Inflation – What it is and what it isn’t (continued)
In the last installment of this series, I mentioned that the big takeaway point was the definition of inflation. As you may recall, we defined inflation a bit differently than is commonly understood. Most people, when they talk about inflation, mean to say that prices – the amount we pay for items such as gas or bread or rent – have gone up.
The most common statistic used to report rising prices is the Consumer Price Index (CPI). The CPI measures the cost of a representative basket of goods and services, comparing the average price of these items in one period with their average price in the following period.
When the CPI shows average prices going up from one reporting period to the next, the rising prices are reported in the news as inflation. Occasionally, average prices fall. When this happens, we are told that deflation has occurred.
But the definition of inflation that was presented in Part 4 of this series did not rely on measuring the average cost of goods. Instead, inflation was defined as the increase in the supply of money. Conversely, deflation was not defined as decreasing prices, but rather the decrease in the supply of money.
But even though inflation and deflation are not the same thing as rising and falling prices, there is a relationship among them. When the money supply increases, assuming the amount of goods and services in the economy remain the same, prices go up. Conversely, when the money supply falls, prices go down. As Peter Schiff puts it, “The money supply expands and contracts. Prices go up and down. Inflation and price increases are not the same thing. One is cause. The other is effect” (Crash Proof, 69).
Now you may be asking yourself why I bother to define inflation as I do. Isn’t the common definition of inflation good enough as long as we all agree that inflation is rising prices? Why confuse things be bringing in the concept of money supply?
The best argument for defining inflation as the increase in the supply of money is that it clearly identifies the cause of rising prices: central banks creating too much money, usually in response to governments spending too much money.
If we are satisfied with the usual definition of inflation, government officials can easily fool us into thinking that prices are going up for reasons that have nothing to do with their own policies. Bad weather, profiteering by greedy speculators and lack of sufficient governmental regulations are common scapegoats for rising prices, even though prodigal politicians and the central bankers that fund their wasteful spending are the real culprits.
Watch for falling prices – The Samaritan CPI Plunges
Going back once again to Part 4, you may recall that Elisha had prophesied an extraordinary drop in prices in the Samaritan economy. The city of Samaria, the capital of the Northern Kingdom, had been under siege by the Syrian army. As a result, there was a scarcity of food and people were paying exorbitant prices for items that were barely edible.
But according to Elisha, within 24 hours food prices would drop so dramatically that people would be able to purchase wheat and barley for a fraction of what they were currently paying to eat bird dung. A government official who heard Elisha make this prophesy was incredulous. “Look, if the LORD would make windows in heaven, could this thing be?” (2 Kings 7:2) was his response.
Elisha proceeded to tell the officer that although he would see the prophesy come true, he would not benefit from it.
On one hand, it’s easy to understand why the official reacted as he did. He knew how bad things were in the city and doubtless had himself suffered greatly as a result of the Syrian siege.
But on the other hand, the word that Elisha spoke to him was not his own opinion, but “the word of the LORD” (2 Kings 7:1). The official was not doubting Elisha, but doubting God. And therein was his sin.
As it turned out, in a manner of speaking God did open windows in heaven as he miraculously provided for the deliverance of his people. But even though God worked a miracle in this case, there are still important principles of economics that we can draw from the account.
2 Kings 7:5-7 provides the details of what happened.
And they [this refers to the lepers living outside the gates of Samaria, the men discussed in Part 3 who had debated among themselves whether to stay in Samaria and die or defect to the Syrians, who just might give them a chance to live; facing certain death if they stayed in Samaria, the lepers took the course of action that had the lowest opportunity cost, quite reasonably choosing to go over to the Syrians where they just might have the chance, however small, of living] rose at twilight to go to the camp of the Syrians; and when they had come to the outskirts of the Syrian camp, to their surprise no one was there. For the LORD had caused the army of the Syrians to hear the noise of chariots and the noise of horses – the noise of a great army; so they said to one another, “Look, the king of Israel has hired against us the kings of the Hittites and the kings of the Egyptians to attack us!” Therefore they arose and fled for their lives. And when these lepers came to the outskirts of the camp, they went into one tent and ate and drank, and carried from it silver and gold and clothing, and went and hid them; then they came back and entered another tent, and carried some from there also, and went and hid it.
