## Saturday, February 14, 2015 ... /////

### Deflation, austerity: good news for Germany

German GDP jumped as twin surpluses, deflation don't hurt at all

Without much ado, the German economy is behaving in the way that may serve as a role model for everyone else. Half a year ago, we would be bombarded by stories about the bad shape of the Germany economy when its GDP growth happened to be negative in a quarter.

However, the situation looks different these days even though none of the media publish any errata. In the fourth quarter, Germany's GDP added 0.7% (quarter-on-quarter, not annualized) which contributed to the 1.6% annual growth in 2014.

Germany's unemployment rate at 4.9% is among the lowest in Europe and lower than in the U.S.

The country announced $247 trade surplus in 2014. I guess that the weak euro could have helped this result. But anyway, you should compare this result with the$505 billion trade deficit of the U.S. in 2014 (which is still better than in many previous years, partly thanks to the fracking revolution). Also, Germany probably continued with its black zero small budget surpluses.

The fourth quarter jump in the GDP (0.7%) looks particularly good because that's exactly in the time when deflation starts to become obvious. Just in January 2015, Germany announced preliminary deflation of 0.5% month-on-month. There is a whole school – perhaps numerically dominant school – of economists who try to present deflation, even a small one, as a bogeyman. Needless to say, all of these people are cranks.

Deflation may be an accompanying sign (i.e. a consequence) of stagnating or dropping GDP. But it is not a cause of the dropping GDP. During a Klaus' birthday party last June, I had a dialogue about these matters with Ms Eva Zamrazilová, an ex-member of the Czech National Bank board. We completely agreed (and of course that lots of other people who use their brains agree as well) about the underlying dynamics.

The idea that "deflation causes bad things" is based on the assumption that if we know that the prices of XY will be lower in one year, consumers delay the purchase or consumption (because they're waiting for prices that are lower, i.e. better for the buyers), and that's why the GDP should decrease now. Does it make sense? When does it make sense?

If you think about making a very long-term investment, e.g. buying a palace, you may be affected by such things. 1% of the price of the palace is a lot (and the relative drop of the price per year may be larger) so it may make sense for you to delay the purchase. You may sometimes even determine that you will save money if you rent it for a year and buy it later.

A 1985 Czecho-Slovak hit, German edition, still sounds great to me.

Should policymakers care if the sales of palaces are delayed? I don't think so. The palace has already been built. When one owner sells it to another one, the economy doesn't really produce anything. It doesn't increase the employment. It doesn't allow the other people to have richer dinners. That was the case for palaces that already exist. What about houses that are being constructed now? Well, gradually dropping prices may convince the construction companies to speed up the work because the sooner they sell it, the better.

Dropping prices may also lead them to reduce the construction activity. But this activity is ultimately determined by the demand, anyway. If people suddenly have slightly more money, they don't buy houses. For these reasons, we shouldn't discuss these long-term purchases at all.

Instead, we should ask what deflation does to the normal products that are being consumed and that are actually included in the baskets by which inflation or deflation is defined. What will you do if you "know" that the prices of food or electronics or cars exhibit a decreasing trend and they will probably drop by 1% in a year? Will you delay the consumption?

You won't postpone the purchase of the eggs because you could die of hunger during the year. The eggs that you buy now are not exactly the same eggs as those that you buy in 2016. They behave as different products and they are used differently which is why the comparison of their prices can't have important consequences. The 2015 eggs are used to feed you in 2015 and the 2016 eggs are used to feed you in 2016. If you like to eat 2015 eggs in 2016, you may feel sick. And if you eat 2016 eggs in 2015, you may make billions for your time machine. My point is that one never "speculates" about the dropping price of food by making reserves because most of food isn't a long-lasting commodity and even if you talk about food that doesn't get spoiled for many years, people just usually don't create reserves for many years (even though I just poured some fennel and thyme from the 1980s into my soup three hours ago LOL!).

Exactly because food isn't a long-term investment, people are not comparing prices of food in one year and the following years, and that's why decreasing prices won't reduce the consumption now.

