Is a World Without Inflation Possible?

In the previous many articles, we have been discussing a lot about the various concepts of inflation. We have understood in great detail, the way things are. However, when it comes to inflation, the ideal way that things must be is also extremely important. The only way to reach an amicable solution is to have a crystal clear goal. While formulating goals related to inflation, one often comes across the question as to whether a world without inflation is even a possibility.

The remainder of this article is meant to study the facts available with us and come up with an answer to the aforementioned question.

Stable Monetary Systems in the Past

Contrary to popular belief, a world without inflation is not at all a ludicrous assumption. It is our modern day media which has led us to believe that inflation can only be controlled not eradicated and this is not the truth. A tertiary look at monetary history is enough to reveal the truth.

For many centuries prior to the current monetary system, the world had never experienced such runaway inflation. The gold standard was a solid base to build a monetary system on and as a result the value of major currencies like the dollar and the pound sterling barely fluctuated during this period. Hence, to go back to this ideal world without inflation, it is essential that we know what has changed since.

  • Fiat Money:The most important change that has happened post Word War-2 is that the entire world is off the gold standard. All countries in the world now have their system of fiat money wherein governments can create money using the power vested in them. This is an unprecedented development and has never happened earlier. This is of vital importance because fiat currency systems allow governments to increase their money supply overnight unchecked! This system has been prone to debasement through the annals of time. A world without inflation is a world where government meddling with the monetary system is minimized.

  • While it may seem like the government works for the general population’s best interest. However, empirical evidence has shown otherwise. For further details, please refer to the book “What has the government done to our money?” published by the Austrian school of economics.

  • Fractional Reserve Banking:The second most important development for an inflation free world is an abolition of the system of fractional reserve banking. Fractional reserve banking is a process wherein bankers lend out the money that they do not have! Like governments, these banks too create money when they lend it! Hence, fractional reserve banking leads to dilution of money supply and a rapidly growing money supply as we all know is the root cause of inflation.

The above suggested measures are radical and almost impossible to achieve given the current geopolitical climate. However, if economic history is studied, any period of sustained prosperity has never been possible with either fiat currency or fractional reserve banking present.

Money Supply Must Grow at the Same Rate as Output

For prices to be stable, the growth in the physical output of the world must be matched with the growth of money in the world. For instance if the world GDP grows by 5% and money supply grows by 5% in the same period, there will be no inflation.

The gold standard was a period without runaway inflation because empirically the stock of new gold being discovered and added to the money supply almost rises and falls at along the same rate as the economy. Thus, like paper currency, it cannot be easily debased or printed overnight in massive quantities to cause hyperinflation. In fact hyperinflation is a bizarre and impossible scenario under the gold standard.

Changing Expectations Regarding Salaries

Another important point to consider is that our expectations regarding the future growth or decline of our wages are conditioned as per the needs of the fiat money system. Consider the gold standard for instance.

A 10% wage hike for everybody would be impossible given that the entire stock of money grows by 3% to 5% only. However, since prices remain stable or in some cases decrease, the money does not lose its purchasing power and spenders can enjoy a better standard of living. No salary growth for years may seem extremely awkward. However, this was always the case under the gold standard.

Changing Expectations Regarding Prices

The good part is that expenses will not increase. In fact in a world without inflation, prices tend to go down. Technological advances lead to growth in productivity. Productivity leads to a decline in prices since it is now cheaper to manufacture. Falling prices combined with stable incomes provide a better standard of living.

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Managerial Economics