Friday, January 14, 2011

Adjusting money supply in aftermath of a crisis

The rapid expansion in monetary policy in the aftermath of current crisis was criticized by many. However, I believe it was necessary (combined with other things).

In my book I explained that inflation is a tax against status quo. It is designed to make it costly to simply hoard money. A crisis, often, results in inappropriate(1) accumulation of money. The accumulation often uses mechanism that do not create value. Inflation, in aftermath of such a crisis, may all those with genuine value creation mechanisms to rise above the scamsters.

Thus, increase in money supply seems desirable as it will nudge inflation while allowing money to move to value creators. However, this is contingent on a premise that new mechanisms are genuine and not simply new scams. The US has failed in ensuring this. That is why unemployment is high and rising while money sloshes around without effect.

(1) How we define inappropriate is another question for other time.