Free To Choose: a personal Statement

The Cure for lnflation
275
been providing has gone up. But this time there is no offset, there
are no declines in demand roughly matching the increases in de-
mand, no declines in prices matching the increases. Of course, this
will not at first be obvious. In a dynamic world demands are al-
ways shifting, some prices going up, some going down. The gen-
eral signal of increasing demand will be confused with the specific
signals reflecting changes in relative demands. That is why the
initial side effect of faster monetary growth is an appearance of
prosperity and greater employment. But sooner or later the signal
will get through.
As it does, workers, manufacturers, retailers will discover that
they have been fooled. They reacted to higher demand for the
small number of things they sell in the mistaken belief that the
higher demand was special to them and hence would not much
affect the prices of the many things they buy. When they discover
their mistake, they raise wages and prices still higher—not only
to respond to higher demand but also to allow for the rises in the
prices of the things they buy. We are off on a price-wage spiral
that is itself an effect of inflation, not a cause. If monetary growth
does not speed up further, the initial stimulus to employment and
output will be replaced by the opposite; both will tend to go down
in response to the higher wages and prices. A hangover will suc-
ceed the initial euphoria.
It takes time for these reactions to occur. On the average over
the past century and more in the United States, the United
Kingdom, and some other Western countries, roughly six to
nine months have elapsed before increased monetary growth has
worked its way through the economy and produced increased
economic growth and employment. Another twelve to eighteen
months have elapsed before the increased monetary growth has
affected the price level appreciably and inflation has occurred or
speeded up. The time delays have been this long for these coun-
tries because, wartime aside, they were long spared widely vary-
ing rates of monetary growth and inflation. On the eve of World
War II wholesale prices in the United Kingdom averaged roughly
the same as two hundred years earlier, and in the United States,
as one hundred years earlier. The post—World War II inflation is
a new phenomenon in these countries. They have experienced

---

276
FREE TO CHOOSE: A Personal Statement
many ups and downs but not a long movement in the same di-
rection.
Many countries in South America have had a less happy heri-
tage. They experience much shorter time delays—amounting at
most to a few months. If the United States does not cure its re-
cent propensity to indulge in widely varying rates of inflation, the
time delays will shorten here as well.
The sequence of events that follows a slowing of monetary
growth is the same as that just outlined except in the opposite
direction. The initial reduction in spending is interpreted as a
reduction in demand for specific products, which after an in-
terval leads to a reduction in output and employment. After an-
other interval inflation slows, which in turn is accompanied by
an expansion in employment and output. The alcoholic is through
his worst withdrawal pains and on the road to contented absti-
nence.
All of these adjustments are set in motion by changes in the
rates of monetary growth and inflation. If monetary growth were
high and steady, so that, let us say, prices tended to rise year after
year by 10 percent, the economy could adjust to it. Everybody
would come to anticipate a 10 percent inflation; wages would rise
by 10 percent a year more than they otherwise would; interest
rates would be 10 percentage points higher than otherwise—in
order to compensate the lender for inflation; tax rates would be
adjusted for inflation, and so on and on.
Such an inflation would do no great harm, but neither would
it serve any function. It would simply introduce unnecessary com-
plexities in arrangements. More important, such a situation, if it
ever developed, would probably not be stable. If it were politically
profitable and feasible to generate a 10 percent inflation, the
temptation would be great, when and if inflation ever settled there,
to make the inflation 11 or 12 or 15 percent. Zero inflation is a
politically feasible objective; a 10 percent inflation is not. That
is the verdict of experience.
MITIGATING THE SIDE EFFECTS
We know no example in history in which an inflation has been
ended without an interim period of slow economic growth and

---