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Question:
Econoland finances government expeditures with an inflation tax.
a) Explain who pays the tax and how it is paid.
b) What are the costs from this tax?
Answer:
Inflation is caused by printing more money. The government's monetary policies are responsible for this. Keynesian spending policies and ideology and the abolishment of the gold standard have permitted the government to depreciate our currency.
The answer is to eradicate state control of the money supply. We need to divest government of its power to arbitrarily increase or decrease the money supply. In addition, we must build in pressures toward fiscal responsibility by the government with respect to the production of balanced budgets and reduction of debt. The federal government must learn to live within its means – government deficits must be prevented. The establishment of the gold standard will stifle the hidden and deceptive tax of inflation. Inflation could be controlled if government were not able to monetize debt or manipulate reserve requirements.
Defining inflation
Money is a commodity the value of which stems from its usefulness as a medium of exchange. The best money is the one developed through the market system. Since barter has obvious limitations, one commodity (e.g., gold) arises as easier to trade and more useful as a medium of exchange. Exchange rates (i.e., prices) are established between this one commodity and each of the other goods. Historically and pragmatically, a commodity's ability to function as money has been transferred to money substitutes (e.g., the dollar). Honest money is fully backed by commodities like gold.
Inflation, a monetary phenomenon, is an increase in money and credit. Its major consequence is rising prices. Inflation occurs when the economy's aggregate volume of money expenditures grows at a faster rate than its total real output grows. Inflation is thus an increase in the supply of money without a corresponding increase in the supply of goods and services.
Inflation consists of expanding a nation's money supply by adding something other than real money (e.g., gold). Such fiat money, backed only by government decree, produces inflation. If the quantity of money is increased, the purchasing power of the monetary unit declines and the quantity of goods and services that can be purchased for one unit of this money also decreases. When government expands the quantity of paper money, the purchasing power of the monetary unit drops and prices rise. After the new money has been added to the economy, the total wealth produced is not any greater than it was previously. With added money now being spent, but with no additional goods and services to spend it on, prices will rise. In the U.S., it is only the federal government and government recognized banks that can print money and/or create new dollar credit.
