate inflation” however I would really like to read opinions by older economists and commentatators who may remember what the conventional wisdom was in the late 60`s prior to the onset of hyper inflation.

It would be a shame if we discovered too late that ” moderate inflation”would lead to hyper inflation. Alternatively we may discover that moderate inflation is actually controllable and beneficial as well as gain further insight into what “moderate inflation” level actually is. (Maybe 4%?).

At the same time I am also inclined to agree that “any run of deflation seems like a bad thing.”

@ Livonian
Stagflation (Hyperinflation was the inter-war years) came about because of resource shortages. The real quantity of oil (yet another example of a reduced factor input) available for production was reduced due to political decisions in the Middle East, therefore the cost of oil and anything made using oil skyrocketed. Add to this a loose monetary policy, used to stimulate growth and the 2 combined to create very high levels of inflation during the period.

However, in that case, monetary policy was causing inflation at a time when inflation in the real economy was already inevitable due to resource shortages. CBs policy was in effect accelerating an already difficult inflation problem. Today, things are different. Outside of Monetary policy there is no innate propensity to inflation (quite the opposite).

While it’s true that the cost of capital has skyrocketed as investors withdraw from lending money, this is slightly different to an oil-shock; not least because successes in causing inflation using monetary policy will compel wealth to start investing again and cause a reduction in cost of funds.

Therefore, unlike the 70s where monetary policy and the real economy fed inflation to one another in an escalating pattern, they are more likely to dampen each other’s effects in present circumstances.

A better analogy for today would be America during the 30s. A financial collapse leading to a shortage of investment capital. Back then FDR used inflation (including coming off the gold standard) to stop dollar hoarding. It was the most successful plank of his recovery plan. Indeed, quantitative easing in Britain and the USA is arguably an even more extreme form of this. While inflation is creeping up the agenda in Britain these days, there’s no denying that QE spared them from experiencing anything like the Irish crash, despite having started from an initially worse situation than Ireland did.

However, QE is a fairly uncontrollable mechanism for stirring inflation, and having created the money, the UK in particular will now spend years trying to rein it back in. Nonetheless, one need only look at Ireland’s catastrophe to see that it was worth it, and even if it takes a decade of inflation fighting in Britain, at least the economic disaster of this country is not replicated there.

Comments are closed.