FREE TO CHOOSE CHAPTER 9 THE CURE FOR INFLATION

I. INTRODUCTION Why do private persons in private transactions accept money? “The short answer is that each person accepts them because he is confident that others will. The pieces of green paper have value because everybody thinks they have value. Everybody thinks they have value because in his experience they have had value.” Value of money rests on a fiction However, money can do great damage when it gets out of order Is value really based on fiction? Discuss merits of this statement.

II. VARIETIES OF MONEY An amazing variety of items have been used as money One thing all had in common was acceptance “It remains as true now as it was then that a more rapid increase in the quantity of money than in the quantity of goods and services available for purchase will produce inflation, raising prices in terms of that money.”

III. THE PROXIMATE CAUSE OF INFLATION “Inflation is a disease, a dangerous and sometimes fatal disease, a disease that if not checked in time can destroy a society.” Inflation is “always and everywhere a monetary phenomenon” “Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation.” Widely held, but false, explanations of inflation: 1)Unions 2)Business 3)Imports/foreign countries 4)Low productivity 5)Supply shocks, i.e. oil Discuss merits of these explanations. Could they be partly to blame?

IV. WHY THE EXCESSIVE MONETARY GROWTH? US rapid monetary growth from about primarily due to: 1)Growth in gov’t spending 2)Gov’t full employment policy 3)Mistaken Fed policy Compare government and Fed actions from this period to Economic Crisis of 2008.

V. GOVERNMENT REVENUE FROM INFLATION John M. Keynes: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.” Sources of gov’t revenue from inflation: 1)The extra money printed is like a tax on money balances 2)Raising effective tax rates 3)Paying off part of the government’s debt

VI. THE CURE FOR INFLATION Cure is simple to state but hard to implement One and only cure- reduce the rate of monetary growth If inflation is advanced, cure takes a long time and has painful side effects Side effects: Lower growth, temporary high unemployment, initially not much reduction in inflation

VII. SIDE EFFECTS OF A CURE Slow growth and high unemployment are not cures, they’re side effects Why do side effects occur? “They occur because variable rates of monetary growth introduce static into the information transmitted by the price system, static that is translated into inappropriate responses by the economic actors, which it takes time to overcome.” On average, roughly six to nine months have elapsed before increased monetary growth has produced growth and employment Another 12 to 18 months have passed before inflation occurred Key point- all of these adjustments are started by changes in the rates of monetary growth and inflation

VIII. MITIGATING THE SIDE EFFECTS No example in history has shown anything other than slower growth and higher unemployment We can mitigate the effects though Most important: slow inflation gradually but steadily by a policy announced in advance Escalator clauses are another mitigating effect By how much do you think these factors could mitigate side effects?