The situation is analogous for electronics and similar products. You buy a tablet in early 2015 because you want to use it already in 2015. At least, you want to use it in a near future. The asymptotic behavior of the prices in the future is therefore irrelevant. You surely know that the tablet will be more or less worthless in 10 years, don't you? And it will only gain the value as an antique in 100 years or so. Moreover, if you talked about the prices of fixed electronic products, you would have to agree that there is a huge deflation in one way or another. The memory and other parameters of tablets etc. are being doubled every 2-3 years. The old tablets become cheaper very quickly. Fixed models see their price decrease by dozens of percent per year. The reduced deflation rate for these products may exceed –10%. It really doesn't matter whether the overall inflation rate is +1% or –1%.

If you think about particular people buying particular classes of products, you will see that the idea that "deflation postpones consumption and therefore reduces GDP" simply doesn't work.

Instead, one mechanism with the opposite result does work. If one sees that (food...) prices seem to be going down, it makes him or her more self-confident that next year, he or she will be able to afford at least the same as now. This improves the sentiment, for a very rational reason. Even with fixed nominal salaries, deflation may be seen to gradually do life easier for the consumer, and that makes him or her buy things more enthusiastically.

If prices go down, the number of things one can buy for a fixed salary goes up, of course, but this isn't the whole story. If things seem to be getting easier, one also tends not to pile up savings and instead, one may be inclined to borrow.

So moderate deflation comparable to 1% or perhaps even several percent would be just fine. Central banks such as ECB are often trying to target inflation – the ECB goal is 2% – but I think that it should only be followed as long as there are conventional tools to achieve that goal. If the inflation is too fast, ECB may and should hike the interest rates. And if the inflation is too low and the rates are high, ECB should lower them. But if the interest rates are already near zero and the inflation rate seems to be slightly negative, it's most sensible for ECB to simply do nothing. If we ignore other bad circumstances that have nothing to do with deflation itself, the situation involving this deflation and zero interest rates is just perfectly OK. Negative "central" interest rates are possible but they bring more disadvantages than advantages, I think.

Twin surpluses

Now, Germany is also running a (tiny) budget surplus and (large) trade surplus. It's an export-oriented economy which "explains" the trade surplus. But it's not a true "explanation". I think that in the normal state of affairs, the market should pretty much adjust all currency exchange rates so that the trade surpluses and deficits of all countries – more precisely, all territories using one currency or another – disappear.

But Germany belongs to the Eurozone and the Eurozone as a whole doesn't reproduce the impressive German trade surpluses. The non-German part of the Eurozone runs trade deficits but Germany's lead is still enough for the whole Eurozone to show trade surpluses, although smaller than Germany's. OK, where is the difference between Germany and others coming from?

I don't think it's right to say that the reason is that the other nations are less skillful, in the sense of being able to achieve a smaller GDP per capita than Germany. Whatever your GDP per capita is, you may have a balanced trade balance (and balanced budget). You must simply adjust all your spending and salaries to your (or your nation's) abilities.

Non-German Eurozone members don't run deficits because they are less skillful than the Germans, even though they mostly are. The actual reasons behind the deficits is that they are less disciplined than Germany. They just don't care about the deficits!

So the disharmony within the Eurozone isn't an unavoidable consequence of the nations' different abilities. Different abilities don't prevent several countries from sharing a currency (as long as they may live with the fact that the average income will be different in different parts of the currency union); for example, Slovakia is doing very well in the Eurozone (although the GDP per capita is several times smaller than in Germany). Instead, what causes the disharmony and imbalance within the Eurozone is the different degree of discipline of the different nations.

The Southern nations are less good engineers than Germans but that wouldn't be a problem for the shared currency. The problem is that the North thinks it's a problem to be in (budget or trade) deficit and a big problem to go bankrupt while the South is not so sure. Someone will bail us out again if we hysterically and self-confidently scream, won't he? And if they won't save us, we still have our ouzo. (The last two sentences only apply to Greece right now; I don't want to create the impression that this meme is applicable to Spain, Portugal, Italy, Ireland, or even France.)

Rammstein: We're all living in Amerika, Amerika ist wunderbar.

