Milton Friedman on Inflation

From “Free to Choose”, chapter 9

Below are Milton Friedman’s five simple truths regarding inflation.

  1. Inflation is a monetary phenomenon arising from a more rapid increase in the quantity of money than in output (though, of course, the reasons for the increase in money may be various)
  2. In today’s world government determines – or can determine – the quantity of money
  3. There is only one cure for inflation: a slower rate of increase in the quantity of money
  4. It takes time – measured in years, not months – for inflation to develop; it takes time for inflation to be cured.
  5. Unpleasant side effects of the cure are unavoidable.

The United States has embarked on rising monetary growth four times during the past twenty years. Each time the higher monetary growth has been followed first by economic expansion, later by inflation. Each time the authorities have slowed monetary growth in order to stem inflation. Lower monetary growth has been followed by an inflationary recession. Later still, inflation has declined and the economy has improved. So far the sequence is identical with Japan’s experience from 1971 to 1975. Unfortunately, the crucial difference is that we have not displayed the patience Japan did by continuing monetary restraint long enough. Instead, we have overreacted to the recession by accelerating monetary growth, setting off on another round of inflation, and condemning ourselves to higher inflation plus higher unemployment.

We have been misled by a false dichotomy: inflation or unemployment. That option is an illusion. The real option is only whether we have higher unemployment as a result of higher inflation or as a temporary side effect of curing inflation.

In my view, we have and will have higher unemployment as a result of higher inflation. I think we are currently in the economic expansion from monetary growth. Based on comments earlier in the same chapter, increased monetary supply takes six to nine months to work its way through the system to increase economic growth and employment. Another 12 to 18 months elapse before the price level appreciates and inflation occurs or is speeded up.Given that a sharp increase in money supply started mid 2008, that would point to first quarter 2009 impact. This may be consistent with the above as we saw a market bottom in March 2009. So that would point to the end of the 1st quarter 2010 to the 2nd quarter 2010 to start seeing increased inflation.

Let’s see what happens.