A small but positive rate of inflation can be good for an economy

It looks like we're going to get deeper economic algebra than I expected, and I'm excited by the challenge of getting into some math while still trying to make my arguments accessible to the casual reader. As a side note, I use the terms "floating" and "fiat" currency interchangeably. As I said in the last round a non-convertable or "fiat" currency has not fixed exchange rate to any other currency or thing. Thus its exchange rate floats vs. any other currency or item. I'm glad my opponent introduced the topic of the quantity theory of money (QTM) through the equation MV=PQ. Now, I'm going to make a simplifying assumption that the economy we're talking about has net zero real and nominal balances of trade. This allows us to ignore the capital account and net imports and exports. Most of what I'm going to say will apply even i the trade balance is not zero, but this will simplify the math considerably. Now, I have one preliminary point and two rebuttals to QTM and the conclusions my opponent draws from it. When Fisher and his contemporaries formalized the theory into the formula above in 1911[1], they were studying a very different monetary regime than either was present in my described economy or in the United States today. 1911 was before the Federal Reserve was created and most countries were either on the gold standard or had currencies tied to one that was [2]. Thus they really weren't studying either the Bretton-Woods system or the truly fiat system that has existed in the U. S. for the last 40 years since Nixon closed the gold window[3]. I would ask my opponent, in the current U. S. , British, Canadian, or Japanese, or Swiss economy, what is M? Is it printed currency, M1, M3, what? First QTM rebuttal: The equation MV=PQ is really an accounting identity, not a description of an economy's behavior. What turns QTM from an equation into a theory is the implicit assumption that V (the number of times per year each dollar, on average, changes hands) is constant. This is quite an assumption, and while my opponent also implicitly assumes it, he offers no evidence why it should be. In his example, if production (i. e. , Q) increases and M (that is the total quantity of money), he concludes that P must decrease. However another possibility is that V would increase. My opponent gives no reason why it should be one over the other. There is good reason to believe that V is not constant in a modern economy. Since PQ is essentially equal to the GDP (technically GDP-I, but lets assume all goods are sold quickly) the equation becomes MV=GDP. So, if V is held constant than two banks loaning money to each other (nominally increasing the money supply) would increase GDP. This is clearly an absurd result. What would actually happen if extra money is created in some purely financial is that the number of transactions would be divided by a large pool of money and V (the average number of times a given dollar is spend) drops. Second QTM rebuttal: My opponent also ignores the transient effects of growth. In his hypothetical, he held M and V constant and asked what happens if Q is rising. Q rising is another way to say that the rate of change of Q (also written dQ/dt, or change in Q / unit time) is positive. However, he doesn't ask how why Q was increasing. If Q increases, it means that more is being produced. Everything produced requires inputs (only God can make something out of nothing) and one needs to buy the inputs before one sells the finished goods. Thus, economic growth (i. e. , positive dQ/dt) creates an increase in demand before it creates an increase in supply. Under exponential growth, the current rate of growth is always increasing. That is to say that today's growth creates more of a bump in demand than yesterday's growth creates a bump in supply. This leads nicely into my next point.1. Average positive inflation prevents deflation My opponent didn't really rebut this point other than to argue that deflation isn't always bad. I still maintain my disincentive to invest argument about deflation though. However, as we've seen, even if we take my opponent's assumption that V is constant, rising Q will create falling P (i. e. , deflation) over the long run unless M increases. A central government should thus increase M to keep P from falling. Because dQ/dt is unpredictable, a central government should increase M by slightly more than is necessary, causing a small amount of inflation, so that if dQ/dt falls suddenly we don't enter a deflationary period.2. Inflation encourages investmentMy opponent chose not to rebut this point. Thus, I have established a reason why inflation can be good for an economy.3. Inflation is caused by growthI have discussed this at great length above in my QTM rebuttal and my discussion of point 1. Factories buy steel before they make cars. To make more cars in the future they must buy more steel now. Rebuttal on money supplyMy opponent makes a few points on "money printing" that I do feel I need to address. First I would note that the term money printing is largely irrelevant to the type of economy I said last round I would be discussing. Concern over money printing really derives from a time when we had a convertible currency because there was a risk that if too much money was "printed" then there could be a run on the nation's gold reserves[6]. This is no longer the case in the U. S. , nor in my proposed economy as both have strictly floating currencies. My opponent also makes a mistake when he says that fiat currencies have value because of law. This is false. If law set the value of a currency then, by definition it would be a convertible currency. This would be true whether its value was set to be equal to a gram of gold (like old times), a gallon of milk (like Brazil at one point[7]), or 0.13 Euros (like Denmark). What truely gives a floating currency value is three fold: that the government offers to buy things with it, that the government only accepts that currency for tax payment, and that the citizens agree to accept it. [8]Final pointsI would also like to make a few side points before concluding this round. My opponent seems to be confusing bubbles with inflation at some points. I agree that bubbles are bad and bubbles can be one cause of inflation, but they are not the only cause. Also, you cannot have inflation in one product type. From the definition, it must be a "general" rise in prices. Soaring real estate and falling wages is not inflation under the definition. My opponent suggested that normal inflation can, itself trigger hyperinflation. I dispute this point strongly, but since he has not argued why this is true there's not really anything to rebut. I will point out that the U. S. has had continuous, positive inflation since 1955[4] and Australia has for 35 years[5] and neither has triggered hyperinflation. When trying to explain this, I do hope you include a real world example. My opponent complained: "My peer makes a mistake though, in not explaining, how inflation is to be controlled. .. " I would love to address this, but alas do not have space. This debate was on whether a small but positive rate of inflation could be a good thing, not whether it is easy or hard to achieve in practice. I'd be happy to discuss that point in another debate on that topic. Though, I note that the U. S. has done just that for over a half century. References[1] . http://www.jstor.org...[2] . http://www.econlib.org...[3] . http://www.businessweek.com...[4] . http://www.tradingeconomics.com...[5] . http://www.tradingeconomics.com...[6] . http://k.web.umkc.edu...[7] well sort of . http://www.npr.org...[8] . http://www.ft.com...