This also says something about the solution: I think that there is nothing wrong about a shared currency for everyone, including nations with weaker skills or even poorer discipline. The real problem – that might grow out of control – are only the fiscal transfers. But if the Eurozone imposed the (existing!) rules that fiscal transfers won't happen, and if it simply allowed unsuccessful governments, much like unsuccessful companies, to go bankrupt (which would happen more frequently in the irresponsible nations), things could work just fine. Clearer rules what happens after a default should be written down explicitly – all these important things were avoided because it was preposterously suggested that "such bad things can't occur in the rosy Europe". Alternatively, the Eurozone (or the EU) may allow both deficits and significant fiscal transfers but a necessary condition for those not to get out of control is that the same demos and politicians will have to decide about all the budgets that may be helped in this way. I don't think that the nations will accept that Germans or others would make important decisions about their national budgets (although I guess that most of the Czechs would okay it!).

Also, Germany is running (small) budget surpluses. By doing so, it proves that it's in no way impossible to record GDP growth even though these principles – such as a nearly balanced budget – are being respected. The likes of Krugman who scream that budget deficits are great and perhaps necessary for the economic growth are unhinged crackpots. Their screaming is plain wrong for theoretical reasons – and it's also experimentally provably wrong. These people are really soulmates of the irresponsible Greek governments of the recent 4 decades. They are not showing that they know anything sensible about economics that Germany doesn't know. They are only showing their own irresponsibility and decadence. And it's not just Paul Krugman. Various Obama aides are shouting (this annoyingly pushy woman, Caroline Atkinson has previously called on the world to waste trillions for nonsensical struggle against CO2 and there are surely other reasons for her to be among the top 9 U.S. folks targeted by Russian sanctions) that Germany should run deficits and waste money in various stupid ways. Why? What do they want to achieve? Why they think that it's a good thing? Why?

Warum?

Can't you just shut up, bitch?

These people are the cause of the mess we are experiencing in Greece these days – and which other countries have experienced in the past and will experience in the future. Why would someone want to copy these mistakes? If I ask you whether the Greek or German macroeconomic management of the economy is preferred, which one will you pick?

The global financial collapse due to the excessive debt and increasingly likely debt crises is in no way inevitable. One may prevent it by simply adopting the German and not Greek logic in much of the world. One may prevent it if billions of people realize that Paul Krugman is an unhinged crank while Luboš Motl is an economics guru. ;-)

Who is the Mr Wichtig here, that is the question.

Fair currency exchange rates: trade balance a better measure than current account

One bonus technicality. I've expressed the same idea in the past but only yesterday, I became very certain about it and could formulate it in a clear way – thanks to a discussion at patria.cz.

The discussion was under an article saying that in 2014, Czechia recorded a current account surplus for the first time. For years, perhaps from the beginning, we would have trade surpluses. But many Czech companies are owned by foreign owners who extract lots of dividends from the Czech daughter companies and these outgoing dividends (which are cash leaving the country, much like in the case when we are buying something) are included with a minus sign to the current account. That's why in the previous years, Czechia would have current account deficits even though it ran trade surpluses.

Now, let's formulate the question rather sharply: if a central bank wants to "repair" some mistakes of the market and determine the "right" currency exchange rate so that we're in a sustainable equilibrium, should it try to set the trade balance to zero, or the current account to zero?

Note that if there are trade deficits (or current account deficits), it's a reason for the currency (CZK – Czech crown – in this case) to weaken because a weaker currency encourages exporters and discourages importers. OK, so which of them is right, trade balance or the current account?

My answer is "trade balance" and for a simple reason. If you weaken your local currency, it doesn't necessarily help to improve the current account (make it less negative or more positive). In fact, it does the opposite to the "dividend flow" part of the current account. The Czech companies that export lots of products may make higher profits thanks to the weaker crown and that leads to higher profits and therefore higher dividends. This, in turn, makes the current account worse. And on the contrary, a weaker crown makes it (a bit) harder for Czech owners of foreign companies. It also makes it more difficult for Czechs to buy foreign companies and perhaps create (new) incoming dividends in the future.

