Is inlfaiton necessary for a growing population and growing economy?

[JeffreyB]

For starters, to address one of the other contributors, Keynes never said that he wanted inflation or that it was necessary but that it was an inherent risk of increasing aggregate demand. Furthermore, he argued that if one had to choose between inflation or deflation he would choose inflation and really only supported policies that allowed for moderate inflation.

What I think is being confused is that adding money causes inflation. Both Keynes and Milton Friedman believed in the quantity of theory money, it is just how to apply it differed. The theory goes that the true money supply isn't just the stock money that is printed, but banks can create money too by lending remember. Remember the money they lend is from their reserves and technically from deposits that can be demanded at any time, so this is money that can be spent just as the money being lent can be spent.

So deflation can occur when the total supply, the money lent and printed decreases. In fact if banks decrease lending faster than the fed prints money, then the supply of money actually shrinks, but it is this number that is considered the money supply represented as M2 and used in policy.

In any event, the quantity of money theory goes that the M2 supply * Velocity = Price level. What this means is that money must change hands at a faster rate to actually cause the price level (i.e. inflation to increase). This means that if velocity increases, then inflation can happen even if there is no change to the money supply and if velocity decreases, then a large supply of money will likely not cause inflation.

The two core differences between Friedman and Keynes is that Friedman believed that velocity was generally stable and did not change while Keynes thought it did. Friedman proposed increasing the supply at the rate of economic growth and population. Keynes said that even with these factors as levels of confidence change and people begin to hoard the money, additional money would be needed to help velocity increase, but because in a liquidity trap like the Great Depression velocity is so low, priting money alone is not enough and other fiscal measures are called for to generate confidence that would increase velocity.

Also, Friedman did believe that printing more money in a liquidity trap makes sense but did not believe any further action would be needed. In fact, this is the policy that Bernanke is pursuing and even Bernanke is skeptical that a stimulus plan will matter very much. By printing more money, the theory is that you are just replacing the money that was lost from the collapse of lending. As lending resumes you can pull the money offline. With that said, Friedman believed that such situation could be avoided by using a natural interest tied to the economy and never change it. We've never practiced this so its hard to say if this would work.

In short, both conservative and liberal economists call for an increase in the money supply to keep pace with both output and population growth. While there are debates on how to do this is the policy and yes the policy makers are trying to keep inflation and deflation at 0.

Keynes just said he preferred inflation over deflation but liked neither. The truth is markets appear to function best in areas where there is predictability which was the crux of Keynes argument. Changing prices made things unstable and deflation created what is known as the Paradox of Thrift, meaning that when uncertainty occured people saved more to guard against future unexpected events leading to less consumption, hence, less things bought, hence less income, hence a weaker economy. Keynes believed the core problem was not supply, but not a lot of aggregate demand. He did believe that full output could not be reached until everyone was working and that inflation was not a significant risk until full unemployment was reached.

Friedman just believed by expanding output demand would follow so the economy could grow with lower price levels. Unfortunately this generally happens with a huge cost to jobs in the long run since increased about does not appear to be able to be sustained unless aggregate demand keeps up and increasing aggregate demand tends to increase inflation some. He did predict that inflation of high levels could occur at high levels even with high unemployment and this did happen in the 70s.

In a wierd way it appears they were both right about different topics, but at the same time they were so diverse in what they believed. In short, money supply should increase with growing output and there is no credible economist that would say otherwise.

Now remember Glenn Beck is not an economist and neither is Ron Paul. These people represent a group of people that have no fundamental understanding about the true debate that has taken place in economics and have no idea what has been proven and settled and what is still debateable.