Economics: Why are mainstream views different from reality?

[panduranghari]

Now if you use gold dig in a year to add to the money supply, it would probably avoid the above situations. But using a fiat currency and scientifically determining how much money to print depending on productivity increase looks more appealing to me.

I agree. The local central bank of any country can increase or decrease its money supply depending on the amount of gold its currency can buy. this ensures there is no uncontrolled growth in the money supply. this also means- inflation and deflation are just things. They make no real long term difference.

 

[panduranghari]

The question is why did he print so much worthless money? Clue: land redistribution, you cannot get more socialist than this...

You are confusing yourself?

First of all I would like to clear up probably the most common misconception about hyperinflation. What most people believe is that massive printing of base money (new cash) leads to hyperinflation. No, it's the other way around. Hyperinflation leads to the massive printing of base money (new cash).

Hyperinflation, in most people minds, conjures images of trillion dollar Zimbabwe notes. But this image is simply the government's reflexive response to the onset of hyperinflation, which is actually the loss of confidence in the currency. First comes the loss of confidence (hyperinflation), then, and only then, comes the massive printing to keep the government and its obligations afloat.

 

[panduranghari]

Oil has a more central role in our daily lives than gold...:thumb:

And gold will be required if you can afford oil.

I have posted this so many times its getting boring. WHY do people not read it.

Another (Thoughts!): The Profound Story of Gold and Oil

When the once highly secretive London Bullion Market Association (LBMA) -- its venerable membership comprising the world's largest gold dealers -- published its daily clearing volume for the first time in January 1997, it rocked the tight-knit world of international gold traders and analysts.

According to this first of many subsequent LBMA press releases, thirteen hundred tonnes of gold (representing more than 50% of the world's annual mine production) changed hands daily in this fog-shrouded center of the global gold market. This figure represented over $10 billion per day and $4 trillion per year in bullion banking activity!

The gold market had always stood in austere, quiet contrast to the highly charged, mega-volume world of stocks and bonds. Now this first LBMA report forced analysts, investors, and brokers to reassess their understandings of the gold market. While some revelled in the glow of the large LBMA numbers, others began to raise some very important and rather unsettling questions. First, Why was this much gold on the move? Second, Where was all this gold going? And third, Where was all this gold coming from?

Then, in October of 1997 at the internet's only gold discussion forum of the day (hosted by Kitco), a series of remarkable postings began appearing under the pseudonym "ANOTHER", offering plausible answers to those questions. What followed in a seemingly incongruous stream of thought over many months was, in the fullness of time, seen to blend into a logical whole by many astute readers following the complete text. If you are not similarly moved to at least reassess your own view of the international financial scene after reading what's revealed below, then you are either firmly entrenched in your world view, or you've been numbed by too many hours of Wall Street's cheerleader (CNBC) and too many Friday nights with Louis Ruykeyser.

What matters most to us here at USAGOLD is ANOTHER's educational value to all who would take the time to read and think through his (at times) arcane and cryptic commentary of international economic dealings behind-the-scenes. ANOTHER demonstrates a feel for and understanding of the gold and oil markets that indicates connections at the highest echelons of international finance, yet for reasons having to do with his "position," as he has indicated, he wishes to remain anonymous. If his "THOUGHTS!" are theory; they are good theory. If they are speculation; they are reasonable speculation. If they are supposition; they are well-grounded supposition.

In the final analysis, ANOTHER offers one of the more plausible hypotheses for why the financial markets have acted as they have in the past few years, and therein lies his immense value to the reader, no matter who he is. Again, knowledge as is conveyed in his series of "THOUGHTS!" is rarely to be found outside the highest levels of international finance, and is seldom to be seen bandied about on the front pages of The Wall Street Journal or your favorite financial newsletter.

As explained by ANOTHER, an opportunistic arrangement for massive physical gold acquisition among important petroleum producing and exporting nations could be comfortably facilitated within these astronomical trading volumes now being publicly revealed via the LBMA. For the oil states this meant receiving real money (as opposed to government-sponsored paper) in payment for their depleting oil reserves. For the industrialized countries, this meant a continuing supply of cheap oil to fuel the economic boom already in progress. These transactions were to be cleared through the bustling London gold market. Up until late 1996, the volumes were a tightly kept secret so "the deal" proceeded without the knowledge of the general public.

