Wednesday, September 10, 2008

Myths according to Mises

The Ludwig von Mises Institute published an interesting article written by David Saied about myths related to energy and inflation. It is a fun article, serving as a step back from the hustle and bustle on Wall Street today. The full article is here, but I have summarized my choice myths below.

Myth 1: “Dependence on Foreign Oil”
This is a great one, and one that I have certainly touted. The high price of oil has nothing to do with the fact that OPEC controls roughly 40% of oil reserves. It’s simply supply and demand: Strong demand plus limited supply leads to high prices. Sound familiar?

Myth 2: “Inflation is caused by rising oil prices.”
No. Inflation is caused by a rising money supply. If firms expect more money to be printed in order to pay for higher oil (due to a shortage in that market), then prices will rise with the expected money supply. It’s a monetary matter.

Myth 4: “Consumption is the most important element of the economy.”
According to Saied (they say it so well), “Consumption is indeed important in a free economy: particularly the freedom of consumers to buy their goods in unhampered markets. However, key to long-term economic growth is investment (savings), which is the opposite of consumption. Public policies that promote consumption — such as low interest rates — do so at the expense of savings."

This is most certainly true!The key to long-term economic growth is investment in the future, or adding technology and capital stock to the economy. That is why a broad-based corporate tax cut arguably gives the biggest bang for your buck. Lower corporate taxes give firms an incentive to invest in research and development and to increase their investment expenditures, which results in stronger growth going forward.

Myth 6: “Federal Reserve interest-rate policy can help the economy.”
According to Saied, “To maintain a target of low interest rates, the Fed must add liquidity to the money supply by creating money without obtaining additional reserves. This is the infamous creation of money "out of thin air," which so many have criticized. Many believe that this artificial injection of liquidity creates economic stimuli and promotes growth. However, even though it creates an apparent bonanza, these monetary injections must eventually be "paid back." This payback happens by means of higher prices, the so-called inflation.”

I disagree with Saied on this one. Libertarians and capitalists will always disagree on the role of the Fed with policy makers and most economists. I side with the Fed and its role in stabilizing prices and economic growth. Over the years, the U.S. Federal Reserve Bank has gained credibility in its ability to stabilize the economy by conducting sound monetary policy, both expansionary (encouraging economic growth) and restrictive (restricting growth, usually to tame inflation pressures).

There are, however, foreign central banks (mostly emerging markets) who do not have well-developed bond markets in which to conduct autonomous monetary policy. Thus, the central government is in charge of fiscal policy (sets spending and tax measures) and monetary policy (in charge of the money supply). Look at Zimbabwe. Mugabe continues to print money in order to satisfy his various political measures, resulting in 50 million percent inflation. Try that on for size.

Honestly, the economics are not always so eloquently written, and I most certainly don't agree with every one of the myths, but the overall notion remains the same: lack of transparency and responsibility on the part of the fiscal and monetary authorities can cause economic problems.

Please leave comments. Best, Rebecca Wilder


  1. Not sure about myth four. High rates of investment do not lead necessarily lead to higher living standards. If it were true, then the USSR would have been much richer than it turned out to be. Diminishing returns to investment quickly set in. In the long run, productivity growth is the key to rising living standards.

  2. Hi Alice,

    Awesome! Classical growth theory (let's say Solow's model) says that adding to the capital stock creates strong growth rates until diminishing returns pushes the impact to zero. I modified the text slightly by deleting "I totally agree" because obviously, I didn't.

    Thanks for the comment, and might I say that I have really liked your blog posts lately!



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