What Inflation Would Look Like in A True Free-Market Economy
The comments below are an edited and abridged synopsis of an article by David Stockman
Former Fed Chair Bernanke said that the Fed needed a 200-basis point inflation rate cushion to steer clear of the dreaded 0.0% inflation line, the other side of which allegedly amounted to a black hole of deflationary demise.
But there is no evidence that the US economy needs a 2% inflation guardrail to thrive, or any fixed rate of inflation at all.
Stockman outlines what happened during the most difficult period of the 20th century, from 1921 to 1946, when the US economy experienced the Roaring Twenties, the Great Depression and WWII; and the period between the 2007 and 2021, when real GDP grew at only 1.72% per annum, while per capita real GDP increased by just 1.04% per year. That was just two-fifths of the rate of annual gain from 1921 to1946.
In short, the Fed doesn’t need an inflation target of 2% per annum, nor does it need targets for unemployment, job growth, actual versus potential GDP or the rest of the Keynesian policy apparatus. All of those are the jobs of people in the free market, producing whatever outcomes their collective actions happened to generate.
The free market operating with sound gold-backed money was never inflationary. In that context, interest rates were also not a policy tool of the central bank, but the result of a market-clearing balancing of supply and demand.
The Fed was not allowed to own government debt, nor did it have an activist arm, the FOMC, empowered to intervene in the money and capital markets by buying and selling debt securities.
This meant that the Fed’s balance sheet reflected the ebb-and-flow of decentralized commerce and production on main street, not a centralized judgment about whether inflation and unemployment were too high, too low or just right.
So, under the bankers’ arrangement the free market put an automatic check on CPI inflation because unsound speculative loans could not be easily made in the first place, since they were not eligible for discount at the Fed window.
And if demand for sound loans got too frisky, interest rates would rise sharply, thereby rationing available savings until more of the latter could be generated or demand for the former was curtailed.