Milton Friedman on Inflation

"Milton Friedman was an American economist and educator, known for his advocacy of free-market capitalism and his role in shaping government policy and public opinion123. He was a leading proponent of monetarism and was awarded the Nobel Prize for Economics in 1976." He was one of the few who properly pinpointed the cause of inflation. Many other try to dismiss what he said but he was right.

Milton Friedman on Inflation
The death of Milton Friedman on November 16, 2006, led Federal Reserve Chairman Ben Bernanke to remark that the “direct and indirect influences of his thinking on contemporary monetary economics would be difficult to overstate” and President Bush to note that “his writings laid the groundwork that transformed many of the world’s central banks.” Undoubtedly a major factor underpinning these assessments is the overwhelming influence that Friedman’s work has had on the way that economists and policymakers look at inflation.

As Friedman emphasized, “Inflation is an old, old disease. We’ve had thousands of years of experience of it. There is nothing simpler than stopping an inflation—from the technical point of view.”1 That remedy took a specific form: “The only cure for inflation is to reduce the rate at which total spending is growing.” This cure involved a temporary side effect, as Friedman noted: “There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked.”

On the issue of how economic policy should manage total spending, Friedman led the profession away from the weight it gave to fiscal policy. His work was important in forming the consensus that monetary actions have more sizable and reliable effects on aggregate spending than fiscal actions. In fact, Friedman offered the judgment, “I don’t think monetary policy has to be backed up by fiscal policy at all. I think monetary policy can curb inflation.”

His reasoning behind this was straightforward: “A budget deficit is inflationary if, and only if, it is financed in considerable part by printing money”—that is, only if fiscal actions are accommodated by the monetary authorities. In light of the importance of monetary policy for aggregate spending behavior, and of total spending for inflation, Friedman stated the policy implication: “[M]onetary policy is an appropriate and proper tool [when] directed at achieving price stability or a desired rate of price change.” This principle underlies the monetary policy framework of major economies today.

Friedman was particularly scathing about “cost-push” theories, prevalent in the 1960s and 1970s, that attributed high inflation to autonomous increases in costs rather than to excess demand. As he observed, “To each businessman separately it looks as if he has to raise prices because costs have gone up. But then, we must ask, ‘Why did his costs go up? Why is it that [for example] from 1960 to 1964 he didn’t find that he had to pay so much more for labor he had to raise prices, but that suddenly from 1964 to 1969 he did?’ The answer is, because, in the second period, total demand all over was increasing.”

Friedman’s monetary view of the inflation process led him to dismiss “incomes policy”— i.e., direct controls on wages and prices—as an alternative or supplement to monetary policy in fighting inflation. [What clueless Kamala wants]. Asked in 1974, “Do you think an incomes policy is an essential adjunct of a strict monetary policy?” Friedman replied simply, “Not at all.”

Consistent with this judgment, many countries that once assigned an important role to incomes policy now rely on monetary policy to control inflation. Policymakers in the 1970s saw that inflation was costly, but failed to grasp that to get inflation under control, they needed to use monetary policy, and only needed to use monetary policy. The fact that today’s policymakers do understand this reflects the profound impact of Milton Friedman on monetary economics.

■ 1 A list of sources for the quotations from Friedman used here is available at http://research.stlouisfed.org/publications/mt/Jan2007MT_Milton_Friedman_ on_inflation-SourcesWeb.pdf. Milton Friedman on Inflation Edward Nelson

How inflation increases

According to Friedman, when a government creates a budget deficit by printing money it causes inflation

1. Let’s say (for the sake of illustration) that the federal government receives only $1,000,000 in tax revenues.

2. But it prints $2,000,000 in paper currency.

3. This creates a deficit of $1,000,000.

4. Then the government decides to give people who are not even tax payers “freebies” to the tune of $1,000,000.

5. Let’s say these welfare recipients and illegal migrants smoke a lot of cigarettes since they have nothing better to do and are not compelled to work.

6. Now a convenience store has only 100 packs of cigarettes @ $10.00 a pack, and they are all purchased almost immediately.

7. So the retailer sees that the demand has far exceeded his normal supply so he orders 200 packs but raises the price to $15.00 a pack.

8. But this does not deter the buyers who have received a lot of “free” money from the government.

9. So now the retailer sells all 200 packs at the inflated price. He says to himself that since there was no problem selling them at $15/pack, he immediately increases the price of his next batch of 300 packs to $17/pack. If the customer asks why he says “This is what inflation is doing”. But they buy it anyway because they are addicted. And the price has risen by 170%.