When the LBMA went public with its figures, it raised the shroud off "the deal." But by then, according to ANOTHER, it no longer mattered. The oil states had already (almost inadvertently) cornered the gold market. As implied by ANOTHER's own words, his motivation for these postings was the discovery by "big traders" in the Far East of this opportune facility to buy gold at ever lower prices. Their subsequent heavy purchases of physical gold upset the delicate balance. Now there was no longer a reason to keep it secret, and hence, the revelation of this extraordinary tale.

His choice to use an Internet forum to tell his story is surely a "story" in itself. Many who have read ANOTHER's "THOUGHTS!" speculate why he would choose this particular venue for his revelations. Why not a magazine article? Or a book? Rather than turning this Foreword into a treatise on the merits of the Internet, let it suffice to say that if ANOTHER and his motives are as implied, then there is probably no better venue than the Internet; allowing his "THOUGHTS!" to be disseminated rapidly, anonymously, and without editing by intermediaries. In addition, they could be efficiently targeted to go directly to the core market audience -- the gold analysts, brokers and investors who frequent such Internet sites as this, devoted strictly to the yellow metal. And after all, as a utility, isn't this capacity for specialization and instant communication what the Internet is all about?

We encourage you to find time to read and consider these remarkable postings of ANOTHER with an open mind. In the field of gold and international economics, these posts are sure to remain as fascinating and worthy of careful study as anything you will find on the web today.

A note on the text: No attempt has been made to correct typographical errors, misspellings, punctuation, grammatical and/or textual errors as originally submitted. This archive of ANOTHER's online commentary is presented here in its unedited entirety in the order his "THOUGHTS!" were posted via the Internet -- beginning at the Kitco website (from October 1997 to April 1998) then proudly hosted here at our expanded USAGOLD website (from May 1998 onward) through mutual agreement and cooperation with ANOTHER.


Date: Sun Oct 05 1997 21:29
ANOTHER ( THOUGHTS! ) ID#60253:

Everyone knows where we have been. Let's see where we are going!

It was once said that "gold and oil can never flow in the same direction". If the current price of oil doesn't change soon we will no doubt run out of gold.

This line of thinking is very real in the world today but it is never discussed openly. You see oil flow is the key to gold flow. It is the movement of gold in the hidden background that has kept oil at these low prices. Not military might, not a strong US dollar, not political pressure, no it was real gold. In very large amounts. Oil is the only commodity in the world that was large enough forgold to hide in. Noone could make the South African / Asian connection when the question was asked, "how could LBMA do so many gold deals and not impact the price". That's because oil is being partially used to pay for gold! We are going to find out that the price of gold, in terms of real money ( oil ) has gone thru the roof over these last few years. People wondered how the physical gold market could be "cornered" when it's currency price wasn't rising and no shortages were showing up? The CBs were becoming the primary suppliers by replacing openly held gold with CB certificates. This action has helped keep gold flowing during a time that trading would have locked up.

(Gold has always been funny in that way. So many people worldwide think of it as money, it tends to dry up as the price rises.) Westerners should not be too upset with the CBs actions, they are buying you time!

So why has this played out this way? In the real world some people know that gold is real wealth no matter what currency price is put on it. Around the world it is traded in huge volumes that never show up on bank statements, govt. stats., or trading graph paper.

The Western governments needed to keep the price of gold down so it could flow where they needed it to flow. The key to free up gold was simple. The Western public will not hold an asset that going nowhere, at least in currency terms. ( if one can only see value in paper currency terms then one cannot see value at all ) The problem for the CBs was that the third world has kept the gold market "bought up" by working thru South Africa! To avoid a spiking oil price the CBs first freed up the publics gold thru the issuance of various types of "paper future gold". As that selling dried up they did the only thing they could, become primary suppliers! And here we are today. In the early 1990s oil went to $30++ for reasons we all know. What isn't known is that it's price didn't drop that much. You see the trading medium changed. Oil went from $30++ to $19 + X amount of gold! Today it costs $19 + XXX amount of gold! Yes, gold has gone up and oil has stayed the same in most eyes.

Now all govts. don't get gold for oil, just a few. That's all it takes. For now! When everyone that has exchanged gold for paper finds out it's real price, in oil terms they will try to get it back. The great scramble that "Big Trader" understood may be very, very close.

Now my friends you know where we are at and with a little thought , where we are going.

 

[panduranghari]

A sudden influx of gold into the economy will inflate its price and make it less valuable. This acts as a natural deterrent against countries relying excessively on gold, though countries with large gold reserves will still have an "unfair" advantage when it comes to the gold standard.

