44 THE BiG DROP
saver is worse off and the debtor is better off in both cases. But
confiscation is politically unacceptable, while inflation of 3%
per year is barely noticed. In effect, inflation is a hidden tax
used to transfer wealth from savers to debtors without causing
the political headaches of a real tax increase.
Why do central banks such as the Fed pursue money illu-
sion policies? The answer involves another academic theory
that doesn’t work in the real world. The Fed believes that
underwater debtors are from a lower income tier than sav-
ers and investors. This means the debtors have what’s called
higher marginal propensity to consume, or MPC.
The MPC measures how much you spend out of each dollar
of wealth you gain. If you gained $1,000 and decided to spend
$50, your MPC would be 5%. If you spent nothing after getting
an additional $1,000, your MPC would be 0%.
Academic theory says that poorer debtors have a higher
MPC than wealthier savers. This means that if inflation transfers
wealth from savers to debtors, total spending will go up because
the debtors will spend more of the money than the savers would
have. This is said to benefit debtors and savers, because debtors
gain from the increased wealth, while savers gain from more
overall spending in the form of jobs, business revenues and stock
prices. This makes inflation a win-win.
This theory sounds neat and tidy, but it has serious flaws.
By lumping all savers together, the theory fails to distinguish
between truly wealthy savers and middle-class savers. It may
be true that if you’re a very wealthy saver, you have a low
MPC. If you are spending a certain amount on vacations and
fine wine and the Fed steals some of your savings through
inflation, you will probably spend just as much on vacations
and fine wine.
But if you’re part of the middle class who is struggling with
an unemployed spouse, children’s tuition, elderly parents’
health care and higher property taxes, your savings and invest-