Paradox of Price Stability

Welcome to today's explainer. We've got a truly fascinating topic to unpack today, and it's one that challenges something you probably hear on the financial news almost every single day. We're exploring a really compelling critique from the Mises Institute regarding the Federal Reserve's policies. Specifically, we're looking at their ultimate goal of keeping prices stable and examining an argument that suggests the consequences of pumping money into the system to achieve this stability might actually be the very thing causing economic instability. It's a paradox that attempts to flip conventional wisdom right on its head. Okay, so to really understand this critique, we first need to look at the mainstream economic consensus. If you ask most economists, they'll tell you that a stable general price level is the absolute bedrock of a healthy economy. Just take a look at the words of William J. McDonald, the former president of the Federal Reserve Bank of New York. He explicitly states that price stability is the one sustainable contribution that monetary policy can make to economic growth. The whole idea here is that when prices are relatively constant over time, it leads to a highly efficient use of an economy's scarce resources. And to achieve this environment of perfect stability, Fed economists have famously established a target. You've probably heard of this. Inflation should sit right around 2%. Any significant deviation from this 2% line, well, that's seen as a major problem, a deviation from the ideal path of growth. So what happens if the yearly growth rate of the price level starts dropping below that mark? The central bank steps in. They embark on monetary inflation, basically pumping money into the economy to prop those prices back up and hit their target. But this brings us to the absolutely crucial question of our explainer today. When the central bank forcefully injects all this money just to maintain a baseline, what unseen damage is actually being done? We really want to look beyond just the surface level of stable prices to understand the true consequences of pumping money. Could this aggressive quest for stable prices actually be breaking the economy from the inside out? Here's our quick roadmap for today. We're going to break this counter-narrative down logically, step by step. First, the price stability goal, then how relative prices work, third, the consequences of pumping money, fourth, the illusion of stability, and finally, the boom-bust cycle. Let's move right into section one, the price stability goal and maintaining that baseline. As we established, central banks want to keep the purchasing power of money relatively constant. But to understand the critique of this goal, we have to understand the fundamental assumption holding it all up. The mainstream view essentially believes that changes in the money supply only have a macro effect on the general price level. In this way of thinking, if you increase the supply of money, it leads to a proportionate decline in the money's purchasing power, which means the general price level goes up. But and this is the absolutely key part, it supposedly leaves the relative prices of individual goods completely unaffected. They treat it like a neutral lever. You pump money in, all prices float up evenly together, and the underlying market structure just remains perfectly intact. Which brings us to section two, how relative prices work and listening to the consumer. So why do relative prices matter so much? Well because they're the ultimate communication tool between consumers and businesses. When a free market operates without interference, businesses rely on these relative prices to listen to what consumers actually want. Imagine a totally stable general price level. Suddenly the price of potatoes goes up by 2%, while the price of tomatoes stays exactly the same. What does that actually mean? For a business, this change in relative prices is a massive flashing green light. It signals a genuine, real shift in consumer demand toward potatoes. Because the general price level is stable, the business can easily identify this signal and confidently allocate their resources to grow and supply more potatoes. They are successfully listening to the consumer. Now let's look at section three, which is the absolute core focus of today's explainer. The consequences of pumping money and the unseen damage. The Austrian critique, as outlined by the Mises Institute, argues that the mainstream assumption we just talked about is fundamentally flawed. They map out a hidden chain reaction that happens when a central bank injects money to hit its target. Step one, the new money is injected into the system. Step two, this sets up an exchange of nothing for something. Think about it. New money was created out of thin air, but it's being used to buy real, tangible goods and services. Step three, this causes a forced redistribution. Wealth is actively diverted away from the individuals who don't receive this new money, or get it much later, straight into the pockets of the individuals and institutions who receive it first. And finally, step four, because of this wealth transfer, individuals' demands