Abstract:
An economic similarity between two economies is defined, which is a correspondence between the futures of two economies in which all, or a certain subset of all acts of production and consumption, are the same. Prices and inflation can be different in similar economies so an economic similarity is the ideal tool for studying inflation and for expressing monetary neutrality, as one aspect of money. A formula for an economic similarity from an arbitrary economy to an economy with a different rate of inflation is stated and proved. An economic similarity is used to formulate and prove a rigorous expression of the quantity theory of money and a different economic similarity is used to elucidate how raising interest rates reduces inflation. The distortion of economic activity caused by raising interest rates to control inflation is identified and quantified. A strategy for managing inflation that avoids distortion of economic activity by focusing on loan repayments rather than on interest rates is identified. The existence of a “painless” inflation management strategy, which adjusts repayment rates as well as interest rates, is deduced by means of the more precise understanding of the neutrality aspect of money that is obtained through economic similarity. Although it is unexpected to discover a purely “technical” mechanism for managing inflation, the theoretical justification, provided through economic similarity, is strong. The practical implications of such a mechanism are considerable.
