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Bernholz, Monetary Regimes and Inflation, 4 [ClearOnMoney]
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Commentary

Bernholz, Monetary Regimes and Inflation, 4

5 Jul 2010 by Jim Fickett.

There are several features typical of most moderate inflations. For example (1) the money supply typically rises earlier and faster then the price of better money, which rises earlier and faster than the prices of goods and services. And (2) because the money supply rises before unit values decrease, an economic stimulus is often an early effect.

The fourth chapter of Monetary Regimes and Inflation, by Peter Bernholz, is titled “Moderate paper money inflations”, and is concerned with typical features of inflation in its more moderate episodes.

The depth of Bernholz' historical knowledge, and his desire to test every generalization very carefully against history, make it quite fascinating to read this book. This chapter is about a few general features that accompany most inflations, for example, that the exchange rate tends to react earlier and more strongly than do prices. Rather than just list these rules and pick supporting facts from history, Bernholz chooses to tell the stories of several inflations: One of the early experiments with an unbacked paper currency in Europe, in Sweden in the 1700s; bills of credit in colonial Massachusetts; the Continental Currency during the American War of Independence; the greenback during the Civil War; and, much earlier than the others, but with less available historical data, experiments with paper money in China, beginning in about 1000.

With historical data on money supply, exchange rates, and prices, and with direct quotes from historical documents, these inflations become quite tangible, and the conclusions that Bernholz presents impossible to disagree with. With a lesser scholar one might grow suspicious – is the data chosen to support the desired conclusion? But not only are there many and varied examples; it is clear that Bernholz is at pains to bring out every possible caveat. Any exceptions to his rules get prominent treatment as well as careful discussion of what might be out of the ordinary in those examples.

Most of these rules are fairly intuitive if you give them a little thought. For example, the price of a good foreign currency rises earlier and more strongly than prices of goods and services because people are trying to prepare for higher prices later by storing value in another currency. My one (small) complaint with this chapter is that such discussion of motivational explanation is mostly absent.

I wish I could give some of the historical flavor here, but I think it is impossible to do so in less space than that required to reprint the chapter. So I will only repeat a few of the conclusions:

  • The money supply typically rises earlier and faster then the price of better money, which rises earlier and faster than the prices of goods and services; wages rise last
  • Because money increases before unit value decreases, there is often an economic boom early in the process
  • If the amount of money is later decreased, the same order holds – first the economy is depressed, then the exchange value is affected, etc.
  • If inflation becomes high and lasts long enough, eventually good money from some other source will drive out the worthless money

Previous chapter reviews

Bernholz, Monetary Regimes and Inflation, 1: This post is a review of the first chapter of Monetary Regimes and Inflation, by Peter Bernholz. Already in this first, introductory chapter it is clear that all material will be treated in an insightful manner and illustrated from the author's broad knowledge of history.

Bernholz, Monetary Regimes and Inflation, 2: The main message of Chapter 2 is that governments have a natural tendency to deficit spending and inflation, and inflation is only absent if somehow the hands of the leaders are bound. This happens most dependably with a gold standard, but an independent central bank, or a fixed exchange rate with another stable currency, can also help.

Bernholz, Monetary Regimes and Inflation, 3: Inflation can occur even under a precious metal standard, either by influx of more of the metal from abroad or, more usually, by debasement of the currency. Debasement has been accompanied, for thousands of years, by price and exchange controls. These never prevent inflation and hoarding, but do cause market disruption and considerable suffering. A precious metal standard can be introduced, and maintained for long periods, if it is in the economic interest of a government. The merchant city-states of Venice and Florence provide an example.