Free To Choose: a personal Statement

The Cure for Inflation
269
entered on the books of the Federal Reserve Bank correspond
to only part of the revenue that government gets from inflation.
Inflation also yields revenue indirectly by automatically raising
effective tax rates. As people's dollar incomes go up with inflation,
the income is pushed into higher brackets and taxed at a higher
rate. Corporate income is artificially inflated by inadequate allow-
ance for depreciation and other costs. On the average, if income
rises by 10 percent simply to match a 10 percent inflation, federal
tax revenue tends to go up by more than 15 percent—so the tax-
payer has to run faster and faster to stay in the same place. That
process has enabled the President, Congress, state governors and
legislatures to pose as tax cutters when all they have done is to
keep taxes from going up as much as they otherwise would have
gone up. Each year, there is talk of "cutting taxes." Yet there has
been no reduction in taxes. On the contrary, taxes correctly mea-
sured have gone up—at the federal level from 22 percent of na-
tional income in 1964 to 25 percent in 1978; at the state and local
level from 11 percent in 1964 to 15 percent in 1978.
Still a third way inflation yields revenue to the government is
by paying off—or repudiating, if you will—part of the govern-
ment's debt. Government borrows in dollars and pays back in
dollars. But thanks to inflation, the dollars it pays back can buy
less than the dollars it borrowed. That would not be a net gain to
the government if in the interim it had paid a high enough interest
rate on the debt to compensate the lender for inflation. But for the
most part it did not. Savings bonds are the clearest example. Sup-
pose you had bought a savings bond in December 1968, had held
it to December 1978, and then cashed it in. You would have
paid $37.50 in 1968 for a ten-year bond with a face value of $50
and you would have received $64.74 when you cashed it in 1978
(because the government raised the interest rate in the interim to
make some allowance for inflation). By 1978 it took $70 to buy as
much as $37.50 would have bought in 1968. Yet not only would
you have gotten back only $64.74, you would have had to pay
income tax on the $27.24 difference between what you received
and what you paid. You would have ended up paying for the
dubious privilege of lending to your government.
Paying off the debt by inflation has meant that although the

---

270
FREE TO CHOOSE: A Personal Statement
federal government has run large deficits year after year and its
debt in terms of dollars has gone up, the debt has gone up far less
in terms of purchasing power and has actually fallen as a per-
centage of the national income. In the decade from 1968 through
1978, the federal government had a cumulative deficit of more
than $260 billion, yet the debt amounted to 30 percent of na-
tional income in 1968, to 28 percent in 1978.
THE CURE FOR INFLATION
The cure for inflation is simple to state but hard to implement.
Just as an excessive increase in the quantity of money is the one
and only important cause of inflation, so a reduction in the rate
of monetary growth is the one and only cure for inflation. The
problem is not one of knowing what to do. That is easy enough.
Government must increase the quantity of money less rapidly. The
problem is to have the political will to take the measures neces-
sary. Once the inflationary disease is in an advanced state, the
cure takes a long time and has painful side effects.
Two medical analogies suggest the problem. One is about a
young man who had Buerger's disease, a disease that interrupts
the blood supply and can lead to gangrene. The young man was
losing fingers and toes. The cure was simple to state: stop smoking.
The young man did not have the will to do so; his addiction to
tobacco was simply too great. His disease was in one sense curable,
in another not.
A more instructive analogy is between inflation and alcoholism.
When the alcoholic starts drinking, the good effects come first;
the bad effects only come the next morning when he wakes up
with a hangover—and often cannot resist easing the hangover by
taking "the hair of the dog that bit him."
The parallel with inflation is exact. When a country starts on an
inflationary episode, the initial effects seem good. The increased
quantity of money enables whoever has access to it—nowadays,
primarily governments—to spend more without anybody else
having to spend less. Jobs become more plentiful, business is brisk,
almost everybody is happy—at first. Those are the good effects.
But then the increased spending starts to raise prices; workers
find that their wages, even if higher in dollars, will buy less; busi-

---