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The phenomenon of inflation is still puzzling, isn't it? The "common sense" theory (that flush of money diminishes value of money tokens with respect to existing goods) implies a closed-market mechanism. A larger amount of money, especially if it comes from higher wages, leads to more intense consumer competition and hence to higher prices - or so they say.

Yet I do not see this mechanism working consistently. Say, take the Baltic countries: they experienced a credit boom in this decade, which increased their nominal wealth and monetary volume enormously - yet the prices did not rose at the height of the boom. Consumers were never more potent then, as realistic worries of debt return were non-existent. Why did entrepreneurs did not raise prices then?

Inflation did rose there on the last months of the boom, when indeed wages started to raise. But how did entrepreneurs reacted so fast to presumably more potent consumer demand? I do not see how consumers had a chance to clash "competitively" so fast. Rather, a much simpler explanation is that entrepreneurs "routinely" included raising costs (of higher wages) into the higher prices, trying to keep their profit share.

If you look at the Weimar Republic, the outside pressure of investors (with utmost skepticism regarding war debts and reparations) was clearly a factor. In a closed economy, the Germans could just as well use Worgl type currency. In contrast, the Nazi Germany largely bypassed control of international financial system and issued "very strange" paper money quite liberally - with remarkable (though inconvenient, controversial?) economic results at the times of Great Depression.

I even speculate that the Spanish inflation (after they got their mountains of silver and gold, as I mentioned) was wishfully fueled by the other financial powers that could not recognize such a large gap in monetary power. The strong money-as-credit association is very much Anglo-Saxan innovation.

by das monde on Wed Sep 2nd, 2009 at 07:13:31 AM EST

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