So the weakening of the local currency only "stabilizes" the trade balance but it does the opposite to the rest of the current account! That's why this policy of "weakening the local currency while there is a current account deficit" could actually destabilize the exchange rate – make it decay out of control – if the dividend flows etc. were more important for the current account than the trade balance. And it could happen. The dividends (i.e. profit) are smaller than the exports but they are not necessarily smaller than the difference of exports and imports.

For all these reasons, I think that the healthy currency exchange rate is one for which the trade deficit or surplus is zero, not one for which the current account is balanced. At this moment, the Czech crown is undervalued by both criteria (it's kept undervalued by completely counterproductive promised new interventions by the Czech National Bank) but I think that the careful analysis implies that it has been comparably undervalued for many years.

This determines my views about the "fair" currency exchange rates everywhere in the world. For example, the U.S. dollar is overpriced, as we see from the (still) very large trade deficit. But we know why the dollar is overpriced: it's a reserve currency. With a certain small twist to the logic, we may argue that the currency exchange rates are still determined by setting a "generalized trade balance" to zero.

What is the "generalized trade balance" that is zero in the U.S.? Well, the U.S. produces and exports some things such as iPhones (well, all the hard work is done in Asia but let's ignore that) but it runs a deficit. But what is not included in the exports are the U.S. dollar banknotes and treasuries themselves. The Chinese and many others still use and pile up these papers as their preferred way to store wealth. If you reclassify (an appropriate part of) the (newly printed) U.S. dollar cash and U.S. treasuries as "products that are being exported by the U.S. much like iPhones", you may conclude that the "generalized trade balance" of the United States is zero, too.

An exercise for you: what is the part of the newly printed cash and treasuries that leave the U.S. and that you must reclassify as "exports" if you want to balanced the generalized trade balance? ;-)

Of course, I agree with those who say that the global financial system is asymmetric and unnecessarily non-uniform, which is bound to lead to inefficiencies, thanks to the ability to effectively consider these easily printed pieces of paper as "exports". I do think that the decoupling of the dominant currency from a territory would make the global economy more sensible.

#### snail feedback (44) :

Dear Lubos,
well, what you write is true. This anti deflation talk is somewhat propaganda I think. But two things should be added about inflation and in effect it is the same thing.
Inflation is like an indirect tax to people resulting in the reduction of the state debts. Austerity or an open tax can also generate this effect but inflation is more indirect and more abstract so people don't go on the street and protest.
Similarly inflation is an accepted way of reducing the salary of somebody while reducing the nominal income is not. So the inflation of the Eurozone should help the Southern countries in the Euro zone which have too high debts and where people earn too high wages relative to their productivity.
The way I see it is that the Northern and Southern countries in the Euro zone historically are used two different levels of inflation. They continued their behaviour with the Euro so over time the current imbalance was generated. The Euro can only survive if the behaviour is adjusted, probably somewhere in the middle. The question is only on which side of the middle.

Dear Mikael, thanks for your comment but your idea that inflation is a tax or reducing debt just isn't right.

Inflation just means that there is a time-dependent redefinition of all the monetary values.

Inflation may only reduce debt temporarily, if the inflation rate spiked, for the period of time up to the maturity of the debt.

But in the longer run, one just can't reduce debt by running higher inflation because the actual interest rates demanded on the bonds are determined by the markets and the buyers of the bonds obviously want the yields to incorporate the inflation rate because they're thinking in terms of real inflation.

So at least the bonds - the state's debt - can't be "fooled" in the long run by running higher inflation. Because of the effect of inflation on the yields of bonds, other competing financial products will see the interest rate rise when there's inflation, too.

I also think it's misleading to say that inflation is a "tax". Tax is a percentage of income or profit etc. that is being lost - transferred from the worker to the government. But when there's high inflation, there is no once-at-a-time transfer. Inflation is the gradual decrease of the value of cash. But if one invests the cash e.g. to bonds, as discussed above, he will see interest rates that are higher if the inflation is higher. If I simplify just a bit, the real interest rate is "always the same". Well, it's not quite "the same" as it depends on other things, but it *may* be the same in two situations that differ by their inflation rate.

