Money Mischief_ Episodes in Monetary History - Milton Friedman [78]
The financial public, too, believes that the Fed can control interest rates, and that belief has spread to the Treasury and Congress. As a result, every recession brings calls from the Treasury, the White House, Congress, and Wall Street for the Fed to "bring down interest rates." Counterbalancing pleas, at times of expansion, for the Fed to raise interest rates are notable by their absence.
The end result of higher government spending, the full-employment policy, and the Fed's obsession with interest rates has been a roller coaster along a rising path ever since the end of World War II—though perhaps it stalled somewhat in the 1980s (see chapter 10 for some reason for optimism). Inflation has risen and then fallen. Until 1980, each rise carried inflation to a level higher than the preceding peak had been. Each fall left inflation above its preceding trough. All the time, government spending was rising as a fraction of income; government tax receipts, too, were rising as a fraction of income, but not quite as fast as spending, and so the deficit, too, rose as a fraction of income.
These developments are not unique to the United States or to recent decades. Since time immemorial, sovereigns—whether kings, emperors, or parliaments—have been tempted to resort to increasing the quantity of money as a means of acquiring resources to wage wars, to construct monuments, or for other purposes. They have often succumbed to the temptation. Whenever they have, inflation has followed close behind.
Government Revenue from Inflation
Financing government spending by increasing the quantity of money looks like magic, like getting something for nothing. To take a simple example, the government builds a road, paying for it in newly printed Federal Reserve notes. It looks as if everybody is better off. The workers who built the road get their pay and can buy food, clothing, and housing, nobody has paid higher taxes, and yet there is now a road where there was none before. Who has really paid for it?
The answer is that all holders of money have paid for the road. The extra money that is printed raises prices when it is used to induce the workers to build the road instead of to engage in some other productive activity. Those higher prices are maintained as the extra money circulates in the spending stream from the workers to the sellers of what they buy, from those sellers to others, and so on. The higher prices mean that the money people have in their pockets or in safe-deposit boxes or on deposit at banks will now buy less than it would have before. In order to have on hand an amount of money with which they can buy as much as before, they will have to refrain from spending all their income and use part of it to add to their money balances. As we saw in chapter 2, the extra money printed is equivalent to a tax on money balances. The newly printed Federal Reserve notes are in effect receipts for taxes paid.
The physical counterpart to these taxes is the goods and services that could have been produced with the resources that built the road. The people who spent less than their income in order to maintain the purchasing power of their money balances have given up these goods and services in order that the government could get the resources to build the road.
Inflation may also yield revenue indirectly by automatically raising effective tax rates. Until 1985, as personal dollar incomes went up with inflation, the income was pushed into higher and higher brackets and was taxed at higher rates. Such "bracket creep" was greatly reduced by the Federal Tax Act of 1981, which provided that personal income tax brackets be indexed for inflation beginning