Money Mischief_ Episodes in Monetary History - Milton Friedman [76]
Low productivity is another favorite explanation for inflation. Yet consider Brazil. During the 1960s and 1970s it experienced one of the most rapid rates of growth in output in the world, and also one of the highest rates of inflation. Nothing is more important for the long-run economic welfare of a country than to improve productivity. If productivity grows at 3.5 percent a year, output doubles in twenty years; at 5 percent a year, in fourteen years—quite a difference. But productivity is a bit player in the inflation story; money is at center stage.
What about the Arab sheikhs and OPEC? They have imposed heavy costs on most of the world. The sharp rise in the price of oil in the 1970s lowered the quantity of goods and services that was available for people to use because everyone had to export more abroad to pay for oil. This reduction in output raised the price level. But that was a once-for-all effect. It did not produce any longer-lasting effect on the rate of inflation. In the five years after the 1973 oil shock, inflation in both Germany and Japan declined, in Germany from about 7 percent a year to less than 5 percent, in Japan from over 30 percent to less than 5 percent. In the United States, inflation peaked a year after the oil shock at about 12 percent, declined to 5 percent in 1976, and then rose to over 13 percent in 1979. How can these very different experiences be explained by an oil shock that was common to all countries? Germany and Japan are 100 percent dependent on imported oil, yet they did better at cutting inflation than did either the United States, which is only 50 percent dependent on imported oil, or the United Kingdom, which has become a major producer of oil.
We return to our basic proposition. Inflation is primarily a monetary phenomenon that is produced by a more rapid increase in the quantity of money than in output. The behavior of the quantity of money is the senior partner, the behavior of output the junior partner. Many phenomena can produce temporary fluctuations in the rate of inflation, but they can have lasting effects only insofar as they affect the rate of monetary growth.
Why the Excessive Monetary Growth?
The proposition that inflation is a monetary phenomenon is important, yet it is only the beginning of an answer to the cause of and cure for inflation. It is important because it guides the search for basic causes and limits possible cures. But it is only the beginning of an answer because the deeper question is why excessive monetary growth occurs.
Whatever may have been true for money linked to silver or gold, with today's paper money it is governments and governments alone that can produce excessive monetary growth, and hence inflation.
In the United States, the accelerated monetary growth from the mid-1960s to the end of the 1970s—the most recent period of accelerating inflation—occurred for three related reasons: first, the rapid growth in government spending; second, the government's full-employment policy; third, a mistaken policy pursued by the Federal Reserve System.
Higher government spending will not lead to more rapid monetary growth and inflation if the additional spending is financed either by taxes or by borrowing from the public. In both cases, the government has more to spend, the public less. However, taxes are politically unpopular. While many of us may welcome additional government spending, few of us welcome additional taxes. Government borrowing from the public is also politically unpopular, generating an outcry against the growing government debt and diverting private savings from investment to the financing of the government deficit.
The only other way to finance higher government spending is by increasing the quantity of money. 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