A week ago, I was analyzing pretty much exactly what would be happening with the Greek debt if it were still held in drachmas. In 2008, as the real GDP would also drop and the Greek debt would be viewed more risky, the market would adjust by 1) increasing the yields on the Greek bonds, 2) decrease of the value of the drachma. In the euro context, only 1) occurred, while this effect would be divided to 1) and 2) if they had the euros.

Things could look smoother with drachmas in 2008 and right afterwards - the holders would instantly lose some of the assets because the bonds would drop, and the drachma would drop, too. The Greek government would continue in excessive spending, probably more than under the euro where it was forced to behave.

However, since that time, the lenders would be aware of this "losing value" due to the drachma depreciation, and they would demand even higher yields. You know, the lenders aren't stupid, so if they know or think it's very likely that there is a new contribution to the loss of their investments, they simply demand it to be compensated, otherwise they do something else with their money!

So after the typical duration of the bond when the bonds are "refreshed", all of the new bonds would have even higher yields than the Greek bonds in euros have now. This would results in de facto inability of Greece to repay the debt or borrow more money except that "what's exactly going on with the large debt" would be obscured by the high inflation rate.

But I don't think that the debt-to-GDP ratio of Greece would be smaller than 175 percent in 2015 if Greece had continued to use drachmas. The only thing that would be different would be the perception of Greece - it would be some periphery country and high inflation or default would look like more normal, much like in Argentina, and people wouldn't try to sell it as a continental or global problem.

Hmm,

"Dear Mikael, thanks for your comment but your idea that inflation is a tax ..... just isn't right.""

But it can be right under some circumstances, can't it?

Imagine a single country with no interaction with anyone else. This country does not have a tax-system, instead all its government employed people are paid for through direct money creation, so the amount of money in circulation constantly increase. Lets say the work done by these people is pretty much useless, yet lots of actual resources go to them - when they buy food and other stuff - meaning that the rest of the population has to work harder to produce more. How is this not a tax? Why is this argument wrong? Sometimes Governments do print money to pay workers, and when they do is it not a tax?
(apparently many here are named Mikael or Michael ;-) )

The last decimal place on those GDP figures is meaningless. GDP is hard to measure. Economists never report error bars.

Well, inflation will certainly reduce the debt burden on a 30 year private mortgage.

Colonel Flick sees Alice in Euroland:

https://www.flickr.com/photos/expd/16518971582/in/photostream/

Well, Lubos, I didn't expect my remarks to be controversial. Inflation is like a time dependent redefinition of units. Great. But a long running contract between lender and borrower cannot be changed in the past, so they both care about this time dependent redefinition. Now the central bank can act as an external agent and print as much money as they want at any time. So as long as their money is accepted to store value, the central bank can transfer money from the people to the government pretty much at will. This is why the central bank should be kept independent from the politicians which sometimes works well and sometimes not so well.

I am confident that a 0.2% change of the GDP is already significant change that has detectable consequences.

The percentage of people who made these spectacularly bad predictions was so high! There was no reason for that. There were all reasons to consider 2014 just another standard average year for which one expects 10% returns on average stocks and all these things - why this 20% decrease?

Dear Mikael, as I already wrote, but I probably wasn't clear, an abrupt one-time episode of inflation indeed helps the existing borrowers and hurts the existing lenders.

But at the same time, and that's what you completely overlook, it helps the future lenders (in a certain timeframe) and hurts the future borrowers because the borrowers will use the inflation episode to raise the inflation expectation and they will demand higher interest rates.

When one integrates what the borrowers or lenders lose or get over a timeframe longer than a time comparable to the duration of the bond, one sees that the printing of the money just doesn't make a difference for either group.

This whole idea that by printing the money, the central bank (or the government) may systematically help borrowers, or systematically hurt lenders, or vice versa is a result of a trivial mathematical error.

Only the increase of inflation actually works as a tax on creditors. "Stable" inflation does not work like that, as the lenders actually incorporate it into their demanded interest rate. So yes, you can "tax" or "steal from" existing creditors by increase in inflation (compared to the that they expected in the past). The catch is, if you keep increasing inflation to achieve this effect, the lenders may adjust by expecting this increase. In fact, you screw up the economy by introducing too much unpredicability.

