Money Mischief_ Episodes in Monetary History - Milton Friedman [83]
As it does, workers, manufacturers, retailers all discover that they have been fooled. They have reacted to higher demand for the small number of things they individually sell in the mistaken belief that the higher demand was special to them and hence would not much affect the prices of the many things they buy. When they discover their mistake, they raise wages and prices still higher—not only to respond to higher demand but also to allow for the rises in the prices of the things they buy. The economy is off on a price-wage spiral that is itself an effect of inflation, not a cause. If monetary growth does not speed up further, the initial stimulus to employment and output will be replaced by the opposite; both will tend to go down in response to the higher wages and prices. A hangover will succeed the initial euphoria.
It takes time for these reactions to occur. As stated at the end of chapter 2, over the past century and more in the United States, the United Kingdom, and some other Western countries, roughly six to nine months have elapsed on the average before increased monetary growth has worked its way through the economy and produced increased economic growth and employment. Another twelve to eighteen months have elapsed before the increased monetary growth has affected the price level appreciably and inflation has occurred or speeded up. The time delays have been that long for these countries because, wartime aside, the countries were mostly spared widely varying rates of monetary growth and inflation. Wholesale prices in the United Kingdom averaged roughly the same on the eve of World War II as they did two hundred years earlier, and in the United States as they did one hundred years earlier. The post-World War II inflation was a new phenomenon for these countries. They had experienced many ups and downs but not a long movement in the same direction.
Many countries in South America have had a less happy heritage. They experience much shorter time delays—amounting at most to a few months. If the United States had not cured (at least for a time, and we hope for a long time) its recent propensity to indulge in widely varying rates of inflation, the time delays would have shortened here as well. So far they seem not to have done so.
The sequence of events that follows a slowing of monetary growth is the same as that just outlined, except in the opposite direction. The initial reduction in spending is interpreted as a reduction in demand for specific products, which after an interval leads to a reduction in output and employment. After another interval, inflation slows, in turn accompanied by an expansion in employment and output. The alcoholic is through the worst of the withdrawal pains and on the road to contented abstinence.
All these adjustments are set in motion by changes in the rates of monetary growth and inflation. If monetary growth was high but steady, so that, let us say, prices tended to rise year after year by 10 percent, the economy would adjust to it. Everybody would come to anticipate a 10 percent inflation. Wages would rise by 10 percent a year more than they otherwise would; interest rates would be 10 percentage points higher than otherwise, in order to compensate the lender for inflation; tax rates would be adjusted for inflation; and so on and on.
Such an inflation would do no great harm, but neither would it serve any function. It would simply introduce unnecessary complexities in economic arrangements. More important, such a situation, if it ever developed, would probably not be stable. If it were politically profitable and feasible to generate a 10 percent inflation, the temptation would be great, when and if inflation ever settled there, to make the inflation 11 or 12 or 15 percent. Zero inflation is a politically feasible objective; a 10 percent inflation