10. So now the government brings in price controls, and tells the retailer that he can only sell a pack of cigarettes at $8.00/pack, and only one pack per person per day. But his original profit margin was $2.00, so he quits selling cigarettes.

11. Now the black marketeer steps in and sells cigarettes for $20/pack, and the addicts continue to buy them. So honest retailers lose business while the black marketeers flourish and also pay no taxes.

12. That does not bother the government so it now prints $3,000,000 in paper currency and also borrows $1,000,000 for this purpose. So now there is an increase in both the deficit and the national debt. But who cares? The debt will never be repaid. But inflation has gone through the roof.

Then a fiscally responsible government takes over and is determined not to spend more than the tax revenues.

1. So this government also receives $1,000,000 in taxes, and sets up a proper budget. This includes only essential federal government expenses, and the states and cities are told that they will not receive any money from the federal government (so they too have to budget properly). Here’s a theoretical breakdown for a total of 100%:

National defense 20% (all fat trimmed)

Infrastructure 20% (with some contribution from states)

Essential health services 20% (with affordable private insurance)

Border, airport, and port security 10%

Government salaries 10% (all excessive salaries reduced)

Social Security 6% (mandatory)

Federal law enforcement and judiciary 5%

National parks 5% (or less)

Welfare 2% (only to those who are disabled)

Paydown of national debt/interest 2%

So it all boils down to legislators being either responsible (not very likely) or irresponsible (as is now common). But if the president vetoes every irresponsible budget, they will soon have to become responsible.

Friedman differentiates between "fiscal policy" and "monetary policy". "Fiscal policy is a tool that governments use to shape the economy by changing taxes and spending". On the other hand "Monetary policy is a set of tools used by a nation's central bank to control the overall money supply". In the USA the Federal Reserve makes monetary policy. If the money supply is more than the tax revenues, you have a deficit. And then you have inflation.

A large part of deficit spending is the waste of billions of dollars by the government (which is essentially broke but can print money, which regular citizens cannot do). 175 billion dollars went to the Ukraine war effort, with 107 billion going directly to Ukraine, and the rest to support the war effort within the states. Did the USA have any national interest is in the Ukraine which sits on the border of Russia. Not in the least. Not a single dime should have gone to Ukraine. In fact all foreign aid should have been shut down long ago, since it has been proven to be useless. In 2023 it was about 61 billion dollars. So over 200 billion already down the drain.

The total cost of war in Afghanistan was 8 TRILLION dollars. It was a total waste of money since only the Taliban benefited. The history of Afghanistan had already shown that foreign invaders would never succeed in that country. But it was all ignored, and the terrorists actually increased and flourished. Iran promotes state-sponsored terrorism, and Obama and Biden gifted Iran with about 100 billion dollars.

Then we have a monstrous tax code (2,652 pages) which means thousands of IRS employees trying to figure out whether tax returns meet all those regulations. Had there been any sanity in income tax regulations, one page would have been enough. All it had to say is "Individual taxpayers will pay 10% of gross income, and businesses and corporations will pay 15% of gross income. There will be no deductions, exemptions, or tax credits". Which would also mean that a one page tax return would suffice (with authentic supporting proof of income). And electronic filing would save tons of paper.

Then we have government departments top heavy with bureaucrats. Chances are 90% of those jobs could be slashed without any harm. Also some government departments should not even exists. Imagine the savings from these items.

@tedincarolina come down here brother and sit with us and explain how a FIAT-based monetary system can reduce inflation.

Hi @Eli1

Well, all you have to do is look at the historical record of the American economy. Inflation levels have gone up and down a number of times in the last 75 years, ... if one were to bother looking. Now, how it's done? I don't know, I'm not an economist, but I know that it is done. The best I can understand is that the fed uses the fed interest benchmark to drive inflation. But if you would like an honest answer to that question you're posting, then go look at how inflation was brought down after the last cycle with fiat money. You do know that we've fought the inflation battle before with fiat money... right?

From 1979-1981 was a particularly rough patch of inflation. How did the monetary policy bring it down in 1981? Surely you can find an answer to that question that will show you how the fed works with our economy's inflation all while being a simple fiat currency system that you seem to think is a really terrible thing.

I'd be happy to sit down and explain to you all the intricacies of 'how' it's done, but I really don't know anything beyond what I've mentioned about the feds use of the benchmark interest rate.

God bless,
Ted

Take the time and explain how the fiat economy works. I believe that's what everyone here is asking.