Right, but recent inflation will also raise the interest rate demanded by the banks on mortgages signed tomorrow, so it will make life *harder* for the new lenders starting from tomorrow.

Right, I see how an expected inflation can be neutralized in the borrowing and lending, but in the hypothetical country some people were given printed money and some were not. They get something - even though there are no taxes. So there is a redistribution of wealth to the Government employees and therefore the money-printing in the example worked as a tax, right?

Dear Michael, right, if a government can print and donate money directly, without legitimately borrowing it from lenders, then the very inflation may be viewed as tax.

In that system of yours, one more thing holds. The money is worthless. If there's no force opposing the printing of the new money and paying it to the parasites, it must be assumed that this activity may grow indefinitely, to infinity, which means that all this money - huge amounts - will be held by the parasites employed in this public sector.

These folks get it for free which is one perspective how to see that the money is worthless. However, the right to become a public sector employee in your system is not worthless. ;-)

The free market that you could built upon this "unlimited government paying from thin air" economy wouldn't use your banknote at all because the prediction of its future value is effectively zero. It will have to choose something else as a currency.

If you legally force the market players to use this quickly-getting-devalued corrupt currency, they will sign contracts - like loans between each other, or construction that takes some time - that will assume a very high inflation rate or devaluation rate or how one should call it. This rate is pretty much ill-defined and perhaps infinite because you said that the government can do this without restrictions or any opposing force.

Perhaps, there will be some "standard" amount of government spending so this may be used by the market to estimate the devaluation of the currency in the future. But there's always a risk that the devaluation will become much quicker.

At any rate, it looks like a hyperinflating currency and people will try not to hold any cash at all, attempting to find something else and use it instead of the money. I think that some countries got pretty close to your picture of the money that the govenment prints and donates out of thin air. Zimbabwe probably did it in this way.

But it's important that America is not doing it in this way. The government budget deficits come from loans, bonds - U.S. treasuries - and they see the opposing force as the interest rates would be rising if the debt were getting too high. Because the economy would spin out of control if the interest rates began to grow and accelerate too much, the U.S. government is effectively forced to make the budget deficits small enough, and that's a part of the mechanism that allows everyone to assume that the dollar banknotes (and treasuries) won't lose their value super quickly.

Right,

""Perhaps, there will be some "standard" amount of government spending so this may be used by the market to estimate the devaluation of the currency in the future.""

That would be assumed to be enforced yes.

""I think that some countries got pretty close to your picture of the money that the govenment prints and donates out of thin air. Zimbabwe probably did it in this way.""

I think so too. And I was not suggesting it as a good idea of course, only that inflation *could* be a form of tax.

In my ideal world there is no state-organised stealing, neither through money-printing donations nor taxes :-). Voluntary - or mutually agreed upon - interactions is the code-word.

""the U.S. government is effectively forced to make the budget deficits small enough, and that's a part of the mechanism that allows everyone to assume that the dollar banknotes (and treasuries) won't lose their value super quickly.""

you do know that it has been determined that it is highly probable that Mendel faked his results...ihis research is an almost universally used example of the application of non parametric analysis of variance...(chi square).
his results were too good.

"let's ignore the Jewish blood of the last one" Get the genes, dump pious baggage, eat the world. Occasionally receive a Nobel Prize from people who are every bit as smart but in marvelous, undiscoverable ways. Invent Socialism as a little joke on God.

How is the runt of the Yahweh litter doing in the Middle East? ISIS is kicking butt! Boco Haram in Africa? Kicking butt! Subcontract the cleanup to Israel. Sure, yer gonna buy four spikes and only get three installed. You got your money's worth last time, didn't you? They pulled a 25% profit. It's like baryogenesis (two sets of books).

Actually, deflation is normal in an economy that is experiencing increases in productivity and efficiency, and an aging, numerically declining population may spend less because there is no more household formation and big-ticket purchases. I say may because the elderly's medical expenses shoot up. Anyway, Europe, especially Germany is experiencing all this.