I have replied to asianobserver about this aspect. I wonder if you agree?

Interestingly, however, from a historical standpoint the wealthiest countries in terms of gold and silver bullion did not have large natural reserves of the metals, but acquired them through trade. Pre-colonial India is one such example.

I agree.

 

[Sakal Gharelu Ustad]

Sir,
The difference is gold increases approximately 2% annually while paper can inflates may be over 200%

But a govt. can print money whenever needed and whenever it has to do it. Look at how Bretton Woods failed after US went to Vietnam war.

Could you please elaborate where did you get the 4% figure from? Or how do you come to a %?

Look at post #72 and #86.

And there is a difference between printing money for supporting socialism and wars and an optimal money growth rate. I support only the later, which should change from time to time depending on the economic situation and not some ad-hoc measure like gold dug in an year.

 

[panduranghari]

But a govt. can print money whenever needed and whenever it has to do it. Look at how Bretton Woods failed after US went to Vietnam war.



Look at post #72 and #86.

And there is a difference between printing money for supporting socialism and wars and an optimal money growth rate. I support only the later, which should change from time to time depending on the economic situation and not some ad-hoc measure like gold dug in an year.

I think you have got it wrong. you believe the inflation can be kept within the 4% range. The BOE has a mandate to keep the inflation within a 2% range hence even less wiggle room. But they cannot and that is because we have disregarded the exponential function.

You claimed that you saw the Albert Bartlett video- even then you cannot get it then I have to give up.

 

[panduranghari]

Euro? Oh you're a funny man.

Why?

Please explain? If you cannot tell me how I am wrong?

 

[Sakal Gharelu Ustad]

I think you have got it wrong. you believe the inflation can be kept within the 4% range. The BOE has a mandate to keep the inflation within a 2% range hence even less wiggle room. But they cannot and that is because we have disregarded the exponential function.

You claimed that you saw the Albert Bartlett video- even then you cannot get it then I have to give up.

I saw the video and found nothing new in it other than the age old Malthusian arguments. My simple argument to his entire video is--we would finish oil and we will then find something else and when we would finish that something else then again we will find another something else. It is just a matter of when the new something else becomes cheaper than the old something else.

You better learn the marginal concepts in economics before professing doom: Back to Basics II: The Marginal Economist - Innovations - The Chronicle of Higher Education

In our first blog post on basic economic concepts, we wrote about opportunity cost. Another basic concept central to economic analysis is the concept of marginal cost (as well as marginal revenue and marginal benefit) in contrast to average cost (or revenue or benefit). Most of life's (and public policy's) choices are not really a matter of "all or none" but of "more and less." Making decisions based on absolutes, on whether something is "good" or "bad," can lead down many counterproductive paths. This lesson is particularly important at this time of intense focus on the federal budget and also on the budgets of colleges and universities.

The question of where budget cuts will do the least harm is very different from the question of ranking our policy priorities on an absolute scale. Few people would suggest that we should zero out the national defense budget and leave our security totally in the hands of private individuals. But that doesn't mean that cutting the defense budget is a bad idea. The question is whether the last few dollars we are spending on the military are buying us more social welfare than they would if they were spent in another way.

A different example may resonate more for people with different political preferences. Need-based financial aid for college students is critical to our nation's future and the future of individuals with particularly limited resources. More is better. But aside from the (fortunately) few extreme voices calling for the end of federal student aid, the relevant question is not whether we need it or not, but how much benefit we get from marginal dollars—and how much we would lose (or gain) from a small decline (or increase) in federal funding for students.

Understanding this issue means focusing on arguments about what would be lost from, for example, a moderate cut in the maximum Pell Grant—not what would be lost if Pell Grants were cut in half or eliminated. Just as important, within a fixed total of spending there are also judgments to be made at the margin about, for example, whether the gain in ease of filing achieved by simplifying the aid formula outweighs the increase (at the margin) in the dollars directed to "undeserving" applicants.

Marginal-cost thinking shows up not only in large public contexts but also in everyday shopping experiences. Clothing stores often advertise shirts or blouses with "buy one and get the second for half price." Why offer one shirt for $100 and a second for $50 instead of just cutting the price to the consumer's average cost for two shirts of $75? The answer is that merchants are aiming at the consumer who comes in to buy one shirt and now sees that once he buys it he might as well get a second for only $50. If he bought one for $75, he might pass up the second at $75. Most of us have probably spent time in stores rummaging around for that second item worth buying for a bargain price.

