Monetarism in Germany: The tale of two Wikipedias

Today, I received an e-mail as a reaction to an interview which I had given the left-leaning German daily “taz” last week (see here for the German text). In this interview, I had claimed that the recent actions by the US Fed to calm markets do not create inflationary pressure. My argument was that the US economy will most likely go into recession and banks will not extend their credit portfolios, so aggregate demand will remain weak which will put downward pressure on wages and prices.

The reader of my interview, however, was quite angry. He claimed that I obviously did not know much economics and that I was part of “a brainwashing scheme of mainstream media”. According to him, a rise in the money supply already is inflation as it always leads to higher prices. At least, so he said, that is what he was taught when he was studying economics at the University in Essen. As a proof, he also cited the German Wikipedia site.

When I looked at the German Wikipedia Website on inflation (which incidently is blocked for editing for new users, so I could only leave plead to have it changed), I was quite surprises by the definition I found there (the quote is the first sentence, hence the central definition) which read:

“Inflation (von lat.: „das Sich-Aufblasen; das Aufschwellen“) bezeichnet in der Volkswirtschaftslehre einen andauernden, „signifikanten“ Anstieg der Geldmenge und damit des Preisniveaus”

For non-German speakers (my translation):

“Inflation (from latin: “balloing”) denotes in economics a continous ‘significant’ increase in the money supply and hence in the price level.”

Interestingly, in Germany, monetarism seems to be so much accepted that for the definition of inflation, people put the increase in the money supply before the increase in prices!

Compare this to the definition of inflation from the English language version of Wikipedia:

“Inflation is a rise in the general level of prices over time. It may also refer to a rise in the prices of a specific set of goods or services. In either case, it is measured as the percentage rate of change of a price index.”

Or to the definition from the New Palgrave’s which cite David Laidler and Michael Parkin (not necessarily known as anti-monetarists):

“Inflation is a process of continuously rising prices, or equivalently, of a continuously falling value in money.”

The definition of the German entry to Wikipedia has several problems – both in relation with historical evidence, but also against modern mainstream monetary theory: First, as we know since the Volcker experiment and Goodhart’s law, the velocity of money is far from stable. There might be periods of rapidly rising money supply without inflation.

And as we know from the time of German hyperinflation, inflation can continue even without a rapid increase in the money supply: During the German hyperinflation, there was one episode when the money printers went on strike. Nevertheless, the price increases continued. In fact, in most periods of high inflation, the real money supply falls. When Hjalmar Schacht introduced the new currency, the Rentenmark (which was backed by claims on mortgages decreed by the German government on private property), people had confidence that the new Mark would be stable. After a short while, money supply started growing quite briskly again – but without a coincident increase in prices. Instead, people started to hold their wealth in money again.

This is also what modern textbooks tell you: In most modern mainstream models, what is important for inflation is inflation expectations plus the deviation of current demand from potential output. Money supply is endogenous and a consequence of developments in the financial sector and portfolio decisions by private households.

While one can sensibly argue that data on money supply might help you to spot excesses in bank lending, it is less clear whether this might lead to inflation in the end. This is why even the ECB has moved away from putting M3 first as a intermediary target for monetary policy.

However, as we see from my reader’s e-mail and the Wikipedia entry, it will take a long time until Germans will widely accept an inflation targeting framework. Being sceptical of the financial sector as a part of “capitalist economy”, many Germans still believe money should best be backed by gold. If this is not possible, it should at least be run by the Bundesbank with a strict monetary targeting (even if this was never what the Bundesbank empirically did). And obviously, this view is also still taught in universities across the country.

This post has been co-posted at Eurozone Watch.

8 Responses to "Monetarism in Germany: The tale of two Wikipedias"

  1. lburgler   March 22, 2008 at 10:50 am

    more of a question, really:Why does Bernanke say inflation is flat when everything I buy has noticeably crept up in price in the last 2 years?Where does Bernanke shop? Otherwise put, what are the potential shortfalls of measurements?

  2. interested reader   March 22, 2008 at 4:26 pm

    How about the following:if wages grow in line with labor productivity, aggregate demand and supply are roughly balanced. If wages grow faster than productivity, this creates excess demand and demand-pull inflation. This is where central banks can and should step in (post-war era). If wages grow below productivity, this creates excess aggregate supply and unemployment (since the 1970s). If in addition prices rise due to cost-push inflation, households’ purchasing power is hurt and consumption suffers even more (France, Germany, Italy). There is nothing the central bank could or should do to fight cost-push inflation: Volcker’s experiment cost the U.S. economy dearly and the ECB should avoid the same mistake. If on the other hand credit availability compensates for wages growing below productivity, consumption suffers less and unemployment recedes but the savings rate falls and the current account deteriorates, ceteris paribus (U.S., UK.) The nominal exchange rate falls thus pushing up prices of imported goods. This is where we are now in the U.S. and it is important to understand that we are fundamentally in a deflationary aggregate excess supply situation and have been so for 30 years on both sides of the Atlantic.

  3. Sebastian Dullien   March 24, 2008 at 10:08 am

    @lburger: I would never say that prices are not increasing at the moment. All I am saying is that inflation most likely will moderate in the coming quarters and that the Fed’s injection of liquidity does not pose inflationary danger.

  4. Sebastian Dullien   March 24, 2008 at 10:09 am

    After two days of discussions in the Wikipedia forums, they have now changed the German definition. Let’s see how long it takes before the part on the money supply is added again…

  5. Guest   March 25, 2008 at 1:19 pm

    The fact is that when you monetarise a fiscal deficit, i.e. when the Central Bank lends money to the Treasury, you can have first the rise in the money supply and then inflation.

  6. eparisi   March 25, 2008 at 11:19 pm

    @ Guest:the U.S. economy and many Western European economies have bigger private sector than fiscal deficits. This time around the problem is in the household and corporate balances, not so much in the public sector.

  7. Mick Rolland   March 31, 2008 at 8:43 pm

    Clearly the weakest point in a simplified monetarist framework is the assumption of constancy in the velocity of circulation. As the ‘velocity of circulation’ (which is quite a misleading term) is affected by expectations and other subjective valuations by economic agents, the relation between M3 and prices is not stable in the short term -although in the long term it is surprisingly reliable (also with M1 or M2).Still, the substitution in present monetary frameworks of the M3-CPI relation by the other Output Gap-CPI relation is highly questionable. ‘Potential output’ is only a crude guess which is very easy to fudge (it is even less reliable than M3).Furthermore, the consideration of an endogenous money supply (as opposed to an exogenous and totally controllable money supply by the central bank) can be confusing. While it is absolutely true that credit demand is a key driver of M3, it would be very wrong to assert that it is independent of nominal and real interest rates -to a large extent controlled or influenced by the central bank.