Is fractional reserve banking inflationary?

Because the Fed (or central bank it is called, if you're not in the U.S.) is siphoning off purchasing power in the form of inflation (a form of taxation), while the government Treasury is also increasing taxes to compensate for their loss of purchasing power.

Actually, come to think of it, you are right, the tax increase would roughly be in proportion to the change in inflation.

 

You mean in actual or relative to the amount of deflation?

No. If anything, increasing prices will encourage (short term) a current purchase as opposed to a delayed one, as the expectation is the delay will cost more money.

As to investing/saving, inflation makes folks more likely to invest as opposed to horde/save.

With inflation, the independent value of the dollar decreases, which creates the incentive to not horde dollars but to invest so that the value of your investment at least keeps up with inflation.

With deflation, the dollar becomes an independent investment vehicle, increasing in value on its own, which incentives people to horde as opposed to invest.

Depends on the state of the economy. We need both. You can have a situation where there is insufficient capital for investment, usually characterized by higher relative interest rates.

The problem we've had is not sufficient capital. We have trillions of dollars laying around which are available for investment in business expansion. They problem we have in insufficient demand/spending, for a number of reasons, IMO.

 

I don't know, that seems to me like it is another fallacy that economists believe is true but is actually not, but I'll have to give that some more thought before I can come back to you with an explanation.

But America also has a trade deficit and has been draining off their capital.

 

Fractional reserve banking has nothing to do with government bods or debt.

It has to do with banks lending out a portion of the cash (or its electronic equivalent, reserves at the FRB) they hold.

 

That is incorrect.

When the Fed injects new base money, it purchases a debt instrument already existing (usually a government bond) in the open market.

The government is not borrowing from the Fed directly.

 

It's practically the same effect, for all intents and economic purposes.

 

It's pretty easy. What can be more complex is differentiating between inflation (a general price increase) and price changes because of supply and demand.

For example, if the price of a gallon of gas goes up $1/gallon, many call that inflation, but it is not, it is a price change because of supply/demand changes. Just as a decrease of the price of a gallon of gas is not necessarily deflation.

That is true, but certainly not impossible to make a good calculation.

 

So the claim about borrowing from the Fed in the post to which I responded is inaccurate.

 

It's just a short hand analogy. Instead of burying it they stick it in offshore accounts or investment portfolios or hold in cash accounts and banks and corporations and governments hold it in cash.

The point is, if the new money is not being loaned and spent in the economy, it doesn't change the effective amount of money in the money supply (money velocity decreases) and thus doesn't have an inflationary effect.

Which is why, even though the Fed increased the base money supply by about $3 trillion, we didn't see a big jump in inflation.

 

I agree that would be a shorter term effect.

But in the longer term, there is incentive to buy things other than simply whether folks think the price will go up or down. People still need to eat, will need a new car, etc.

 

Call it what you want. I don't see any particular benefit to having our currency controlled by dumb luck either.

 

Just in the last year, and for most people, they pay tax as they go along (withholding) so the inflation effect is nil.

 

That doesn't explain why taxes would go up faster than inflation. You're basing your argument on an unproven assretion (inflation is a form of taxes) which you have not established.

Taxes can go up or down for many reasons, including obviously political ones.

But if the rate of taxation is constant, the net effect on one's relative position is basically nothing.

 

It's just logical. If we have 10% inflation, you know the value of your holdings in cash are going to decrease 10% a year. OTOH, if you can get 10% by putting the money in a CD or investing in stocks or business expansion or loaning it out, you will be incentivized to do that.

If you have 10% deflation, the dollars have independent value and increase in value by 10% a year. Your investment options are going to be much more limited (because with decreasing revenues, profits and incomes, dividends and stock values decrease and the cost of borrowing increases) so you will be incentivized to hoard your money.

I didn't say we can't or couldn't in the future have problem with capital sufficiency. But we don't now.

The point is your assertion about whether saving versus spending is good or bad is relative to the current state of the economy. We have had more than enough capital but insufficient demand for a long time now.

