The Cure for lnflation
265
by increasing the quantity of money. As we noted in Chapter 3,
the U.S. government can do that by having the U.S. Treasury—
one branch of the government—sell bonds to the Federal Reserve
System—another branch of the government. The Federal Reserve
pays for the bonds either with freshly printed Federal Reserve
Notes or by entering a deposit on its books to the credit of the
U.S. Treasury. The Treasury can then pay its bills with either the
cash or a check drawn on its account at the Fed. When the addi-
tional high-powered money is deposited in commercial banks by
its initial recipients, it serves as reserves for them and as the basis
for a much larger addition to the quantity of money.
Financing government spending by increasing the quantity of
money is often extremely attractive
to both the President and
members of Congress. It enables them to increase government
spending, providing goodies for their constituents, without having
to vote for taxes to pay for them, and without having to borrow
from the public.
A second source of higher monetary growth in the United
States in recent years has been the attempt to produce full em-
ployment. The objective, as for so many government programs,
is admirable, but the results have not been. "Full employment"
is a much more complex and ambiguous concept than it appears
to be on the surface. In a dynamic world,
in which new products
emerge and old ones disappear, demand shifts from one product
to another, innovation alters methods of production, and so on
without end, it is desirable to have a good deal of labor mobility.
People change from one job to another and often are idle for a
ti me in between. Some people leave a job they do not like before
they have found another. Young people entering the labor force
take time to find jobs and experiment with different kinds of jobs.
In addition, obstacles to the free operation of the labor market—
trade union restrictions, minimum wages, and the like—increase
the difficulty of matching worker and job. Under these circum-
stances, what average number of persons
employed corresponds to
full employment?
As with spending and taxes, there is here, too, an asymmetry.
Measures that can be represented as adding to employment are
politically attractive. Measures that can be represented as adding
266
FREE TO CHOOSE: A Personal Statement
to unemployment are politically unattractive. The result is to
i mpart a bias to government policy in the direction of adopting
unduly ambitious targets of full employment.
The relation to inflation is twofold. First, government spending
can be represented as adding to employment, government taxes
as adding to unemployment by reducing private spending. Hence,
the full employment policy reinforces the tendency for govern-
ment to increase
spending and lower taxes, and to finance any
resulting deficit by increasing the quantity of money rather than
by taxes or borrowing from the public. Second, the Federal Re-
serve System can increase the quantity of money in ways other
than financing government spending. It can do so by buying out-
standing government bonds, paying for them with newly created
high-powered money. That enables the banks to make a larger
volume of private loans, which can also be represented as adding
to employment. Under pressure to promote full employment, the
Fed's monetary policy has had the same
inflationary bias as the
government's fiscal policy.
These policies have not succeeded in producing full employ-
ment but they have produced inflation. As Prime Minister James
Callaghan put it in a courageous talk to a British Labour party
conference in September 1976: "We used to think that you could
just spend your way out of a recession and increase employment
by cutting taxes and boosting government spending. I tell you,
in all candor, that that option no longer exists; and that insofar
as it ever did exist, it only worked by injecting bigger doses of
inflation into the economy followed by
higher levels of unemploy-
ment as the next step. That is the history of the past twenty years."
The third source of higher monetary growth in the United
States in recent years has been a mistaken policy by the Federal
Reserve System. Not only has the Fed's policy had an inflationary
bias because of pressures to promote full employment, but that
bias has been exacerbated by its attempt to pursue two incom-
patible objectives. The Fed has the power to control the quantity
of money and it gives lip service to that objective. But like
Demetrius in Shakespeare's
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