Tight Money is a Tax on the Unemployed

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One argument commonly made by inflation hawks is that inflation is bad because it is a tax on savers. The idea being that since inflation erodes the purchasing power of a dollar, those who keep their money in a savings account will end up being able to buy less with that money down the road if there is inflation than if there is not. There is an element of truth to this idea, though if inflation is expected there are ways to deal with the problem, such as offering higher interest rates for savings accounts.

A propos of David’s post earlier to day, however, it occurs to me that there is a flip side to the inflation taxes savings argument, namely that disinflation (i.e. lower than expected inflation) functions as a tax on the unemployed. When a certain amount of inflation is expected over the coming years, this ends up getting built into people’s wage demands, contracts, loans, etc. If inflation is approximately 2-3% a year for several decades, then people will come to expect a raise of at least 2-3% a year to cover the increase in the cost of living, and they will get upset if this doesn’t happen, even if inflation is significantly below 2-3% (on election day I met a man who was angry he had been denied a cost of living raise in his Social Security for 2009, even though there was deflation that year).

If expected inflation doesn’t appear, there won’t be enough money for businesses to pay their workers and will have to cut either wages or employment. But since workers hate nominal wage cuts (even where these don’t translate into real wage cuts), employers tend to respond to this situation by laying people off rather than spreading the pain around. The result is that during inflationary or disinflationary periods real wages tend to increase (since prices are falling while wages remain constant in nominal terms) and so does unemployment. Functionally this acts as a kind of wealth transfer from the unemployed to those who still have jobs. Thus, tight money is a tax on the unemployed.

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  1. No, no, no.

    Tight money is not a tax on the unemployed in the same sense that inflation can act as a tax. Inflation is a tactic to the extent that it takes what a person currently has or currently earns. This is particularly the case when inflation and debt monitization go together, since then you are losing value while the government gains it.

    Now it is true that tight money can at times have a negative impact on employement. However, that is not a tax on the unemployed.

    Further, the conditions under which the money supply will be the restrictor on employement are I think very often over stated.

    Finally, the unemployed are almost universally living on either fixed incomes or savings, and thus price increases for essential goods and services will be particularly difficult to handle.

    Official inflation is not up, but most of the social security recipients I know are seeing considerable increases in many of the things they buy. The method used for calculating general inflation is not a good indicator of the cost of living for a retired person, particularly one living a modest lifestyle.

  2. Disinflation is not necessarily lower than expected inflation. Disinflation is a falling inflation rate. It is possible people would expect inflation to fall, but it still would be disinflation.

  3. BA: An economist you are not. That would be inflation tax, not tight money tax.

    And, how is money tight? Near zero % short term interest rates; reserve requirments were not raised; $3 trillion in cash is in banks and corporations; M1 and M2 not declining; etc.

    One problem is low loan demand, another is dire uncertainty caused by the anti-private-sector regime’s hideous anti-jobs/anti-growth legislations, policies, burgeoning regulations, and daily threats against productive people, er, right-wing extremists.

  4. Maybe I’m missing something here – if we have deflation then the cost of basic necessities goes down; that works out as a tax break for the poor.

    Inflation is good for two sorts of people:

    1. Big government spenders who want to get out of paying their debts.

    2. Financial sharks who make money by manipulating markets rather than engaging in long term investing.

    We’ve had inflation since we create the Federal Reserve in 1913 and between that day and this, what sorts of institutions have flourished? Big government and “investment” banks which manipulate markets.

  5. Mark,

    If you have deflation prices will fall, so that the same nominal wage translates into a higher real wage. On the other hand, it means that employers won’t have enough money to pay these higher real wages. If wages also fell this wouldn’t be a problem. However, it is difficult for nominal wages to fall, both because of long term contracts, and because people have a particular aversion to nominal wage cuts (even when they don’t translate into real wage cuts, as prices have also fallen). The result is that instead of cutting wages employers tend to cut employment. So the people who still have jobs benefit (they get the advantage of lower prices with the same nominal wage), but those who are unemployed do not (they get the benefit of lower prices too, but the fact they have lost their job more than outweighs this).

  6. blackadder,

    That is a good point – minimum wage laws also make deflation difficult. Out here in Nevada, the minimum wage is $8.25 and hour. Quite simply, that is too much money for a burger-flipping job in 2010…thought if Bernanke gets his way, $8.25 might soon become the equivalent of 50 cents.

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