Money Mischief_ Episodes in Monetary History - Milton Friedman [13]
Consider the representative individual who formerly held 5.2 weeks' income in cash and now holds 10.4 weeks' income. He could have held 10.4 weeks' income before, if he had wanted to, by spending less than he received for a sufficiently long period. When he held 5.2 weeks' income in cash, he did not regard the gain from having $1.00 extra in cash balances as worth the sacrifice of consuming at the rate of $1.00 per year less for one year, or at the rate of 10 cents less per year for ten years. Why should he think it worth the sacrifice now, when he holds 10.4 weeks' income in cash? The assumption that he was in a position of stable equilibrium before means that he will now want to raise his consumption and reduce his cash balances until they are back at the former level. Only at that level is the sacrifice of consuming at a lower rate just balanced by the gain from holding correspondingly higher cash balances.
Note that the individual has two decisions to make:
To what level does he want to reduce his temporarily enlarged cash balances? Since the appearance of the helicopter did not change his real income or any other basic condition, we can answer unambiguously: to the former level.
2. How rapidly does he want to return to the former level? To this question we have no answer. The answer depends on characteristics of his preferences that are not reflected in the stationary equilibrium position.
We know only that each individual will seek to reduce his cash balances at some rate. He will do so by trying to spend more than he receives. However, one person's expenditure is another's receipt. The members of the community as a whole cannot spend more than the community as a whole receives. The sum of individual cash balances is equal to the amount of cash available to be held. Individuals as a whole cannot "spend" balances; they can only transfer them. One person can spend more than he receives only by inducing another to receive more than he spends. They are, in effect, playing a game of musical chairs.
It is easy to see what the final position will be. People's attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services. The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available. They alter no tastes. They alter neither the apparent nor the actual rates at which consumers wish to substitute one commodity for another or at which producers can substitute one commodity for another in production. Hence, the final equilibrium will be a nominal income of $40,000 per representative individual instead of $20,000, with precisely the same flow of real goods and services as before.
It is much harder to say anything about the transition. To begin with, some producers may be slow to adjust their prices and may produce more for the market at the expense of nonmarket uses of resources. Others may try to make spending exceed receipts by taking a vacation from production for the market. Hence, measured income at initial nominal prices may either rise or fall during the transition. Similarly, some prices may adjust more rapidly than others, so that relative prices and quantities will be affected. There might be overshooting and, as a result, a cyclical adjustment pattern. In short, without a much more detailed specification of reaction patterns, we can predict little about the transition. It might vary all the way from an instantaneous adjustment, with all prices doubling overnight, to a long-drawn-out adjustment, with many ups and downs in prices and output for the market.
We can now drop the assumption that each individual happened to pick up an amount of Cash equal to the amount he had to begin with. Let the