The concept of marginal cost is even more central to most decisions about production. A firm that has to decide whether to hire an extra worker to generate a small increase in output has to compare the additional (marginal) revenue that would be gained to the additional (marginal) cost that would be incurred. The great historic battles among industrial giants have always been about the contrast between marginal and average cost—and they still are. Businesses that grow very large tend to be ones where infrastructure costs—railroad lines, automobile factories—are high, while the marginal cost of one more car or one more rail shipment is low. When that is the case, the higher the volume, the lower the average cost, and giantism prevails. Today's and tomorrow's giants are on the Web: One more Google search costs the supplier almost nothing, but the investment in creating and maintaining the software engines that keep those search results timely cost billions to build and googles of effort to sustain. In businesses like Google and Facebook, where revenue is gained in fractions of a penny per transaction, scale, and therefore market share, is everything.

A college considering raising enrollments in search of increased revenues has to look at the marginal cost of educating those additional students. As we examine the impact on public universities of recent declines in state funding, it's not enough to cite average costs per student and assume that the number of students who can't be accommodated because of the funding cuts is equal to the funding reduction divided by that average cost. It is quite likely that the marginal cost of educating the last student is different from—and probably lower than—the overall cost per student, especially in the near term. Cutting a few students will shrink class sizes but not much affect the number of instructors getting paid to teach, and even reducing the number of sections taught, while saving on teacher salaries, still leaves the same number of classrooms to be heated, lighted, cleaned and maintained. So dropping students to reduce costs significantly might require dropping many more students than the simple calculation based on averages would suggest, as well as a longer adjustment period to reap savings in physical plant.

Of course, marginal reasoning applies to growth as well as decline in enrollment, so accommodating an influx of students seeking an alternative to the bleak labor market might not require as much extra funding as average cost per student times the number of new students would imply. Squeezing more bodies into classrooms or keeping the buildings open more hours enables schools to accommodate more students (at least in the short run) without expensive physical-plant projects or massive hiring of new faculty.

Comparing costs and benefits at the margin is not always the right way to make decisions. The nation ultimately could not survive bargaining over a little more slavery vs. a little less when the only really acceptable answer was none at all. Similarly, cost-benefit calculations are generally out-of-court in deciding free-speech cases.

But cases like these are exceptional and rare, in public policy and in daily life. Many debates about the role of the humanities in higher education fall short because they take on the flavor of a "yes or no" instead of a "more or less" question. Agreeing that the humanities have a place doesn't tell you whether to hire one more English professor or whether to add a billion dollars to the NEH budget. We are equally in need of marginal thinking when we debate more dollars for Pell vs. more spending on, say, high-school improvement—or more dollars for education vs. more dollars for community health services.

It is too common to hear the argument that the army is more important than new highways—or that education is more important than foreign aid. We don't actually have to settle those big questions to think more clearly about the marginal costs and benefits of reducing or increasing spending on certain areas. We will be more effective advocates for educational opportunity, and better leaders of colleges and universities, if we are more careful about thinking about marginal costs and benefits rather than focusing only on total costs and benefits and unit costs.

I believe in the ability of human mind and hence sustained growth and hence the space for a scientific monetary policy.

 

[pmaitra]

Read some of my above posts above and I said their is productivity gain that is unaccounted for in the inflation indices. Some researches found how much productivity does increase over time to find that unaccounted thing. Now, to keep the economy growing, you print money with 4% inflation target keeping your inflation index in mind. But that is not printing money out of thin air, that is printing money for the unaccounted growth of productivity.

I was on the bent of agreeing with you last time I left this discussion. I thought over it, and now I see that what you said makes no sense to me, but then, that's me, a non-expert.

You said that 4% growth is required for increased productivity that is unaccounted for. Anything that is unaccounted for, cannot be enumerated. Anything that can be enumerated, must be accounted for. So, either that 4% value is a completely fudged up number, or the justification for it is spurious. In other words, your argument collapses on its own weight.

So far, so good. Now let us take a step away from this and look at it this way.

