Principium Volume III, Book 12, Quote 1302 and 1303

1302. (2-21-2011) (Inflation, one of the mechanisms of bad government.)ATJ We have seen how every one of the chief features of the welfare state which we have considered tends to encourage inflation. We have seen how wage pressures from the labor unions, combined with the current full-employment policies, work in this manner and how the heavy financial burden which governments are assuming through old age (retirement)ATJ pensions are likely to lead them to repeated attempts to lighten them by reducing the value of money (maybe this is why the dollar is so weak?)ATJ We should also note here, although this may not necessarily be connected, that governments seem invariably to have resorted to inflation to lighten the burden of their fixed obligations whenever the share of national income which they too exceeded about 25 per cent. And we have also seen that, because under a system of progressive taxation inflation tends to increase tax revenue proportionately more than incomes, the temptation to resort to inflation becomes very great.

- Friedrich A. Hayek – The Constitution of Liberty, 1960

1303. (2-22-2011) (Sometimes inflation is difficult to understand and to reason why it is bad, here is a discussion regarding inflation.)ATJ It is, however, rather doubtful whether, from a long-term point of view, deflation is really more harmful than inflation. Indeed, there is a sense in which inflation is infinitely more dangerous and needs to be more carefully guarded against. Of the two errors, it is the one much more likely to be committed. The reason for this is that moderate inflation is generally pleasant while it proceeds, whereas deflation is immediately and acutely painful. There is little need to take precautions against any practice the bad effects of which will be immediately and strongly felt; but there is need for precautions wherever action which is immediately pleasant or relieves temporary difficulties involves much greater harm that will be felt only later. There is, indeed, more than a mere superficial similarity between inflation and drug-taking….Inflation at first merely produces conditions in which more people make profits and in which profits are generally larger than usual. Almost everything succeeds, there are hardly any failures. The fact that profits again and again prove to be greater than had been expected and that an unusual number of ventures turn out to be successful produces a general atmosphere favorable to risk-taking. Even those who would have been driven out of business without the windfalls caused by the unexpected general rise in prices are able to hold on and to keep their employees in the expectation that they will soon share in the general prosperity. This situation will last, however, only until people begin to expect prices to continue to rise at the same rate. Once they begin to count on prices being so many per cent higher in so many months’ time, they will bid up the prices of the factors of production which determine the cost to a level corresponding to the future prices they expect. If prices then rise not more than had been expected, profits will return to normal, and the proportion of those making a profit also will fail; and since, during the period of exceptionally large profits, many have held on who would otherwise have been forced to change the direction of their efforts, a higher proportion than usual will suffer losses. The stimulating effect of inflation will thus operate only so long as it has not been foreseen; as soon as it comes to be foreseen; only its continuation at an increased rate will maintain the same degree of prosperity. If in such a situation prices rose less than expected, the effect would be the same as that of unforeseen deflation. Even if they rose only as much as was generally expected, this would no longer provide the exceptional stimulus but would lay bare the whole backlog of adjustments that had been postponed while the temporary stimulus lasted. In order for inflation to retain its initial stimulating effect, it would have to continue at a rate always faster than expected….Inflation thus can never be more than a temporary fill up, and even this beneficial effect can last only as long as somebody continues to be cheated and the expectations of some people unnecessarily disappointed. Its stimulus is due to the errors which it produces. It is particularly dangerous because the harmful effects of even small doses of inflation can be staved off only by larger doses of inflation. Once it has continued for some time, even the prevention of further acceleration will create a situation in which it will be very difficult to avoid a spontaneous deflation. Once certain activities that have become extended can be maintained only by continued inflation, their simultaneous discontinuation may well produce that vicious and rightly feared process in which the decline of some incomes leads to the decline of other incomes, and so forth. From what we know, it still seems probable that we should be able to prevent serious depressions by preventing the inflations which regularly precede them, but that there is little we can do to cure them, once they have set in. The time to worry about depressions is, unfortunately, when they are furthest from the minds of most people.

- Friedrich A. Hayek – The Constitution of Liberty, 1960

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