Econ 101 with Stephen Poloz

Also available at mises.ca

On June 19th, Stephen Poloz gave his first major speech as Governor of the Bank of Canada. Reading through it, it’s clear that Poloz – like his predecessor – has no real understanding of economics. So I’ve decided to pick apart a couple paragraphs and give Poloz (or anyone else who may be reading) a short, rudimentary introduction to sound economics.




Poloz said,

What happens to business in Canada matters for the Bank of Canada. Not just because we care – which, let me assure you, we do. But in order for us to do our job properly, in order for us to promote the economic and financial welfare of Canadians, we need to understand all the dynamics that feed into the Canadian economy.

Well then, let’s discuss dynamics. I’ll be approaching this subject from an “Austrian” perspective simply because this is the only “school” describing the economic reality. While Keynesianism (a favourite among central bankers) tends to approach economics as a mathematical discipline, the Austrian school is a deductive method that begins with irrefutably true axioms such as: only individuals act. The Austrian school of economics is not a “free-market” school nor are the various institutes acting as policy think-tanks for governments. Austrian economics is not ideological. It is a series of analytical claims about how people act. Austrians strive to understand the role of exchange and how individuals, groups and the rules condition to those exchanges.
 
For example, when people exchange goods they are doing so because they believe they will be better off afterward. This follows from the premise that cost and value are subjective. Value cannot be objectively measured, only individuals determine the costs of their actions. While all economists discuss opportunity costs, only Austrians emphasize that this cost is subjective and – to a certain extent – expected.
 
Through exchange, prices arise as to determine the costs of action. Therefore, prices are knowledge surrogates. The price system conveys knowledge to entrepreneurs and consumers that can only come into existence when people freely exchange. When a natural resource becomes scarce, people will use less of it. How? Through the price system! The owners of the resource economize on their use, which then "ripples" through the production structure eventually leading to higher prices for entrepreneurs and consumers. Higher prices tell us that good x is more scarce and thus incentives us to economize on it precisely because it is more expensive.
 
Prices inform us on people’s changing preferences, knowledge and a change in natural resources. But the price system can only work if private property is sacrosanct. In order for prices to be meaningful signals, they have to be the result of individuals freely exchanging their own property. In fact, the only way exchange can even be fathomable is if people are free to own property. For without property, what are people exchanging?
 
This is particularly true in the means of production, or capital inputs. Capital, of course, being a concept Keynesians like Poloz and his predecessor Mark Carney have trouble grasping. Without market means of production, prices for capital goods remain unknown and thus these goods cannot be allocated in any efficient manner. Without prices, there’s no indicator as to how scarce these resources actually are.
 
Markets, then, are a form spontaneous order – a result of human action but not design. No one invented the market and nobody is in charge of it or can control it. Markets are an evolutionary process that work when human beings, free to own property, begin exchanging. Because markets are spontaneous order, it is a fatal conceit to believe that one can control or regulate the processes. But Poloz disregards this warning. He says,

The Bank of Canada aims to keep inflation low, stable and predictable. Our flexible inflation-targeting framework is the best contribution monetary policy can make so that Canadian households and businesses can make decisions about their financial futures with confidence….

This is wrong on so many levels. First off, let’s define inflation. Poloz defines it as an increase of prices as determined by the CPI. The CPI (Consumer Price Index) is a basket of goods (minus food and energy) determined by the central bank. The bias is obvious. Increases in prices (including food and energy) are not the cause of inflation but an effect. The cause of inflation is the Bank of Canada producing more money than people wish to hold. When people find themselves with more money they have an incentive to spend, especially when the purchasing power of the money dwindles over time. Spending this money causes prices to rise, but this is not the cause of inflation. Spending is the result; the cause is excess money creation.
 
Also, this money doesn’t enter everyone’s bank account equally. Some people get it before others so prices increase in a haphazard way. Since entrepreneurs depend on prices, the price system begins to disintegrate as a knowledge surrogate. Prices allow entrepreneurs to make decisions without knowing complete information on scarcity or people’s underlying preferences. Prices are guides on how to best allocate resources. When the central bank increases the money supply, prices lose their ability to communicate this knowledge to entrepreneurs.
 
Therefore inflation results in an inefficient allocation of resources. Entrepreneurs don’t know if they are following real price signals or the disturbance caused by inflation. By undermining the market, people look to the government as a way to increase their wealth. Because markets are causing confusion and inefficiencies (due to inflation), the government enlarges its role for allocating resources. The problem is, governments cannot calculate and politicians and bureaucrats are self-interested individuals. Overtime, inflation will undermine the entire market order and result in a 100% planned economy.
 
Trade is a civilizing process; “planned” economies always result in totalitarian governments. Inflation undermines the base for human social cooperation and will ultimately destroy the social order. I don’t think Stephen Poloz wants this. He finished his speech with,

To help nurture confidence, an active engagement with Canadians must remain a cornerstone of the policy of the Bank of Canada. So thank you for being here today. I’m keen to hear your views, and I would be pleased to take your questions.

Yes, I have a question. When will you take time to read Human Action?