Does Inflation Have a Good Side?

Some old fallacies never die no matter how hard we try to expose them. The fallacious notion of the virtues of inflation among some of the mainstream economists and media pundits is one such fallacy. Such fallacies are the result of a total misunderstanding of how an economy works. Mainstream economists and pundits, who rely on this Neoclassical school of economic science to understand the economy, suffer the most from these fallacies because of their faulty partial analysis of the economy. As Bastiat and after him Henry Hazlitt said, it is peoples’ tendency to see things which are seen and to ignore the unseen things or to only focus one part of the economy and ignore other parts. 

One argument that is in circulation right now in India is that inflation is good because it supposedly increases the income of farmers! One commentator in the newspaper Times of India expressed this fallacy in this way, 

A somewhat less straightforward, but perhaps more high-impact consequence of inflation is a partial reversal of the terms of trade (ToT) in agriculture. It’s well-known that ToT in farming has been on a secular decline. Even during periods of food price hikes – something that happens periodically in India – farm gate prices have kept capturing lesser and lesser of those hikes.

but ToT is shifting just a tad bit in favour of the farmer due to the current inflationary spell.

This is a classic example of an economic fallacy of doing only partial analysis of the economy. What the author here is trying to say is because the prices at which farmers sell their products have risen due to inflation, their income has gone up because their revenues are going up with every unit of farm product selling at higher than past prices. He commits a lot of economic fallacies here. As Bastiat and after him Hazlitt said, 

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups. (Economics in One Lesson, P. 5)

Higher prices of final consumer farm goods that farmers sell doesn’t mean higher income for the farmers. The author here completely ignores the basic difference between the nominal and real income. He isn’t clear whether he is talking about farmers’ real income or nominal income. Terms of trade becoming a tad bit favorable to farmers doesn’t mean their real income is rising. Only real income is important for a sound economic analysis. Nominal income is just a figure with no significance for life. To say concretely that farmers’ income is rising we need to take into consideration consumer goods price inflation also. Remember, real income is how much economic goods rupees can buy. If due to favorable terms of trade in farm sector the farmers’ nominal income is rising but at the same time if he has to pay more than his risen income to buy consumer goods then his real income has fallen and not risen. This is the unseen effect of inflation on farmers’ income which our author is ignoring. 

Also this article doesn’t tell us in which subsection of the farm sector the terms of trades have become a tad bit favorable, and what is the meaning of “tad bit favorable”? Which farmers are benefitting from these favorable terms of trade? All farmers, or only large ones? Including all this data in his analysis would’ve informed our author that inflation isn’t helping any farmers in a big way. 

Another alleged good effect of inflation, according to our author, is

For starters, inflation, in moderate doses, is a great aid to the government expanding fiscal intervention amid economic sluggishness. After many years in the 70-75% (of GDP) range, India’s public debt-to-GDP ratio has shot up in the last two years.

Partly on account of the sharp slowdown in growth and partly on account of higher government borrowing to support the Covid-impacted economy, India’s debt-to-GDP touched 87% in the fiscal year ending March 2022. It is expected to settle in the 85-90% range in the foreseeable future.

That is likely the peak range for comfort – both for a government that has made fiscal cautiousness its calling card as well as for international ratings agencies. In other words, even as India struggles with a K-shaped recovery and myriad imported challenges, the government has limited headroom to expand fiscal intervention.

Unless, a high-ish inflation, trending at a rate higher than the yields on government bonds, inflates the debt away faster, creating the headroom for the government to expand the fisc.

It is possible that moderate inflation (sic) might help the government to keep its real debt load less and allow it to continue to spend money to accumulate more debt without a high probability of insolvency. But this is just a theoretical possibility and not a surety in practice. There are all kinds of ifs and buts involved here like the one our author mentions about “a high-ish inflation”. What is this high-ish inflation? Our author doesn’t give us any number for his concept of high-ish inflation! Is high-ish inflation a rate of 15% or 50% or 60 % or 100%? Also what is this moderate inflation? 10%? 15%? We do not know. What are the chances that the government’s central planners will be able to so nicely control the inflation level in the economy that they do not shoot over into this dangerous high-ish inflationary territory? Theory and history both tell us that once the inflation genie is out of the bottle it is very hard to control and bring back into the bottle. Inflationary expectations feed on itself and we never know when 10% inflation becomes 1000%. Government bureaucrats have no way to control inflation so finely; they are not God. This ongoing high dose of inflation might become hyperinflation in a matter of few days – e.g., look at Sri Lanka – and in a matter of days the alleged good effects of inflation will turn into a nightmare for Indians and their rulers. Tinkering with a dangerous phenomenon like inflation will prove to be very costly for the government. 

