Inflation Causes Misallocation of Production

The spike in car buying has caused automakers to ramp up production (via John Stossel):

Many auto industry analysts and dealers expect sales volumes to fall now that the program is over. They worry that many people who took advantage of the program were merely accelerating purchases they would have made later in the year.

If that’s true, the premature sales could hurt automakers, which increased production in the third quarter to replenish clunker-depleted inventories that had already grown low because of factory shutdowns over the summer.

Cash for Clunkers is essentially an inflationary policy. This is a policy well described by Adam Smith Milton Friedman, with the exact same consequence:

In a dynamic world demands are always shifting, some prices going up, some going down. The general signal of increasing demand will be confused with the specific signals reflecting changes in relative demands. That is why the initial side of faster monetary growth is an appearance of prosperity and greater employment. But sooner or later the signal will get through.

As it does, workers, manufacturers, retailers will discover that they have been fooled. They reacted to higher demand for the small number of things they sell in the mistaken belief that the higher demand was special to them and hence would not much affect the prices of the many things they buy.

The government has arbitrarily and falsely increased demand for a specific good (new cars). They’ve done so by throwing money at it (a locally inflationary policy) and the automakers are ramping up production in response to what they THINK is a more stable recovery. But they may soon find, as Adam Smith Friedman predicted, that they have been fooled.

  • Peter

    This is exactly what we have been saying on this site ever since the program was announced. I just wish the politicians would think these things through before ramming them down our collective throats.

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  • Ben

    You mean Milton Friedman?

  • Brad Warbiany


    Thanks for catching that. Trying to find that quote, I first thought it was Smith, couldn’t find it on Google, then looked it up under Henry Hazlitt, same problem, before finally remembering it was a Friedman quote — then promptly forgot all of that when attributing it in the post.

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  • VRB

    So the car companies will shut production down again and lay off the workers they hired back. To the “just in time” inventory and robots it will not mean a thing; to the worker, it will be three or four months more of work. I don’t even see how that quote applies.

  • Suzie Orman

    According to my point of view in a dynamic world demands are always shifting, some prices going up, some going down. As problem, before finally remembering it was a Friedman quote.