I’m afraid that Mr Tamny has already missed the boat on this one. Although inflation is a monetary phenomenon the idea that it will never emerge so long as “the central bank matches currency supply with currency demand” is a dangerous fallacy, one that is responsible for the boom-bust cycle.

The great error that Tamny and so many others have fallen prey to is the one that assumes money is neutral. According to this view monetary expansion only influences the price level, leaving the relationship between individual prices unchanged. But this is impossible. Money enters the economy at various points, from which it ripples out and affects different prices at different rates.

If, for instance, newly created money was given only to eager house buyers in the form of easy credit, the demand for houses would rise, as would their prices, long before the prices of other goods felt the monetary pressure.

The same thing happens in business when the Fed forces interest rates down below their market rates. These lower rates deceive businessmen into thinking there is more capital available than actually exists. They therefore undertake additional investment projects in anticipation that the complementary capital goods will be available. However, shortages and bottlenecks eventually emerge and the prices of inputs rise as the additional demand for capital goods is frustrated.

This phenomenon was well known in the first half of the nineteenth century. It was also noted that rising prices made themselves first felt in the higher stages of production and not the point of consumption.

The historical evidence therefore makes it patently clear that money is not neutral. While history provides the evidence sound economic reasoning supplies the explanation. Nevertheless, both are still completely ignored by the economic commentariat. I sometimes wonder if this is because if they acknowledge the fact that money is not neutral then the whole case for manipulating interest rates and the money supply will collapse.

Tamny concludes that “The Fed must continue to monitor the dollar’s value and not allow the arrival of low-cost goods to distort its judgment”. But the value of money is determined by the supply and demand for money. This means that if the supply of money was held constant in a progressing economy then prices would gently decline as productivity steadily rose. In other words, the value of money would rise because increasing productivity raises the demand for money and hence its value.

But Mr Tamny would have it that this is an unhealthy situation that has to be avoided through a price stability policy that will hold the price level steady. However, as money is not neutral, the effect of Tamny’s policy would be to destabilise the economy by distorting prices and production.

Gerard Jackson is Brookes’ economics editor

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