[HR][/HR]

In a span of 12 months, say April 2011 (k) and April 2012 (k+1) [hypothetically]

There is increased productivity across the board, between point k and k+1. What has happened then? Some examples:

• More iron ore has been mined: this is due to use of better excavators that are more energy efficient.
• More grains and vegetables have been produced: this is due to use of better fertilizers, more efficient irrigating water pumps, more efficient tractors that till land burning less fuel, etc.
• More passengers have been carried in public transport systems: this is due to use of modern technology that has increased the frequency and speed of trains.
• More students have graduated: this is due to use of more effective methods of education and opening of more schools or colleges.

Now, consider three scenarios:

Scenario 1: No extra currency notes have been introduced in the system. This means, there is a greater supply of iron ore, greater supply of grains and vegetables, better supply of train tickets, better supply of skilled workers, but same supply of currency notes between k and k+1. This results in what? An automatic increase in the demand for the currency notes, thus reducing prices of iron ore, food and vegetables, train fares and reduced wages for skilled workers.

Scenario 2: Commensurate extra currency notes are printed and pumped into the economy. The result is there is no change in the prices of iron ore, food and vegetables, train fares, and unchanged wages for skilled workers between k and k+1. This is, if the increased productivity was correctly accounted for leading to zero inflation (even by Gold Standard, assuming there has been a commensurate increase in Gold Reserves, but this is not an essential point).

Scenario 3: There is some increase in productivity and some extra currency notes printed. Eventually, there is price rise all across the board, from k to k+1.

[HR][/HR]

Now, what is happening in real life? Neither scenario 1, nor scenario 2. All we are seeing is scenario 3. Obviously, that 4% number is way off mark.

So, now, could you please explain how these so called experts arrived at this magic number of 4%? Did they wave a magic wand? Did they see it in their dreams, like the Benzene ring? Or was it a revelation delivered from the divine?

What makes it all the more preposterous is to claim that it is scientific, when it is not. It starts with a claim or a justification, and falls flat on its face.

I would like you to convince me otherwise, because, right now i am more inclined to believe that inflation happens at the behest of the banking cartels, who benefit by inflating the currency so that they can lend out more money than they actually have, i.e. sell debt and make profits out of the buy-back of the debts. I wonder what would happen if there was a profitable prospect in case, instead of selling debt, they were selling credit?

 

[panduranghari]

Now, what is happening in real life? Neither scenario 1, nor scenario 2. All we are seeing is scenario 3. Obviously, that 4% number is way off mark.

IMHO,

We have lived through the scenario 2 for the past 30 odd years but its moving towards scenario 3. It is going hyper to maintain the status quo.

 

[Sakal Gharelu Ustad]

I was on the bent of agreeing with you last time I left this discussion. I thought over it, and now I see that what you said makes no sense to me, but then, that's me, a non-expert.

You said that 4% growth is required for increased productivity that is unaccounted for. Anything that is unaccounted for, cannot be enumerated. Anything that can be enumerated, must be accounted for. So, either that 4% value is a completely fudged up number, or the justification for it is spurious. In other words, your argument collapses on its own weight.

So far, so good. Now let us take a step away from this and look at it this way.

[HR][/HR]

In a span of 12 months, say April 2011 (k) and April 2012 (k+1) [hypothetically]

There is increased productivity across the board, between point k and k+1. What has happened then? Some examples:

• More iron ore has been mined: this is due to use of better excavators that are more energy efficient.
• More grains and vegetables have been produced: this is due to use of better fertilizers, more efficient irrigating water pumps, more efficient tractors that till land burning less fuel, etc.
• More passengers have been carried in public transport systems: this is due to use of modern technology that has increased the frequency and speed of trains.
• More students have graduated: this is due to use of more effective methods of education and opening of more schools or colleges.

Now, consider three scenarios:

Scenario 1: No extra currency notes have been introduced in the system. This means, there is a greater supply of iron ore, greater supply of grains and vegetables, better supply of train tickets, better supply of skilled workers, but same supply of currency notes between k and k+1. This results in what? An automatic increase in the demand for the currency notes, thus reducing prices of iron ore, food and vegetables, train fares and reduced wages for skilled workers.

Scenario 2: Commensurate extra currency notes are printed and pumped into the economy. The result is there is no change in the prices of iron ore, food and vegetables, train fares, and unchanged wages for skilled workers between k and k+1. This is, if the increased productivity was correctly accounted for leading to zero inflation (even by Gold Standard, assuming there has been a commensurate increase in Gold Reserves, but this is not an essential point).

Scenario 3: There is some increase in productivity and some extra currency notes printed. Eventually, there is price rise all across the board, from k to k+1.