The lepers soon realized that they had an obligation to let the people in the city know what happened, and this they did. Once the situation had been confirmed, king Jehoram stationed the officer who had doubted Elisha at the city gate, apparently for the purpose of controlling the crowd. But so great was the people’s eagerness to partake of the spoils that they trampled the officer and he died.
What happened to the food prices as a result of the unexpected massive supply increase? Verse 18 tells us, “So it happened just as the man of God had spoken to the king, saying, ‘Two seahs of barley for a shekel, and a seah of fine flour for a shekel, shall be sold tomorrow about this time in the gate of Samaria.’ ”
Keep in mind that what we have here is not deflation – remember inflation and deflation refer to the increase/decrease in the supply of money – but a steep decline in average prices. The Samaritan CPI took a nosedive.
There was, in fact, no deflation in the account of Siege of Samaria, for the money supply did not fall. In fact, it appears that quite the opposite took place. According to verses 5-7, not only did the lepers find food, drink and clothing in the Syrian camp, but also gold and silver which were money in that economy. The money supply actually increased at the same time prices dramatically fell.
How then do we reconcile falling prices with inflation of the money supply? The proper conclusion is that even though the money supply went up, the increase in the food supply went up by even more. Recall what Peter Schiff said about the relationship between money supply and prices,
When new money or credit is added to an economy, thus diluting the existing supply, the general level of prices (aggregate prices) will rise, assuming the amount of goods and services within the system stays the same (Crash Proof, 69).
Had the lepers found only gold and silver the camp of the Syrians but nothing to eat, all that would have happened is that the already sky high Samaritan CPI would have gone even higher. Maybe people would have had to pay 10 shekels of silver for pint of bird dung instead of 5 shekels as reported in 2 Kings 6:25.
The Bible doesn’t tell us how much food was found in the Syrian camp. But we can conclude that it was found in such great quantities that even with inflation of the money supply, prices still dropped.
Hedonic Adjustments to the CPI
In recent times, economists have included what are called hedonic quality adjustments in their calculation of the CPI. This is done, because sometimes items that are included in the CPI calculation in one period are not available in the next period.
For example, the price of cell phone service goes up from one period to the next. One can conclude from this that prices rose. But what if technological improvements had taken place during this same time, so that cell phone service improved at the same time prices went up. You’re paying more as a consumer, but you’re also getting an improved product.
This is where hedonic quality adjustments come in. As the US Bureau of Labor Statistics explains, “The hedonic quality adjustment method removes any price differential attributed to a change in quality by adding or subtracting the estimated value of that change from the price of the of the old item.
If one were to apply the principle of hedonic quality adjustments to the case of the Samaritan CPI, it would make God’s miraculous deliverance of the city even more stupendous. After all, not only were people paying less for food, but they were paying less and getting much better quality to boot. Whereas in the prior period the basket of goods comprising the Samaritan CPI included donkey’s heads and bird dung, the new period included wheat and barley.
Supply Side Economics
God is a supply side economist. Really.
I know that sounds strange. Perhaps even a bit disrespectful. But the truth of this statement can be demonstrated from Scripture. Here’s why.
If you’re of a certain age, you may recall the supply side revolution that took place in the early 80s under president Reagan.
From the depression era up until that time, the US federal government had modeled its economic policies along strictly Keynesian lines. Another name for Keynesian economics is demand side economics.
Demand side economics says that when an economy goes into recession, the problem is that there is insufficient spending going on. People are just saving too much money. John Maynard Keynes, the economist for whom Keynesianism is named, called this the paradox of thrift.
