It’s Not Stagflation, But Inflationary Impoverishment

It is a matter of personal interest that it was my uncle, Iain Macleod, who invented the term stagflation shortly before he was appointed shadow chancellor in 1965i. It is no longer used in its original context. From Hansard (the official record of parliamentary debates) 17 November that year:

We now have the worst of both worlds —not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of "stagflation" situation and history in modern terms is indeed being made.ii

The inflation that Iain was referring to was of wages, which were averaging an increase of 6.2%, and rising, and stagnation in production, which had declined from an index of 134 to 131. It was this divergence that gave him the opportunity to invent this portmanteau word. It has now passed into more common use to describe an economy that fails to respond to the stimulus of monetary inflation.

Its use in this context is therefore different from the original. The idea that stagflation exists as an economic phenomenon is only really true for neo-Keynesians, who view inflation as economically stimulative, and its failure to stimulate perplexing. In this sense it is frequently applied to conditions today, where massive monetary stimulus does not appear, so far at least, to have brought about the economic growth that might have been expected from it.

The explanation why monetary stimulus has not worked as intended is not difficult to understand, but for neo-Keynesians it is unpalatable. This article takes its cue from the misapplication of the stagflation term to explain why Keynesian stimulation of the economy is bound to fail, and symptoms commonly but incorrectly referred to today as stagflationary are simply a reflection of the costs of monetary policy imposed on ordinary people.

It involves the reinstatement of Say’s law to its rightful place, not as Keynes misleadingly described it, that supply creates its own demand. It requires an understanding of why inflation destroys wealth, the opposite of the creation of wealth that a stimulus implies. And it necessitates an appreciation that GDP is no more than a misleading accounting identity covering only a minor part of the economy. I shall explain the relevance of these topics in turn, and why stagflation is an inappropriate description of some sort of intermediate condition between inflation and deflation.

Say’s law

According to Say’s law, we work in order to consume, which is the purpose behind the division of labor. This is self-evidently true, and it is a mystery why anyone can think otherwise. Keynes resorted to sleight of pen by giving it a definition which was wrong, mysterious and therefore hard to comprehensively criticise. However, if we return to the point Jean-Baptiste Say made over two centuries ago, there can be no doubt he was right. Even the unemployed, the retired and children are included in Say’s law, because if they don’t work, someone else has to foot the bill out of their own production.

Say’s law was an insurmountable obstacle for state planners. Keynes needed to dispense with it to make room for the state to have a role intervening in our everyday affairs. Keynes denied the equation’s validity and played on our desire to believe that money rained upon us from the state is true money. Say’s law tells us this is impossible, but by establishing the independence of money from production, Keynes went even one step further and divorced production from consumption entirely. So strong is the collective desire that this something-for-nothing formula is true, that we willingly subscribe to it.

But there is a cost, which is perhaps difficult for the ordinary citizen to grasp. If the state taxes the wealthy or debauches their money to redistribute wealth, the wealth is simply dissipated to the point where it is no longer wealth. It ends up paying the bureaucrat’s salaries and being spent on welfare. When it is invested in public services, it is done so wastefully. But above all, it is the state that impoverishes its citizenry through taxes and monetary debauchment, and it is the unwritten objective of monetary policy to enrich the state.

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Gary Anderson 3 months ago Contributor's comment

There is a bit of a slight of hand at work in this article. Everyone knows that massive economic stimulus reaaly wasn't massive. It never spilled over to mainstreet. The reserves stayed in the banking sector.