“inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
“Government spending may or may not be inflationary. It clearly will be inflationary if it is financed by creating money, that is, by printing currency or creating bank deposits.”
“There is a great deal of evidence from the past attempts by monetary authorities to do better. The verdict is very clear. The attempts by monetary authorities to do better have done far more harm than good. The actions by the monetary authorities have been an important source of instability.”
“A steady rate of monetary growth at a moderate level can provide a framework under which a country can have little inflation and much growth. It will not produce perfect stability; it will not produce heaven on earth; but it can make an important contribution to a stable economic society.”
Milton Friedman, The Counter-Revolution in Monetary Theory, Institute of Economic Affairs 1970.
I was blessed to attend this First Wincott Memorial Lecture delivered at the Senate House, University of London, 16 September 1970. It was the very first time that I saw Milton Friedman weave his spell of monetary magic over an audience. It was the moment when I first truly understood the significance of the monetarist counter-revolution against the Keynesian hegemony that still held sway over the backward, xenophobic British economics profession, of which I was an increasingly disenchanted member.
Ideas, for the most part, like changes in the quantity of money, make their way slowly through a system, with long and variable lags. Monetarism was such an idea. It took 9 years for the idea that inflation is a monetary phenomenon to percolate through British politics into the thinking of the Thatcher administration. It took 10 years, with the election of Ronald Reagan, for it to percolate into the thinking of Paul Volcker, Chairman of the Federal Reserve, who reversed the Fed’s policy of easy money and placed the United States economy into a monetary refrigerator. It would be several more years before monetarism finally squeezed out inflationary expectations and set the British and the US economies on course for 16 years of the splendid Great Moderation.
Certainly, monetarism did not take us to Paradise; but it eased one big worry from our minds. Ordinary people could go about their business and live their lives without concerning themselves about the uncertainties created by high and volatile rates of price inflation. Economic decisions could be registered on the basis of real factors, without undue concern for nominal white noise. The brilliant son of poor Jewish immigrants, who had started out their lives in the United States gladly working in sweatshops, had delivered an enormous benefit to mankind.
Only to be reversed by the inexcusable ignorance of two younger members of his own ethnic group, Alan Greenspan and Ben Bernanke. Now, it is true that neither of these two future Fed Chairmen learned their economics at the feet of the Maestro. Certainly, however, they had more personal exposure to his nonstrums than had I, living through the critical years of the counter-revolution some 4,000 miles away from the capital of Freshwater Economics. In each case, before they assumed high office, they had the spectacular success of Maestro Volcker to guide them in their ministrations.
As a historical fact, both Greenspan and Bernanke failed to understand the message, failed to honor their oaths of office. Jointly and severally, they have returned the United States to its former inflationary path. Jointly and severally, they have abandoned the great monetary counter-revolution and returned the US economy to the dominance of the Keynesian episode. They should be thoroughly ashamed, not just for themselves, and their own monetary ignorance, but more importantly, for all our children and our grandchildren, who now seem to be doomed to the returning misery of stagflation.
For make no mistake about it, Dear Readers, the specter of inflation once again stalks the United States as a consequence of the monetary furnace fired up by Ben Bernanke since September 2008. Because Bernanke misread his own scholarship, and wrongly identified a limited economic contraction in 2008 as a return to the Great Depression, he has debauched the currency of the United States. Because he falsely believed that the United States was teetering on the edge of a deflationary cliff, he poured high-powered money into the financial system, tripling the size of the Fed’s balance sheet, and setting the scene for a potential 96 per cent increase in M2 money, once the income velocity of circulation of money returns to its historical norm.
For the time being the world sleeps, as money exerts its slow influence in the manner identified by Milton Friedman. First, monetary expansion will impact on real output, as already is the case. Then it will impact on the price level, slowly at first, but then with increasing venom. The first signs are already evident: the CPI rose 2.7 per cent in 2009, according to the recent update by the Bureau of Labor Statistics, and it did so against a backcloth of 9.3 per cent unemployment. This is a first green shoot of stagflation. A 2.7 per cent rate of price inflation is above the rate achieved in 5 out of the past 10 years in the United States. It does not signify a nation teetering on the edge of deflation.*
Do you still remember the Misery Index that became such a central feature of economic evaluations during the stagflation era? This Index is the sum of the unemployment and the inflation rates at any point in time. In 2009, the Misery Index is measured at 12.0. This is the highest level of the index over the past 26 years, going right back to 1983, when it was 13.4, immediately before Paul Volcker’s monetary refrigerator conquered inflationary expectations.
Brace yourselves, Dear Readers, for worse that is yet to come. Ben Bernanke is no Paul Volcker; and Barack Obama is no Ronald Reagan. The Fed is still firing up the monetary furnace, would not dare to tighten the economy by reversing course. Barack Obama is still spending the nation’s wealth as though there is no tomorrow. The promise of a new era of Great Moderation lies as far ahead at this moment in time as it did in September 1970, when I attended that eye-opening presentation by Milton Friedman.
Milton Friedman sadly is no longer with us to sound the warning yet again. And almost everyone else is asleep, as the Captain of the Titanic steers his ship full speed ahead onto the silently floating iceberg that will surely destroy his vessel, and all our lives.
* These statistics were reported by Robert Murphy in The Washington Times (February 19, 2010). The monetarist interpetation of these developments is my responsibility. I am usually careful to cite sources. In my initial posting of the column, I regretfully overlooked the source of these statistics, believing that they had been published in an unnamed Editorial. I am now rectifying that omission.