Money, Growth and Credit: The Inevitability of Inflationism in a Period of Output Growth:

- By Chinedu Okoye 

Introduction:

Economic growth is inseparable from the expansion of money and credit. Societies that have witnessed sustained increases in output have done so, through technological advancement, productivity gains, and capital deepening. They have also, simultaneously experienced a corresponding rise in the supply of money and credit.

However, this relationship of money, credit and growth is laced with the inevitability of inflationary pressures. This is especially so when monetary expansion outpaces productivity. Or when monetary policy is politicized.

Below, is an explanation in the relationship between growth, assert prices, and demand for money, and an inquisition into a fixed and flexible monetary system wild play out in the credit-based capitalist economy. Starting from the Post-Keynesian viewpoint of money which favors flexible monetary systems.

 

1.0 The Post-Keynesian Perspective:

From a Post Keynesian standpoint, money is endogenous —i.e., should be created within the system in response to demand. Rather than exogenously injected by central banks. Inflationism under this framework, isn't a policy error br a structural consequence of the growth-credit dynamic.

The more central banks accommodate credit expansion, the more they implicitly validate higher price levels. But inflation during growth is not uniformly detrimental, or always detrimental at all.

Mild inflation can act as a lubricant for economic adjustment, reducing real debt burdens and encouraging investment Money Supply and Sustained Growth. We illustrate this thinking further by showing the relationship between economic growth, asset prices and demand for money.

2.0 Economic Growth, Asset Prices and Demand for Money:

 In a period of prolonged expansion, as output increases the demand for capital goods and other factors of production increases as well. This raises the cost of production which if significant enough, filters down through prices of consumer (or finished) goods.

What Austrians would call first order (production goods) and second order goods (finished goods).

As a result credit markets becomes tighter leading to higher borrowing costs to finance or refinance asset positions. The rise in the cost of capital rises in response to an increased demand for production goods would eventually be transmitted into consumer goods prices, for a given level of productivity.

Overtime as prices rises and credit markets becomes more crowded the consumer and producer have budget or income constraints that forces them to the capital markets. This is as expectations drive demand for production goods, raising it's prices and also demand for money to purchase these goods (transactionary demand).

Now we look at two scenarios of a rigid and flexible monetary system.

2.1 Rigid Money Scenario :

If lending and money supply is rigid, or fixed, liquidity preferences rise and with a shortage of credit (or more expensive credit), this would have Inflationary impacts, as the prices of second order goods rise with the price of first order goods and the cost of credit money demanded to augment for the price increases.

Naturally it leads to a relatively lower real disposable income, and sales drop, as does demand for labour and other factors of production, leading to output begins to decline or slowdown.

2.2 Flexible Money Scenario:

However in a flexible Fiat system, and fractional reserve banking, this effect can be mitigated by a calculated monetary expansion, and output growth levels sustained for longer periods of time.

Since demand raises prices, and price increases reduce disposable income, individuals are unable to afford goods at the new price on their current (rigid) wage structure, and producers aren't willing or able to increase output given the reduction in sales (effective demand), of the recent.

This is because capital assets also rise in prices along with interest rates. This build up leads to a change in expectations of future states of the economy. With changing expectations come a reluctant lender as well (Banks). Since this is clearly a case of demand for capital outweighing supply, a logical response would be to expand money supply.

This can be done by reducing benchmark rates, or buying back previously issued government securities, so lenders can earn off the spread and price appreciation of government bonds.

This increase in money supply, raises the opportunity cost of holding cash, and new money flows from banks —and non-bank financial institutions — to industry, under instruments that offer higher yield potential.

Funds pooled by these non-bank financial institutions are then used to purchase stocks, commercial papers corporate bonds etc. to finance real assets purchases for a sustained or increased level of production.

From this investment demand, comes an increased demand for factors of production, whose prices will also adjust to suit the new realities albeit with a time lag.

The new money, is then transformed into new capital allocation, which funds new investment activities which demand new labor —raising employment levels—and an overall new output level.

Monetary Expansion and the Growth - Inflation Trade off:

For a given technological state, an increase in output cannot occur —for reasons mentioned above—without an associated increase in price levels.

So the monetary system has to be such that there's an efficient mechanism that transmits these new monies more toward financing real capital and other production (or investment) goods, for which labor is also a major component.

This is so that productivity gains are derived such that output levels per capita increases enough to moderate the inevitable price level increases. A successful endeavor would result in employment (and real wage) gains, real output increases and moderate nominal price changes.

Human Error and the Effects of Policy Fine-tuning:

But the problem arises when policy makers pursue growth regardless of real constraints —thereby making money exogenously determined.

This has the tendency to overheat the economy by stimulating aggregate demand beyond supply capacity, and as more money chases a relatively fixed amount of goods/services, prices rise as a natural consequence.

An unnatural monetary increase leads to an unnatural price level increases, as the economy builds up to instability. The very logic  —and reality —of a credit-based capitalism, with its reliance on future profitability ensures that inflation remains a structural feature of the economy. And not a passing anomaly as Austrians would argue.

Concluding Remarks:

Inflation is not an anomaly in periods of output growth, but a structural feature. As economies expand, so too must money and credit to sustain production,. investment and employment.

When this expansion aligns with productivity, inflation can be moderated, and growth stabilized. But if driven by excessive consumer demand and politicized spending, it becomes destabilizing.

But inflation, for all its ills, is less a policy failure than a consequence of the internal dynamics of the economys future oriented credit markets, liquidity preferences, and the constant push for growth.

The challenge becomes not to eliminate inflation, but to manage its pace within a policy framework that prioritizes real investments and sustainable output gains.