[HR][/HR]

Now, what is happening in real life? Neither scenario 1, nor scenario 2. All we are seeing is scenario 3. Obviously, that 4% number is way off mark.

So, now, could you please explain how these so called experts arrived at this magic number of 4%? Did they wave a magic wand? Did they see it in their dreams, like the Benzene ring? Or was it a revelation delivered from the divine?

What makes it all the more preposterous is to claim that it is scientific, when it is not. It starts with a claim or a justification, and falls flat on its face.

I would like you to convince me otherwise, because, right now i am more inclined to believe that inflation happens at the behest of the banking cartels, who benefit by inflating the currency so that they can lend out more money than they actually have, i.e. sell debt and make profits out of the buy-back of the debts. I wonder what would happen if there was a profitable prospect in case, instead of selling debt, they were selling credit?

A claim is preposterous because our humble Pmaitra does not understand it.

And yes, Scenario 2 does not exist. It is almost always scenario 3 i.e. why you have inflation registered even in your inflation indices.

Coming to the calculation part. Now, in any economy: nominal GDP = M * v where M=quantity of money in the economy and v=velocity of money. If you want to do it in a crude way, you can look at the GDP growth rate keeping the velocity of money fixed and find the amount of money supply needed in the economy. But in case of a recession there are other reasons as well to inflate the money supply and this reason alone does not determine the value of inflation.

 

[pmaitra]

A claim is preposterous because our humble Pmaitra does not understand it.

And yes, Scenario 2 does not exist. It is almost always scenario 3 i.e. why you have inflation registered even in your inflation indices.

Coming to the calculation part. Now, in any economy: nominal GDP = M * v where M=quantity of money in the economy and v=velocity of money. If you want to do it in a crude way, you can look at the GDP growth rate keeping the velocity of money fixed and find the amount of money supply needed in the economy. But in case of a recession there are other reasons as well to inflate the money supply and this reason alone does not determine the value of inflation.

Nominal GDP does not take into account adjustment for inflation. In other words, it is a function of money that is inflated or has been in the process of inflation. So, how does this variable explain the cause and amount of inflation?

If you want to explain something, would you not use something that is conditionally independent of what you are trying to measure or explain? Again, the question is where this 4% comes from. That is the inflation for unaccounted for increase in productivity. There is nothing in your post that explains how this 4% number is arrived at.

Again, I do not understand it.

Perhaps PanduRangHari can explain? This is going over my head.

 

[Sakal Gharelu Ustad]

Nominal GDP does not take into account adjustment for inflation. In other words, it is a function of money that is inflated or has been in the process of inflation. So, how does this variable explain the cause and amount of inflation?

If you want to explain something, would you not use something that is conditionally independent of what you are trying to measure or explain? Again, the question is where this 4% comes from. That is the inflation for unaccounted for increase in productivity. There is nothing in your post that explains how this 4% number is arrived at.

Again, I do not understand it.

Perhaps PanduRangHari can explain? This is going over my head.

GDP growth rate reflects the increase in productivity and can be used as a proxy. Then use it back in the equation of money circulation to get the amount of money that needs to be created to support this growth, assuming the velocity remains the same. This is how the central bank tries to drive the nominal GDP.

 

[pmaitra]

GDP growth rate reflects the increase in productivity and can be used as a proxy. Then use it back in the equation of money circulation to get the amount of money that needs to be created to support this growth, assuming the velocity remains the same. This is how the central bank tries to drive the nominal GDP.

Ok, so let me see if I am getting this.
We know how much money has been printed out of thin air. Let's say, inductively, 4% money has been added into the economy.
We know how much our nominal GDP has increased. Let us say GDP growth is also 4%.
Therefore, we conclude that the 4% number was correctly assumed, and that there has been zero increase in GDP. That is fine with me.

Now, with zero GDP growth, (but no shrinkage either), why are prices rising? Refer to the 3 scenarios I mentioned.

Is it because that assumed rate of 4% increase in productivity is not correct?

 

[Sakal Gharelu Ustad]

Ok, so let me see if I am getting this.
We know how much money has been printed out of thin air. Let's say, inductively, 4% money has been added into the economy.
We know how much our nominal GDP has increased. Let us say GDP growth is also 4%.
Therefore, we conclude that the 4% number was correctly assumed, and that there has been zero increase in GDP. That is fine with me.

Now, with zero GDP growth, (but no shrinkage either), why are prices rising? Refer to the 3 scenarios I mentioned.

