Free To Choose: a personal Statement

part because of the smoke screen with which governments try to
conceal their own responsibility for inflation.
If the quantity of goods and services available for purchase—
output, for short—were to increase as rapidly as the quantity of
money, prices would tend to be stable. Prices might even fall
gradually as higher incomes led people to want to hold a larger
fraction of their wealth in the form of money. 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. There is probably
no other proposition in economics that is as well established as this
one.

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The Cure for lnflation
255
Output is limited by the physical and human resources avail-
able and by the improvement in knowledge and capacity to use
them. At best, output can grow only fairly slowly. Over the past
century, output in the United States grew at the average rate of
about 3 percent per year. Even at the height of the rapid growth
of Japan after World War II, output grew about 10 percent per
year. The quantity of commodity money is subject to similar
physical limits, though, as the examples of tobacco, precious
metals from the New World, and gold in the nineteenth century
illustrate, commodity money has at times grown far more rapidly
than output in general. Modern forms of money—paper and
bookkeeping entries—are subject to no physical limits. The
nominal quantity, that is, the number of dollars, pounds, marks,
or other monetary units, can grow at any rate, and at times has
grown at fantastic rates.
During the German hyperinflation after World War I, for ex-
ample, hand-to-hand money grew at the average rate of more than
300 percent a month for more than a year, and so did prices.
During the Hungarian hyperinflation after World War II, hand-
to-hand money rose at the average rate of more than 12,000 per-
cent per month for a year, and prices at the even higher rate of
nearly 20,000 percent a month.''
During the far more moderate inflation in the United States
from 1969 to 1979, the quantity of money rose at the average
rate of 9 percent per year and prices at the average rate of 7 per-
cent per year. The difference of two percentage points reflects
the 2.8 percent average rate of growth of output over the same
decade.
As these examples show, what happens to the quantity of
money tends to dwarf what happens to output; hence our refer-
ence to inflation as a monetary phenomenon, without adding any
qualification about output. These examples also show that there
is not a precise one-to-one correspondence between the rate of
monetary growth and the rate of inflation. However, to our
knowledge there is no example in history of a substantial infla-
tion that lasted for more than a brief time that was not accom-
panied by a roughly correspondingly rapid increase in the quantity
of money; and no example of a rapid increase in the quantity of

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256
FREE TO CHOOSE: A Personal Statement
money that was not accompanied by a roughly correspondingly
substantial inflation.
A few charts (Figures 1—5) show the persistence of this relation
in recent years. The solid line on each chart is the quantity of
money per unit of output for the country in question, year by year
from 1964 through 1977. The other line is the consumer price
index. In order to make the two series comparable, both have been
expressed as percentages of their average values over the period as
a whole (1964—1977 = 100 for both lines). The two lines neces-
sarily have the same average level, but there is nothing in the
arithmetic that requires the two lines to be the same for any single
year.
The two lines for the United States on Figure 1 are almost in-
distinguishable. As the remaining figures show, that is not special
to the United States. Though the two lines differ more for some
of the other countries than they do for the United States, for
every country the two lines are remarkably similar. The different
countries experienced very different rates of monetary growth.
In every case, that difference was matched by a different rate of
inflation. Brazil is the most extreme (Figure 5). It experienced
more rapid monetary growth than any of the others, and also more
rapid inflation.
Which causes which? Does the quantity of money grow rapidly
because prices increase rapidly, or vice versa? One clue is that
on most of the charts the number plotted for the quantity of
money is for a year ending six months
earlier
than the year to
which the matching price index corresponds. More decisive evi-
dence is provided by examination of the institutional arrange-
ments that determine the quantity of money in these countries and
by a large number of historical episodes in which it is crystal clear
which is cause and which is effect.
One dramatic example comes from the American Civil War.
The South financed the war largely by the printing press, in the
process producing an inflation that averaged 10 percent a month
from October 1861 to March 1864. In an attempt to stem the
inflation, the Confederacy enacted a monetary reform: "In May,
1864, the currency reform took hold, and the stock
of
money was
reduced. Dramatically, the general price index dropped . . . in

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1964-1977
-100