 

In some ways, the practical effect is no different. But your point was "every time the Fed issues money it is a form of borrowing." You seemed to be implying that the creation of money by the Fed increases the amount of borrowing. That is not correct. When the Fed creates money, it does not increase the amount of borrowing. The borrowing already existed.

 

That is true, it targets a 2% inflation rate, which is thought to be a most beneficial rate, for reasons I've noted in my posts.

 

It does increase the amount of borrowing. If the Fed buys up government debt out of the open market, the market will make up the difference and buy more debt.

It's effectively the same thing as buying from the government, they're just going through an intermediary in the private market.

Well I believe that any draining out of capital is a bad thing and started a thread about it: US trading away their ASSETS

Well, a part of that reason is the trade deficit, and making Americans spend more money is not going to increase demand if all that demand is going to another country.

That was my point. If the rate of taxation was kept from increasing, the burden of inflation would fall mostly on the government's purchasing power, theoretically.
Although as you pointed out that would not be the case if taxes were withheld for withholding.

Well, obviously it would be a form of tax if the burden of decreased purchasing power was not falling on the government.​

 

That is a presumption that may or may not be true.

If the government floats a bond and it is purchased by an individual or bank and then sold to the Fed, the mere fact it was sold to the Fed does not mean that the Govt will float more bonds. The govt floats bonds based on whether it has insufficient revenues, not whether the Fed buys it or not.

Whether the Fed buys it or not doesn't change the amount the government borrows.

The Fed buys (or sells) based on money supply management. The government borrows based on insufficient revenues. These are two independent causes and effects.

If it results in a lack of capital, sure. But trading deficits is a different thing that really is tangential to what we've been discussing. But in fact we do not have a lack of capital now. Interest rates are low and there are trillions sitting in cash available for investment. The problem we have is lack of spending.

No, because the government gets the same amount of relative dollars.

If gross income in $10T and the effective tax rate is 20%, government revenues are $200B.

If because of 10% inflation only gross income goes to $11T, government revenues are $220B, exactly keeping up with inflation.

​

Still wouldn't be. See example above.

 

DEBT? KEEP KICKING IT INTO THE FUTURE!

Not if Uncle Sam keeps kicking the debt into the future. Which is what he does every day by borrowing more to pay of dent whose term has arrived.

Just wondering ...

How the NYT responded to that question - excerpt:

America has become a spendthrift. No doubt about it.

Let's spend less, and more wisely ...

 

I think we were just arguing about semantics then.

By "tax", I meant that the Fed was essentially siphoning off purchasing power to spend to effect public monetary policy. I'd regard that as a form of "taxation".
Most economists regard inflation as a "hidden tax".

The example you used only shows taxable income after inflation has already occurred.

What I was discussing was inflation happening in the interval between when income is earned and when government collects the tax on it.​

 

The Fed isn't siphoning off anything. Fed policies can affect the value of the dollar, which may or may not affect a person's purchasing power.

I question that. Most people I see using that phrase are folks with an anti-tax agenda.

 

That seems to be a vague run-around from the issue we're discussing.

If the Fed wants to alter interest rates in the open market, they need purchasing power, and that purchasing power has to come from somewhere. That's why I used the "siphoning off" analogy.

You can play around with paper all you want, but ultimately at some level there is a transfer of actual wealth. As economists say, "There's no free lunch."

 

If you are really concerned about the debt, why did you leave out half the equation?

Stop decreasing tax revenues if you want to decrease deficits, and raise them instead.

 

It does seem that way to me at all. Maybe it seems that way to use because of your inaccurate use of terms. How is the Fed "siphoning off" purchasing power? If too much money is created and we have inflation, that decreases purchasing power of the dollar, but its not like it is magically going to the Fed.

 

No, it doesn't. The Fed is the one entity that has the power to create money out of thin air. It doesn't need "purchasing power." It just creates it.

That's why your "siphoning off" analogy is wrong.

A transfer of wealth from what to what? The Fed? There is no transfer. The Fed just creates it. Or destroys it. Depending on what it wants to do with the money supply.