Is it because that assumed rate of 4% increase in productivity is not correct?

Well, the GDP growth rate is not nominal(the term itself implies that it is calculated over fixed prices). I am sorry to say but you need to rephrase your question.

But according to what I have understood from your question, my answer is following:-

The central bank normally tries to predict the gdp in next quarter from various models usually based on leading indicators. Since, deflation is considered to be bad(assuming my arguments in this thread are correct) the central bank now increases the money supply. But they always try to be on the positive side of inflation and this increase in money supply does not necessarily translate into equal GDP growth to give zero inflation(It would anyway not be true because real inflation and inflation index are two different things and may not coincide). This difference between expected real GDP and realized real GDP is called output gap and goes into inflation. So, it is almost scenario 3 in action. The reason people think scenario 2 is played out because most commodities you talked about follow staggering prices i.e. prices do not increase immediately after increase in the money supply. Firms take time to increase the prices and hence price rise does not get reflected all across the board.

This is another interesting read which helps in understanding the monetary policy: http://www.imf.org/external/pubs/ft/spn/2010/spn1003.pdf

 

[panduranghari]

There is nothing in your post that explains how this 4% number is arrived at.
.

Neither do I. I still find 4% number pulled out of thin air.

 

[pmaitra]

Related thread: http://defenceforumindia.com/forum/...42-enslavement-through-financial-systems.html

 

[Sakal Gharelu Ustad]

I will try once more to explain the 4% number.

Real interest rate= Nominal interest rate - Inflation rate
(for eg. with an inflation of 7% and nominal rate charged by bank equal to 11%, what you actually end up paying is 4% real interest rate)

Now, if you have a deflation in the economy, which occurs during any business cycle, higher inflation gives more leeway to central bank in conducting monetary policy. For eg. Nominal rates usually hover around 2-4% in developed economies.

Inflation rate determines how effectively monetary policy can intervene during downturn of economy. Let me show how(you cannot cut nominal rate below 0%):

Case 1: Normal time: nominal = 2, inflation =2 => real = 0%
maximum change the central bank can bring in real rate during downturn: nominal=0, inflation=2 => real=-2%, so you can cut real rate by 2%

Case 2: Normal time: nominal = 4, inflation =4 => real = 0%
maximum change the central bank can bring in real rate during downturn: nominal=0, inflation=4 => real=-4%, so you can cut real rate by 4%

So, you can see it provides more space for monetary authority to influence real interest rate, if you have higher inflation before. Obviously, if you were able to cut nominal rate below zero, it would be ideal situation. But since that is not feasible in most situation, better stick with higher inflation. Now, given the fluctuations in business cycles for the country, the central bank tries to find how much room does it need to tackle a downturn. This is how you get 4% number!!

 

[pmaitra]

I will try once more to explain the 4% number.

Real interest rate= Nominal interest rate - Inflation rate
(for eg. with an inflation of 7% and nominal rate charged by bank equal to 11%, what you actually end up paying is 4% real interest rate)

Now, if you have a deflation in the economy, which occurs during any business cycle, higher inflation gives more leeway to central bank in conducting monetary policy. For eg. Nominal rates usually hover around 2-4% in developed economies.

Inflation rate determines how effectively monetary policy can intervene during downturn of economy. Let me show how(you cannot cut nominal rate below 0%):

Case 1: Normal time: nominal = 2, inflation =2 => real = 0%
maximum change the central bank can bring in real rate during downturn: nominal=0, inflation=2 => real=-2%, so you can cut real rate by 2%

Case 2: Normal time: nominal = 4, inflation =4 => real = 0%
maximum change the central bank can bring in real rate during downturn: nominal=0, inflation=4 => real=-4%, so you can cut real rate by 4%

So, you can see it provides more space for monetary authority to influence real interest rate, if you have higher inflation before. Obviously, if you were able to cut nominal rate below zero, it would be ideal situation. But since that is not feasible in most situation, better stick with higher inflation. Now, given the fluctuations in business cycles for the country, the central bank tries to find how much room does it need to tackle a downturn. This is how you get 4% number!!

You said, " For eg. Nominal rates usually hover around 2-4% in developed economies."

Where did you get this piece of statistic from?

 

[Sakal Gharelu Ustad]

Look anywhere, it is the most common statistic. Look here: United States Interest Rate

Keep in mind, in normal times, no one charges nominal rate < inflation.