for goods change, which fundamentally alters the relative prices of those goods. The newly pumped money doesn't enter the economy evenly. It enters at specific points, heavily distorting those vital price signals we just talked about with the potatoes and tomatoes. Furthermore, there's a huge conceptual hurdle with the very idea of a general price level. We have to look at the purchasing power of money, or PPM. If you exchange one dollar for one loaf of bread, the purchasing power of that dollar is exactly one loaf of bread. If you exchange it for two tomatoes, its power is two tomatoes. But how do you mathematically combine those? You really can't just arithmetically add one loaf of bread and two tomatoes together to create a single, coherent aggregate total. It just doesn't work that way in the real world. So the crucial point is captured beautifully in this insight from economist Murray Rothbard. Because the general exchange value of money cannot actually be quantitatively defined or isolated in history, striving to mathematically stabilize it is inherently flawed. As the quote points out, if we don't know what a general aggregate price level actually is in real, physical terms, we can't very well act to keep it constant. Yet, this is exactly what central banks attempt to do every time they pump money into the system to hit their targets. Let's look at section 4, the illusion of stability, using the 1920s as a fascinating case study. To see how this builds into a real-world scenario, and to demonstrate how relying strictly on a general price index can set a really dangerous economic trap, we look at the period known as the Great Boom. From July 1921 to July 1929, the United States saw a massive monetary expansion. The money supply increased by $28 billion. That was a staggering 61.8% increase over just an 8-year period. It represented an average annual increase of 7.7%. By literally any standard, this was a very sizable degree of monetary inflation being pumped directly into the system. But while all that money was being aggressively pumped into the economy, what was actually happening to the general price level? Check this out. The wholesale price index stood at 93.4 in June 1921. It drifted up to 104.5 in 1925, and by June 1929, it had fallen back to 95.2. Prices were remarkably stable. But how is that even possible with a 61% increase in the money supply? Well, according to the Austrian analysis, the severe monetary inflation was completely offset by incredibly rapid increases in industrial productivity during the Roaring Twenties. Real economic growth was actively pulling prices down while the mass of money pumping was pushing them up. The result? A flatline that completely masked a brewing disaster. For Austrian economists like Rothbard, this flawlessly illustrates the danger of focusing solely on the price level. As he points out, the apparent stability of general prices during the 1920s basically convinced most economists that there was absolutely no inflationary threat. Because prices weren't skyrocketing, they thought the fundamentals were perfectly healthy. They completely ignored the massive consequences of the money pumping occurring right beneath the surface, and therefore, the catastrophic events of the Great Depression caught them completely unaware. Which brings us to the climax of this entire critique. If a stable price index can hide massive monetary inflation, and if pumping money actively distorts market signals and redistributes wealth behind the scenes, we really have to ask the hard question, does the artificial pursuit of price stability actually lead to economic instability? Let's wrap this all up in Section 5. So what is the ultimate consequence when a central bank continuously intervenes with the money supply and interest rates to maintain a rigid target? First, it falsifies market signals. Remember our potatoes and tomatoes? When new money enters the system, businesses can no longer tell if a price increase is a real shift in consumer demand or just the result of newly printed money sloshing around. Second, this interference actually undermines the wealth generation process by actively siphoning resources away from productive sectors. Third, these false signals create massive distortions within the structure of production, meaning businesses build factories for goods the consumers don't actually have the real savings to buy. And finally, it is these exact fluctuations in the money supply that ignite the destructive boom-bust cycle, regardless of whether the general price level looks perfectly flat and stable on a chart. So I want to leave you with this final, provocative thought. If the central bank's aggressive pursuit of price stability—the constant pumping of money into the system to maintain a numerical target—is exactly what falsifies market signals and actively creates the boom-bust cycle, is it time we fundamentally rethink how we measure economic health? It's a really heavy question, and it completely challenges the mainstream narrative we hear every single day. Thank you so much for joining me for this explainer, and I hope this gives you a powerful new lens through which to view monetary policy.