Keynes was fond of deriding savers. His comments in his 1920 work The Economic Consequences of the Piece are typical of his attitude toward those who practiced financial prudence. Speaking of capitalists in the 19th century Keynes wrote,
The duty of ‘saving’ became nine-tenths of virtue and the growth of the cake the object of true religion. There grew round the non-consumption of the cake all those instincts of puritanism [you just knew Keynes was going to go after the Puritans, the very contemplation of whom causes bouts of Tourette’s syndrome among the ungodly] which in other ages has withdrawn itself from the world and has neglected the arts of production as well as those of enjoyment (as quoted in Henry Hazlitt, The Failure of the ‘New Economics’, 86).
Hazlitt goes on to note that for Keynes, “The great virtue is Consumption, extravagance, improvidence” (127). Or to put it another way, Keynes argued that we could deficit spend our way to prosperity.
This is absurd. And is the economic equivalent of calling evil good and good evil.
Naturally, depression-era governments the world over loved Keynesianism, because it provided intellectual justification for their already existing policies of economic interventionism, which included inflation of the money supply, outright nationalization of industry, governmental regulation of what remained of the private sector, price controls, and make-work programs as exemplified by Roosevelt’s Works Progress Administration (WPA).
The stated purpose of all this heretofore unprecedented governmental intervention in the private economy was to boost aggregate demand and thus cure the depression.
Only it didn’t work that way. The depression went on for a decade, ending only after WWII, when in the US the federal government dropped some of its more destructive economic interventions, allowing market forces to reassert themselves.
When Reagan entered the White House in January 1981, the US was mired in a recession. But instead of approaching the problem with the usual demand side solutions, Regan came at them from the supply side.
Supply side economics says that when the economy is in recession, the problem is not, as the Keynesian demand siders insist, insufficient consumer demand. The problem is that the supply of goods and services is being artificially constrained by high taxes and onerous regulations. Supply siders say that to correct an economic recession, what is needed is the removal of these man-made barriers to prosperity.
Long story short, under president Reagan significant tax cuts and industry deregulation took place, resulting in a remarkable economic recovery in the US during his two terms in office.
God did for the Samaritan economy much the same thing as Reagan did for the US in the 1980s, he removed artificial barriers to prosperity. Much like heavy taxes or crushing regulations, the Syrian siege was a man-made impediment to prosperity, destroying the ability of the Samaritan economy to function. Once the siege was lifted, the man-made barriers to prosperity were removed and the economy once again was able to provide for the needs of the people.
God is a supply side economist. He did not attempt to treat the barely functioning economy of Samaria by raising taxes, debasing the money, or burdening the people with more regulations. God went to the heart of the matter and corrected the problem which was inhibiting the supply of goods, in this case that required the removal of the Syrian army.
Demand side Keynesianism is bunk. This can be argued from Scripture in many ways. But the recovery of the Samaritan economy that resulted from the lifting of the siege certainly is a powerful argument by way of example against the Keynesians and for advocates of the free market, supply side approach.
It has been my goal in this series to show that many of the important concepts of economics are demonstrated in the Bible’s account of the siege of Samaria.
This is important, because many Christians labor under the impression that the Bible is good for learning about Jesus on Sunday mornings, but when it comes to answering questions about economics, politics or any number of other subjects important to our daily lives, the Scriptures are of little help.
But the Bible, as John Robbins liked to say, has a monopoly on truth. And if we are to have a true understanding of economics, the source of our information must be Scripture alone. Starting with the express statements of Scripture and their necessary consequences, we can develop a full body of Christian economic thought in accord with the mind of God.
This is a critical task for Christians at this point in history. The current financial system is breaking down, and soon the world will be in search of answers. As Christians, we are in the unique position of being able to provide real answers, but this we can do only if we diligently seek the mind of God as expressed in the 66 books of the Bible alone.