Money Mischief_ Episodes in Monetary History - Milton Friedman [97]
One result of bracket creep was political pressure that led to the indexation of the personal income tax schedule for inflation, which has largely though not wholly eliminated this source of revenue.* I do not know what the situation is in other countries, but I suspect that wherever there has been substantial inflation there has also been substantial indexation of the personal tax structure.
The third component has also been extremely important. At the end of World War II, the funded U.S. federal debt amounted to 106 percent of a year's national income. By 1967 the debt was down to about 32 percent of national income, despite repeated deficits in the official federal budget. Since then it has risen as deficits have continued and increased, but, even so, to only about 46 percent currently. Real growth partly accounts for the decline in the deficit ratio, but inflation has been the: major explanation. Inflation converted the positive nominal interest rates at which the debt had been issued into negative real rates ex post (see Figure 1 in chapter 2).
Developments in the financial markets have sharply eroded this source of revenue. Market pressures have made it difficult for governments to issue long-term debt at low nominal rates. One result in the United States was a sharp reduction in the average term to maturity of the federal debt during the inflation of the 1970s—from nine years and one month for the marketable interest-bearing public debt in 1946 to as low as two years and seven months in 1976. After fluctuating only slightly above that level during the rest of the 1970s and the early 1980s, the average maturity has risen as inflation has come down, reaching six years and one month in 1990. Except under wartime conditions, it is far more difficult to convert positive nominal interest rates on short-term debt into ex post negative real rates by unanticipated inflation than it is to do so for long-term debt. Moreover, it is less profitable to do so for short-term debt than it is for long-term debt. Several decades of historically high and variable inflation have made it far more difficult to produce unanticipated inflation of any magnitude for any substantial period than it was even a decade or two ago, when the public's perceptions still reflected the effect of a relatively stable price level over long periods.
In the United Kingdom, the government now issues bonds adjusted for inflation. For such bonds, there is no way that the government can benefit from ex post negative real interest rates. There has long been support in the United States for the Treasury to issue similar securities, but so far it has been unwilling to do so. However, pressure to issue purchasing-power securities would undoubtedly intensify if inflation in the United States again became high and variable.
Perhaps several decades of a relatively stable long-run price level would again lull asset holders into regarding nominal interest rates as equivalent to real interest rates. But that is certainly not the case today.
To summarize, inflation has become less attractive as a political option. Given a voting public very sensitive to inflation, it may currently be politically profitable to establish monetary arrangements that will make the present irredeemable paper standard an exception to Fisher's generalization.
Recent experience provides some support for that view. The inflationary episode of the 1970s was severe by the standards that had become accepted in the United States, the United Kingdom, Japan, and other advanced countries during the nineteenth and most of the twentieth century (though it was mild by comparison with the experience of many other countries of the world). It was sufficiently severe to generate political pressures that led to policies of disinflation throughout the Western world, policies of restraining monetary growth and of accepting substantial temporary unemployment in order to avoid continued inflation.