One of the main topics of Hungarian economic policy today is the so called overheads reduction. The popularity of this policy of reducing prices by fiat is a brilliant example of the old wisdom that good politics is always bad economics. Many say that reducing overheads is good because it reduces inflation by reducing the prices of a lot of important products people buy. Reducing inflation is good, isn’t it? Well, I do not want to tell anyone what is good or bad. What I want to tell is that if one believes that it is okay to fight inflation by regulating prices, then he or she misunderstands something deeply, fundamentally about inflation and about economics in general.
One of the misunderstandings is concerned with the damages inflation causes. Why is inflation bad? The economically uneducated reply is that it is bad because when prices go up the value of our incomes go down. No, I’m sorry, that is not a real damage. Without inflation our nominal wage would not grow that fast, either. After all, if you can make people richer by reducing prices, why not reduce them to zero?
The damages that inflation causes are not as obvious as it first seems. Inflation is a rise in prices brought about by economic policy, not by a true change in the costs of production or in the tastes of people. To make wise decisions about how much to spend on investment, on how many people to employ, how many times to go to theatre or a football match a week, in which restaurant to have your daily lunch, etc., you must know the true prices of these things. But in the case of inflation the prices tell you a lie about the value of the things you plan to buy. As economists put it, inflation distorts prices. If prices are telling you a lie about costs, you will spend on things you would not spend on otherwise. Note that it’s the artificial change in prices, not their rise that really matters.
In addition, because of inflation, money itself will be less sound as a store of value. As a result, in case of high inflation you will not leave as much money on your checking account as with low inflation; you will make more effort to manage your cash balance; you will be more cautious about lending and borrowing money, even if the money you borrow could be invested with high returns. The firms would be happy to employ more people in production and less in cash management, but inflation makes this unprofitable.
In sum, inflation discourages us to use two of the marvellous inventions of humankind: money and prices. This damage of inflation is a bit more complicated than a political slogan. But the damages of inflation are not the only thing that you deeply misunderstand if you think that reducing overheads by fiat is a good idea in fighting against inflation. If you think so, you have the naïve idea that prices are rising because some bad guys are raising them, period. To think in this way is to deny any systematic thinking about social issues. To think in this way is to think that in society there are no causes and effects which are to be analysed, and if you want to reach a good result, all you need is to order someone to produce that result. Are prices increasing? Let’s ban people to increase it! Sounds logical, doesn’t it?
It doesn’t. In the end, curing inflation by regulating prices is like curing a disease by banning the doctors to tell their patients that they are ill. But if they don’t like the truth, why not?
30 June 2013
Pál Czeglédi