Also, shouldn't good Greens, like the Germans (who were Green before, during and after[?] being Brown), applaud shrinking populations and GDP's

Profound antifound - they both meet in the back, right?

Dear Lubos,
I understand your point that the new lenders and borrowers will consider the new inflation rate in their contracts. But what your are overlooking is that the one you can print money can distribute wealth from everybody else who owns money to himself. This is why printing fake money is punished, isn't it? The total amount of money is increasing (inflation), but the one who printed it has a higher share now compared to the others. The central bank can know e.g. buy state loans with this printed money and thereby lower their interest rate. This very thing Draghi is doing now with the quantitive easing program. In theory he could even go one step further and just destroy the loan he bought. I agree that if this is done excessively, in the long run the economy will be destroyed by hyperinflation etc. But otherwise it is hard for the market participants to escape unless they invent their own private money system which has other problems etc.

Hi Mikael,

""But what your are overlooking is that the one you can print money can distribute wealth from everybody else who owns money to himself. This is why printing fake money is punished, isn't it? The total amount of money is increasing (inflation), but the one who printed it has a higher share now compared to the others.""

I basically objected the same thing below and he gave a comprehensive answer below.

Lubos cannot give a comprehensive answer because there is none. Even the kings in the middleages knew that the way to pay for their castles is to print money. In their case they had to lower the degree of gold or silver in the coins. In our modern age it is just some printed paper or rather some bits and bytes in the computer of the central bank. The only protection is that normally the goal of the central bank or politicians is not to destroy their country's economy. But a malicious government can do whatever they like such as distribute all the wealth to themselves by printing huge amounts of money. I am not saying that it would not have consequences. Ultimately there is no free lunch of course which is why the analogy of the tax is totally to the point,

I especially see this kinds of "freedoms" of Governments to be a problem in the case of wars, because the true cost can be hidden by postponing it to the future. The support for the Iraq war would have been more difficult to get, if anyone were told to hand over a check immediately. Years later when people may even discover that they were tricked, its like, oh its history, or, oh, the crisis wasn't caused by us lowering interest rates to a ridiculous degree so everyone thought they could buy a bigger house, oh no, it was the evil free markets. All this crap.

Situations like wars are the extreme cases. (I think you may simplify a bit the US housing crisis but that is another story.) In fact I think that some small inflation may be good for reasons I gave above and it is a familiar argument in economy. But the effect of the money printing press is also key to understanding the Euro crisis. With the Lira a country like Italy could never go bankrupt. In an emergency case the central bank would always collaborate and help the government out of a debt crisis. I am not saying the solution is trouble free but it would prevent the country from formally going bankrupt. Now with the Euro the printing press is owned by all countries together so a country can formally go bankrupt. One can still use the printing press to evade it of course but then other countries will claim the same right for their debt which can become a death spiral.

Very entertaining music videos BTW Lubos!

I was referring to Oscar Morgenstern's book on The Accuracy of Economic Observations:

http://www.econlib.org/library/Enc/bios/Morgenstern.html

Al, this lady comes from ISIS heartland

This is the secret for Germany's Success.

http://www.hannovermesse.de/en/exhibition/industrial-automation-it/industrial-automation/

Hopefully I will be there in April.

http://www.foreignaffairs.com/articles/67899/steven-rattner/the-secrets-of-germanys-success

bet this went videoed anywhere near isis, you think?

This Lady is a very well known artist specializing( taking it to the limit I would say) in folklore dancing and singing in the accent of the people straddling the Iraq Syria border.

Right, and yes I am aware of the simplification, but its difficult when writing only one line about it.
However - as I am sure you agree - socialism can kill/severely hurt any economy no matter how the money are created or by whom.

Can you elaborate on this a bit, puhlease:
"I do think that the decoupling of the dominant currency from a territory would make the global economy more sensible."

""which is bound to lead to inefficiencies, thanks to the ability to effectively consider these easily printed pieces of paper as "exports" ""

Well, it hasn't been inefficient for the US so far, and it has largely enabled their wars. Some claim the wars were even related to this more intimately. It is claimed by some that when the US first made the deal with Saudi Arabia in the seventies that Saudi Arabia (and Opec) would trade their oil only in Dollars and reinvest their profits in US treasuries it helped the US because it helped/contributed to keep the status of the Dollar as the reserve currency.

