Money Mischief_ Episodes in Monetary History - Milton Friedman [96]
The key challenge that now faces us in reforming our monetary and fiscal institutions is to find a substitute for convertibility into specie that will serve the same function: maintaining pressure on the government to refrain from its resort to inflation as a source of revenue. To put it another way, we must find a nominal anchor for the price level to replace the physical limit on a monetary commodity.
It is not possible to say whether Fisher's 1911 generalization that "irredeemable paper money has almost invariably proved a curse to the country employing it" will hold true in coming decades. The recent experiences of such countries as Argentina, Bolivia, Brazil, Chile, Mexico, and Israel support Fisher's generalization. However, they all are less highly developed countries, and they may have more in common with the kind of country Fisher had in mind than they do with the more advanced countries of today. The experience of those more advanced countries—Japan, the United States, and the members of the Common Market—gives grounds for greater optimism. The pressures on governments to obtain resources for government use without levying explicit taxes are as strong today in these countries as they were earlier. However, counterpressures have developed that reduce the political attractiveness of paper money inflation. The information revolution has greatly reduced the cost of acquiring information and has enabled expectations to respond more promptly and accurately to economic disturbances, including changes in government policy. As a result, both the public at large and the financial markets have become far more sensitive to inflation and more sophisticated about it than in earlier times.
As chapter 8 points out, inflation provides governments with resources in three ways: first, issues of government money constitute an implicit inflation tax on base money holdings; second, inflation may produce an unvoted increase in explicit taxes as a result of the failure to adjust for inflation at least some of the components of the income tax base, or income tax brackets; third, inflation reduces the real value of outstanding debt issued at interest rates that do not include sufficient allowance for future inflation. Recent economic, political, and financial developments have greatly eroded the potency of all three sources of revenue.
With respect to the first, the figures for the United States suggest the trend. Base, or high-powered, money remained remarkably constant at about 10 percent of national income from the middle of the nineteenth century to the Great Depression. It then rose sharply, to a peak of about 25 percent in 1946. Since then the ratio of base money to national income has been declining, and in 1990 was about 7 percent. For a modern society in which government taxes and spending have mounted to between 30 percent and 50 percent—occasionally even more—of the national income, this component is perhaps the least important of the three. Even if inflation did not reduce the ratio of the base to national income (which it unquestionably would do), a 10 percent annual increase in the base would currently yield as revenue to the U.S. government only about seven-tenths of 1 percent of national income. Further financial innovation is likely to reduce still further the ratio of base money to national income, even aside from the effect of inflation, making this source of revenue still less potent. I believe that the same tendencies have been present in many other countries, so that this source of revenue has become less important for them as well.
The second component of revenue—bracket creep—has very likely been far more important than the first. That certainly was true in the United States in recent decades. Inflation subjected