How Monetary Expansion Creates Income And Wealth Inequality

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“Every change in the money relation alters … the conditions of the individual members of society. Some become richer, some poorer.” – Mises, Human Action, p. 414.

New money enters the economy at a particular point. It does not enter in the form of a proportional and simultaneous increase in everybody’s incomes. This means that there are uneven effects of monetary expansion, including exacerbated income and wealth inequality. When we trace the consequences of monetary expansion, we notice that it creates winners and losers as resources are shifted toward the first receivers and spenders of new money.

This idea is an old one. It goes back to Richard Cantillon, who in the mid-eighteenth century outlined the step-by-step process that new money works its way into an economy, causing some prices and incomes to rise before others. Rothbard summarized these “Cantillon effects” in his history of economic thought text:

In short, the early receivers of the new money will increase spending according to their preferences, raising prices in these goods, at the expense of a lower standard of living among the late receivers of the new money, or among those on fixed incomes who don't receive the new money at all. Furthermore, relative prices will be changed in the course of the general price rise, since the increased spending is "directed more or less to certain kinds of products or merchandise according to the idea of those who acquire the money, [and] market prices will rise more for certain things than for others…". Moreover, the overall price rise will not necessarily be proportionate to the increase in the supply of money. Specifically, since those who receive new money will scarcely do so in the same proportion as their previous cash balances, their demands, and hence prices, will not all rise to the same degree. Thus, "in England the price of Meat might be tripled while the price of Corn rises no more than a fourth."

The Gini ratio, one of the more popular measures of income inequality, showcases the effects of an unrestrained central bank. A ratio closer to one indicates more income inequality; a ratio of zero means complete income equality. The graph below shows that the trend in inequality measured by the Gini ratio changed when the US completely went off the gold standard. Since 1971, the central bank has not been constrained by physical gold at all.

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How New Money Is Created

In our modern fractional reserve banking system with an active central bank and profligate federal government, monetary inflation is a given. In the US, money originates as bank reserves created by the Federal Reserve to pay for US government debt or other assets from commercial banks. Commercial banks can then use these reserves as a basis for multiplying deposits in the form of extending new loans.

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