"It's kept undervalued by completely counterproductive promised new interventions by the Czech National Bank"

In Denmark they have a policy of trying to keep the Danish Crown at a fixed exchange rate with respect to the Euro and it was starting to deflate, so the Central Bank printed more than a billion Danish Crowns and bought Euros on the market, lowered the interest rates at home, even made it cost money for banks to have reserves and stopped issuing state obligations. Now everyone are refinancing their loans or taking up new ones as its suddenly so cheap to borrow (historically very very cheap).

Off topic, hope its okay:

I haven't been able to post this comment to you below the article, where it belonged (the size of dinosaurs)?:

It was not meant as a joke, and yes the proposal does demand that the air is 100+ times denser. It does not matter that the air was less dense further back, only that it was more dense in the dinosaur era. I know it sounds ludicrous but if you can suspend disbelief for a moment, there really is something interesting here. I thought about the problems with having a "bird" as tall as a giraffe (!) and animals that are 100 + tons some years ago. Conditions must have been very very different, and really the thick atmosphere solution seems the only plausible possibility.

It turned out that a guy named David Esker had already done loads of work and he has a website where he presents his solution to the paradoxes around the dinosaurs. His site is optimized for non-physicists I guess - its very detailed - but its actually really nice how super simple, yet powerful his arguments are. Here he explains flight

http://dinosaurtheory.com/flig...

beautifully, with high-school math.

Also consider the fact that fast dinosaurs are two-legged. Exactly if you try to push your way through something with resistance your weight is transferred to the hind legs and the typical dinosaur shape suddenly makes perfect sense.

He also explain/argue why he finds tidal effects from the moon to be the primary cause of earths internal heat (conversely it explains why the moon is geologically dead since it is locked in resonance (I don't think he uses this example though)). And also that a thick atmosphere with strong greenhouse effect makes it more plausible that the temperature differences between the poles and the equator where smaller back then. (With greenery on Antarctica and stuff like that, yes I know one has to consider the movement of the plates and so, but still)

I am pretty sure you won't be disappointed if you check his site. It would be very fast for
you anyway. Perhaps he would even be interested in doing a guest-blog? I think it could be fun, since dinosaurs are a funny subject that captivated many as children and there are some real issues here that need some resolution.

100 billion crowns* sorry

why can't I post my follow-up comment on the dinosaur thing? Have you not gotten it, or do you remove it? I don't get it.

The Central [Bank-supported] institution is (together with people's ingrained expectations) what basically upholds the mechanics and principle of Interest (not quite as mysterious as that of Quantum outcomes ;->) and endemically and systematically drives the (to me mild but still annoying to know about) insanity called "Inflation".

Dear David, if his claims about the ratios and probabilities of various properties of the offspring are right, I am impressed anyway - even if his experiments weren't kosher.

Excellent blog, thanks.
I am pretty sure the ECB directors understand as much. I remember you describing Dhragi as "sensible", is that right?
If so, the only explanation for their current monetary policy is that they want to devalue exisiting gov debt enabling future irresponsible spending. It's not monetary policy, it's (yet another) redistribution scheme.

Dear Mikael, as Michael says, I answered the same thing to Michael below.

One may express the point more strongly. If someone may print the money and directly use them as his extra cash, without any borrowing etc., these banknotes shouldn't be considered money, or should be considered worthless, or he should be considered counterfeiter.

This is not what we mean by fiat money in civilized countries. When a government needs to spend on deficit, it must *borrow* the extra money which is very different than simply printing the money out of thin air.

Why it's different? Because when the government borrows the money, it distributes bonds among the lenders, the productive part of the public, and these bonds may be used much like money itself. So when government properly borrows and issues bonds, no redistribution between the government and the public sector is taking place. In all the regimes I am talking about, your claim that the central bank may redistribute the money from private entities to itself or the government is simply wrong.

where do you think it was recorded Qsa?