Free To Choose: a personal Statement

The Cure for Inflation
273
As inflation accelerates, however, sooner or later it does so
much damage to the fabric of society, creates so much injustice
and suffering, that a real public will develops to do something
about inflation. The level of inflation at which that occurs de-
pends critically on the country in question and its history. In
Germany it came at a low level of inflation because of Germany's
terrible experiences after World War I and II; it came at a much
higher level of inflation in the United Kingdom and Japan; it has
not yet come in the United States.
SIDE EFFECTS OF A CURE
We read over and over again that higher unemployment and
slow growth are cures for inflation, that the alternatives we must
face are more inflation or higher unemployment, that the powers
that be are reconciled to, or are positively promoting, slower
growth and higher unemployment in order to cure inflation. Yet
over the past several decades, the growth of the U.S. economy
has slowed, the average level of unemployment has risen, and at
the same time, the rate of inflation has moved higher and higher.
We have had both more inflation and more unemployment. Other
countries have had the same experience. How come?
The answer is that slow growth and high unemployment are
not cures for inflation. They are side effects of a successful cure.
Many policies that impede economic growth and add to unem-
ployment may, at the same time, increase the rate of inflation.
That has been true of some of the policies we have adopted—
sporadic price and wage control, increasing government inter-
vention into business, all accompanied by higher and higher gov-
ernment spending, and a rapid increase in the quantity of money.
Another medical example will perhaps make clear the differ-
ence between
a
cure and
a
side effect. You have acute appendi-
citis. Your physician recommends an appendectomy but warns
you that after the operation you will be confined to bed for an
interval. You refuse the operation but take to your bed for the
indicated interval as a less painful cure. Silly, yes, but faithful in
every detail to the confusion between unemployment as a side
effect and as a cure.

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274
FREE TO CHOOSE: A Personal Statement
The side effects of a cure for inflation are painful so it is
i mportant to understand why they occur and to seek means to
mitigate them. The basic reason why the side effects occur has
already been pointed out in Chapter 1. They occur because
variable rates of monetary growth introduce static into the infor-
mation transmitted by the price system, static that is translated
into inappropriate responses by the economic actors, which it
takes time to overcome.
Consider, first, what happens when inflationary monetary
growth starts. The higher spending financed by the newly created
money is no different to the seller of goods or labor or other
services from any other spending. The seller of pencils, for exam-
ple, finds that he can sell more pencils at the former price. He
does so initially without changing his price. He orders more pen-
cils from the wholesaler, the wholesaler from the manufacturer,
and so on down the line. lf the demand for pencils had increased
at the expense of some other segment of demand, say at the ex-
pense of the demand for ball-point pens, rather than as a result
of inflationary monetary growth, the increased flow of orders down
the pencil channel would be accompanied by a decreased flow
down the ball-point pen channel. Pencils and later the materials
used to make them would tend to rise in price; pens and the ma-
terials used to make them would tend to fall in price; but there
would be no reason for prices on the average to change.
The situation is wholly different when the increased demand
for pencils has its origin in newly created money. The demand
for pencils and pens and most other things can then go up si-
multaneously. There is more spending (in dollars) in total. How-
ever, the seller of pencils does not know this. He proceeds as
before, initially holding the price at which he sells constant, con-
tent to sell more until, as he believes, he will be able to restock.
But now the increased flow of orders down the pencil channel is
accompanied by an increased flow down the pen channel, and
down many other channels. As the increased flow of orders gen-
erates a greater demand for labor and materials to produce more,
the initial reaction of workers and producers of materials will be
like that of the retailers—to work longer and produce more and
also charge more in the belief that the demand for what they have

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