Money Mischief_ Episodes in Monetary History - Milton Friedman [82]
The answer is that slow growth and high unemployment are not cures for inflation. They are side effects of a successful cure—as we found out in 1980–83. Many policies that impede economic growth and add to unemployment may at the same time increase the rate of inflation. That has been true of some of the policies the United States has adopted—sporadic price and wage controls, increased government intervention in business, accompanied by higher and higher government spending and a rapid increase in the quantity of money.
Another medical example will perhaps make clear the difference between a cure and a side effect. You have acute appendicitis. Your physician recommends an appendectomy but warns that after the operation you will be confined to bed for an interval. You refuse the operation but take to your bed for the indicated interval as a less painful cure. Silly, yes, but faithful in every detail to the confusion between unemployment as a side effect and as a cure.
The side effects of a cure for inflation are painful, so it is important to understand why they occur and to seek means to mitigate them. The basic reason why the side effects occur is because variable rates of monetary growth introduce "static" into the information transmitted by the price system. This static is translated into inappropriate responses by the economic actors, and it takes time to overcome those responses.
Consider, first, what happens when inflationary monetary growth starts. A seller of goods or labor or other services cannot distinguish the higher spending financed by the newly created money from any other spending. Retail merchants, for example, find that they are selling more goods at their former prices. The initial reaction is to order more goods from the wholesaler, who in turn orders more goods from the manufacturer, and so on down the line. If the demand for the goods had increased at the expense of some other segment of demand—say at the expense of government spending rather than as a result of inflationary monetary growth—the increased flow of orders for one set of goods would be accompanied by a decreased flow for another. Some prices would tend to rise, others to fall; but there would be no reason for prices on the average to change.
The situation is wholly different when the increased demand has its origin in newly created money. The demand for most goods and services can then go up simultaneously. There is more total spending (in dollars). However, the retail merchants do not know this. They proceed as just outlined, initially holding the selling price constant, content to sell more until, as they believe, they will be able to restock. But now the increased flow of orders down the retail channel is not offset by a decreasing flow down the government channel. As the increased flow of orders generates a greater demand for labor and materials to produce more, the initial reaction of the workers and the producers of materials will be similar to that of the retailers—to work longer and produce more, and also to charge more, in the belief that the demand for what they have been providing has gone up. But this time there is no offset, no declines in demand roughly matching the increases in demand, no declines in prices matching the increases. This situation will not at first be obvious. In a dynamic world, demands are always shifting, with some prices going up, some going down. The general signal of increasing demand will be confused with the specific signals reflecting changes in relative