Two lesser known variables in the inflation equation
Two lesser known economic concerns among those who know of them, are possible differences in how we perceive the value of money depending on how it was received, and how quickly it is spent.
The Value of Free Money
There is a popular conception that when we are given money without “earning” it, we don’t value it as highly. Because of this, the logic goes that if people are given basic incomes, they will be more likely to just throw it all away because it just won’t have the same value to them as money they earned in exchange for their labor due to it being unearned.
The concern then is this will cause prices to rise because people will be just fine paying $8 for milk instead of $4, because they didn’t actually earn the extra $4 required to buy $8 milk.
“… the value of the basic income effects no change on the ratio of allocation of income, but merely raises expendable income by the expected amount of the basic income, and, therefore, that there is no theoretical shift in consumption preferences, but merely a shift upwards in the utility maximizing consumption bundle. What has happened, in simple microeconomic terms, is a simple price and substitution shift a la Slutksy…”
Translation: People treat basic income just like the rest of their income, and this is again further backed by the Alaskan PFD, where the spending by Alaskan residents of their “unearned” dividends supports this permanent income hypothesis with observed behavior.
“Net of federal income taxes, about one-third of dividend income went to saving and debt reduction. The majority went to day-to-day expenses, and about 10 to 15 percent went to special large purchases. However, when asked what was the most significant effect of the dividend on their consumption behavior, most respondents said it had little or no effect, or that it helped with regular expenses.”
Does this sound like people throwing their money away?
This is not to say there aren’t any differences whatsoever between earned and unearned income. The differences more recently found however, may just surprise you as much as it did the researchers.
Using surveys of lottery winners, we analyse the effects of unearned income on the well-known Big Five personality traits. After correcting for potential endogeneity problems associated with the size of lottery prizes, we find that unearned income improves traits that predict pro-social and cooperative behaviours, preferences for social contact, empathy, and gregariousness, as well as reduce individuals’ tendency to experience negative emotional states; all of which are known in the economics literature as incentive-enhancing personality traits.
Our results suggest that economists may need to revise their standard conceptual apparatus and come to accept that there may be scope for later intervention to improve the personality traits of adults after all.
So it appears that unearned income (of amounts less than $280,000 per year) is different than earned income after all, but instead of our perceiving it differently, it makes us perceive differently. And these effects, because they are all valued by employers, can lead to an improved workforce.
Unearned income makes people more social, more empathetic, more gregarious, and less neurotic.
The Velocity of Money
In any given year, money changes hands at a certain rate. This is referred to as money velocity. When an economy is healthy, people exchange a single dollar over and over again. A dollar buys groceries, is given to a cashier as income, is spent by the cashier at a hair salon, is spent by the stylist at a movie theater, and on and on the dollar goes, facilitating exchanges in the market.
So, velocity can be up.
Now imagine an unhealthy economy. There is little buying of haircuts and movies, just groceries. In this economy, the same amount of money exists as in the healthy economy, but no one aside from those with large incomes are really spending it. It’s mostly just sitting idle somewhere, unused.
So, velocity can be down.
Which economy do we have?
Our velocity as measured by the St. Louis adjusted monetary base is lower than it’s ever been recorded, in U.S. history. We are exchanging our dollars in our money supply more slowly than even during the Great Depression.
The reason this is important to understand is that there is another fear increasing velocity will lead to higher prices because of an equation known to economists as the equation of exchange, and that therefore a basic income would be a bad idea, because it would allow people to exchange dollars with a greater frequency. This would then lead to higher prices, and higher prices raise fears of runaway prices and 1920's Germany.
Now look again at the above chart. Even if prices rose because velocity rose, does this outcome seem like something we in no way want? Are we so afraid of higher prices that we don’t want people actually exchanging money for goods and services more frequently than during or immediately following the Great Depression?
Don’t we instead want some kind of middle ground?
Well that’s not fair to use the adjusted monetary base of the money supply, some economists might say. It’d be much better to use a smaller measure called M1, because it looks only at actual money and not all the imaginary money out there. Fair enough, let’s look at M1.
The velocity of M1 has been crashing since 2007, with no end in sight.
Meanwhile, prices need not even rise if the money supply is simultaneously reduced, again because of the equation of exchange. This is one of the tools in our economic toolbox. Additionally, interest rates can also be raised to supply a brake to slow velocity. Different forms of taxes can be raised or lowered accordingly as well.
We have powerful tools for both increasing and decreasing inflation.
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