Wednesday, December 05, 2007

Mainstream economics in a nutshell

Today, the Reserve Bank of Australia decided to leave interest rates unchanged. This has bought about the usual wave of economic commentary from the media. Your average pundit keeps seeing the same themes repeat themselves, with the same underlying assumptions, and assumes the following is all you need to know about economics:

1/ The Reserve Bank does its best to keep inflation in the 2%-3% bracket. Inflation is a "key risk" that needs to be contained above all else. The RBA sets the cash rate , which in turn affects the rate that banks lend money at.

2/ Tax cuts are only as interesting as the impact they have on inflation. In fact they can be bad because they are believed to be inflationary. The head of the RBA even calls these tax cuts "fiscal spending".

Nobody in the media discusses where inflation comes from, or what the correct definition is. The media uniformly accepts CPI as the best index for inflation, and then every effort is made to agonise, analyse and forecast what the next CPI estimate will be and what action the Reserve Bank will take in setting the cash rate.

I'm not sure which one of these assumptions is more aggravating and misguided to come across.

Assumption #2 is infuriating as hell, because it typically comes from left-wing pundits who look for any excuse to justify more taxes and more government control of our money. We are already being taxed to hell and beyond, we are paying more taxes per person than ever before, and every year we pay more in taxes because of economic growth, inflation and bracket creep. As I've mentioned before, the Federal Government could have abolished the income tax entirely, and it would still have as much money to play with as in 1996 !

But assumption #1 is extremely infuriating because it is based on a whole heap of assumptions itself:

  • That we need a central bank to begin with
  • That inflation should be targeted
  • That CPI is the perfect and only way to measure inflation.
Our economic commentary is all fine and dandy until you start to question any one of the above assumptions. I am currently reading Murray Rothbard's "The Mystery of Banking" and I don't accept these assumptions any more.

In fact, I strongly believe the presence and actions of a central bank are causing the inflation. And that inflation can be measured by monetary aggregates, not CPI. CPI is used as a method to understate and camouflage the devastating and rampant inflation that we are experiencing.

UPDATE: The Daily Reckoning has an article which covers this exact topic nicely:

Economists of the Austrian School of economics define inflation differently than much of the mainstream of the economics profession. The typical mainstream intermediate macroeconomics textbook defines inflation as “[a]n increase in the overall level of prices” (Mankiw, Macroeconomics 5th Edition, 530). The eminent Austrian economist, Ludwig von Mises, suggested otherwise:

What people today call inflation is not inflation, i.e., the increase in the quantity of money and money substitutes, but the general rise in commodity prices and wage rates which is the inevitable consequence of inflation. (Mises, Planning for Freedom, 79)