FREE TO CHOOSECHAPTER 9

THE CURE FOR INFLATION

I. INTRODUCTION

Why do private persons in private transactions accept money?

“The short answer is that each person accepts them because he is confident that others will. The pieces of green paper have value because everybody thinks they have value. Everybody thinks they have value because in his experience they have had value.”

Value of money rests on a fiction However, money can do great damage when it gets

out of order Is value really based on fiction? Discuss merits of

this statement.

II. VARIETIES OF MONEY

An amazing variety of items have been used as money

One thing all had in common was acceptance “It remains as true now as it was then that a

more rapid increase in the quantity of money than in the quantity of goods and services available for purchase will produce inflation, raising prices in terms of that money.”

III. THE PROXIMATE CAUSE OF INFLATION “Inflation is a disease, a dangerous and sometimes fatal

disease, a disease that if not checked in time can destroy a society.”

Inflation is “always and everywhere a monetary phenomenon” “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.”

Widely held, but false, explanations of inflation:1) Unions2) Business3) Imports/foreign countries4) Low productivity5) Supply shocks, i.e. oil

Discuss merits of these explanations. Could they be partly to blame?

IV. WHY THE EXCESSIVE MONETARY GROWTH? US rapid monetary growth from about 1965-

1980 primarily due to:1) Growth in gov’t spending

2) Gov’t full employment policy

3) Mistaken Fed policy Compare government and Fed actions from

this period to Economic Crisis of 2008.

V. GOVERNMENT REVENUE FROM INFLATION John M. Keynes: “There is no subtler, no surer

means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Sources of gov’t revenue from inflation:1) The extra money printed is like a tax on money

balances

2) Raising effective tax rates

3) Paying off part of the government’s debt

VI. THE CURE FOR INFLATION

Cure is simple to state but hard to implement One and only cure- reduce the rate of

monetary growth If inflation is advanced, cure takes a long time

and has painful side effects Side effects: Lower growth, temporary high

unemployment, initially not much reduction in inflation

VII. SIDE EFFECTS OF A CURE

Slow growth and high unemployment are not cures, they’re side effects

Why do side effects occur? “They occur because variable rates of monetary

growth introduce static into the information transmitted by the price system, static that is translated into inappropriate responses by the economic actors, which it takes time to overcome.”

On average, roughly six to nine months have elapsed before increased monetary growth has produced growth and employment

Another 12 to 18 months have passed before inflation occurred

Key point- all of these adjustments are started by changes in the rates of monetary growth and inflation

VIII. MITIGATING THE SIDE EFFECTS No example in history has shown anything

other than slower growth and higher unemployment

We can mitigate the effects though Most important: slow inflation gradually but

steadily by a policy announced in advance Escalator clauses are another mitigating

effect By how much do you think these factors

could mitigate side effects?