Our author also forgets here that the sluggishness that he mentions is one of the chief consequences of the expanding government expenditure itself, as I have mentioned elsewhere. Government intervention in the economy is what is creating this sluggishness. Demonetization, GST, and totally unnecessary covid lockdowns are government measures which have wrecked the economy. Increasing government expenditure has eroded savings which has reduced investment and slowed down the economy since decades. Inflating the currency to reduce the debt levels and increase expenditure is a highly toxic policy mix, which will destroy India.  

Again our author is ignoring the unseen effects of inflation which are far more dangerous than alleged good effects that he is talking about. Inflation creates price rises eroding the standard of living of people, it generates inequality by making rich people more rich and poor people more poor, and it generates the deadly boom-bust business cycle in the economy. Inflation is also behind the rise of welfare-warfare state which is a big danger to the life, liberty, and property of the population. Apart from these economic consequences, inflation also erodes the moral of the population. Remember the fabric of morality is the basis for any healthy society. As Henry Hazlitt mentioned, 

During every great inflation there is a striking decline in both public and private morality. Let us look at three outstanding historic examples. 

The first is the French assignat inflation of 1790-96. The moral consequences of this have been vividly depicted by Andrew Dickinson White in his little book, Fiat Money Inflation in France, which grew out of a lecture he first delivered in 1876.

With prices soaring and the value of money savings rapidly diminishing, an early effect was the obliteration of thrift. Accompanying this was a cancerous increase in speculation and gambling. Stockjobbing became rife. More and more people began to see the advantages of borrowing and later paying off in depreciated money. A great debtor class grew up whose interest was to keep the inflation going. Workers, finding themselves with less and less real pay in terms of what their wages would buy, while others grew rich by gambling, began to lose interest in steady work. The evaporation of the incomes and savings of the lower and middle classes, and the sudden enrichment of speculators, with their ostentatious luxury, led to mounting social resentment and unrest. Cynicism and corruption set in. Even Mirabeau, who only a few months before had risked imprisonment and even death to establish constitutional government, began secretly receiving heavy bribes. The evidence of the general spread of corruption led to widespread distrust and a loss of faith in patriotism and virtue…

Those who benefit by inflation, in short, do so, and must do so, at the expense of others. The total losses through inflation must offset the total gains. This creates class or group divisions, in which the victims resent the profiteers from inflation, and in which even the moderate gainers from inflation envy the bigger gainers. 

Under inflation, nearly everybody is in fact being subjected to an invisible tax. For if the government in a given year spends, say, $70 billion more than it collects in visible taxes, and merely prints the rest, the public as a whole must be losing the equivalent of this $70 billion in real income. But only a handful of people realize clearly what is going on. The majority tend to blame their plight, not on the government, but on those of their neighbors who appear to be profiteering from the inflation. There is a growing sense that the whole economic system has become radically unjust. “They are stealing from me, and I will steal back.” 

It is not merely that inflation breeds dishonesty in a nation. Inflation is itself a dishonest act on the part of government, and sets the example for private citizens. (Henry Hazlitt, Inflation Crisis and How to Solve It, Chapter: Inflation versus Morality, pp.138-39)

In a nutshell, inflation destroys society. Justifying any amount of inflation, like what many mainstream economists and media pundits like our author are doing, is justifying theft. It is justifying immortality and crime. Inflation helps no one in the end as it destroys the politicians and bureaucrats also when the populace rises in revolutionary fervor like what we witnessed in Sri Lanka recently. By promoting the government of India to inflate, these clueless economists and pundits are endangering the whole Indian society. 

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