New Zealand’s finance minister recently made a hilariously quaint argument against a proposed taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cut plan—it might boost demand and unleash a bout of old fashioned Keynesian “demand pull” inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. .
Apparently Dr. Cullen hasn’t kept abreast of developments in monetary economics over, say, the last two decades, in which the notion that inflation is caused by anything other than excessive growth in the money supply has been rightfully tossed on the ash heap of history.
Thankfully, New Zealand’s National Business Review steps in to offer a lesson:
ShareTo any serious economist, this argument [that tax cuts cause inflation] is an embarrassment…
Dr Cullen has described himself as “an old-fashioned Keynesian”. Economists then were taught that the causes of inflation were ‘cost push’ or ‘demand pull’…
But how realistic is this model? The answer is, not very…
Inflation is a monetary phenomenon, as Milton Friedman demonstrated in his attack on Keynesian economics. Only central banks can generate inflation by printing money. The widespread acceptance of Friedman’s argument has led the main central banks of the world to target inflation and reduce it to low levels since the 1980s.
Non-monetary theories of inflation based on ‘demand-pull’ ideas have fallen by the wayside. They were discredited by the stagflation of the 1970s.
The reality is that there is scarcely any relationship between the state of the government’s budget and inflation in an open economy with a floating exchange rate. This conclusion is well established in the economic literature.