Hi @Billyd

As I've been clear to explain, I'm not an economist. But the question was asked how you control inflation with a fiat currency and I pointed him to the occurrences of inflationary periods in the past. Considering that if the poster really wanted to know how it was done, he could actually read about how it has been done. He seems to be operating under some delusion that you can't control inflation with a fiat currency. But the U.S. has controlled inflation now for nearly 100 years with a fiat currency.

People!!!! We've had a fiat currency now since 1933. If you want to know how things are done with a fiat currency, we now have enough empirical evidence to show how these things are done.

But I'm not an economist. As far as I know, the fed manipulates the benchmark interest rate to generally control inflation. Other than that, I'm sure there are monetary policies that are put in place or worked around to bring about changes in the inflation rate. If you want to know how it's done, don't ask me, I don't know. But I know that we have controlled it now for nearly 100 years with a fiat currency.

What part of this do you not understand?

Go and look at how inflation was tamed in 1981. Go ahead! If you want to know how one can work with a fiat currency to control inflation. Go ahead! Read all about it. But I'm not an economist. I can't tell you 'how' it's done, I just know that is is done.

God bless and vote wisely,
Ted

Here is what Investopedia says: "Fiat money is a government-issued currency that's not backed by a physical commodity such as gold or silver. It's backed by the government that issues it."

When a currency is back by gold, and paper can be exchanged for cash, then the government can only print sufficient paper currency to cover the gold reserve. And that should have always been the case. But when there is not enough gold to back up the currency, it means that the government is creating the potential for inflation.

Because all currency went off the gold standard, the US government decided to simply keep printing paper with no actual value in gold, and increased the national debt, since the money had to come form somewhere. Also the tax revenue was a lot less than the currency. The Federal Reserve was more than happy to run this scam, and not a single president did anything about it. If the money supply increases it creates inflation since demand exceeds supply. Which also means that it devalues the dollar.

"The dollar had an average inflation rate of 3.55% per year between 1950 and today, producing a cumulative price increase of 1,173.97%1. This means that today's prices are 12.77 times as high as average prices since 1950, according to the Bureau of Labor Statistics consumer price index2. A dollar today only buys 7.830% of what it could buy back then2".

Hi @Nehemiah6

And yet it works for every single economy on the face of the planet. One has to say, Hmmmmmm. Name one economy whose money is tied to their gold reserves. I think that Switzerland was one of the last nations to drop the gold standard in 2000. Most of Europe had dropped it before the U.S. did in 1933.

God bless,
Ted

@tedincarolina what are your thoughts on the financial market crash of 2008?

The problem is not inflation. Low inflation builds wealth. The house you buy after 30 years has greater value than when it was purchased. Inflation did this. The problem is running deficits...spending more than is brought in. This causes huge amounts of money to be printed that doesn't have with it an increase in goods and services. The government went off the gold standard so it could run deficits to promise voters programs they do not pay for.
Interesting fact...if we simply went back to pre-pandemic levels of government spending, the budget would be balanced.

Hi @Eli1

Research shows that it was brought about by traders selling tranches of mortgages that were given to folks who couldn't/wouldn't pay back. That was based on a loosening of credit requirements and part of that was a push by the Clinton administration to make housing more available by loosening those credit requirements that had prevented those unable to afford to purchase a home. It was exacerbated by the greed of the markets in also attempting to make mortgages easier to qualify for with adjustable rate mortgages. This teaser rate mortgage that would adjust to a more normal rate a few years down the road became a ticking time bomb as those rates reset. Many people who had barely qualified for the lower initial payment of the adjustable rate, were left adrift when those mortgages reset to more normal interest rates. Some people's housing payments increased over $1,000/month when their mortgages reset. But for many, the reset was more than they could handle since the initial mortgage payment had been a stretch for them.

Bottom line, trillions of dollars of mortgage notes failed and the domino effect from that swept across the entire economy.

Economic movers, in an economy that services over 300 million people, can sometimes be devastating. But I'm fairly confident that the 2008 market crash had nothing to do with whether or not our money was backed by a rock of gold sitting in Ft. Knox.

God bless,
Ted

Hey @Eli1

Let's put a pencil to it. Let's say that today the U.S. passes a law that the total money supply be backed by an equal value of gold.

The current money supply is almost $21T. The current gold reserves held by the U.S. is somewhere between $400-500B.

What are you going to do?

Do we inflate gold until our holdings cover $21T or do we take over $20T out of the money supply?

God bless,
Ted

No man.
In my country there's an expression "You stretch your legs depending on how long the blanket is".
Which means, you don't need a new car or a new tv surround sound system on credit, if you can't afford to pay for it in cash.
This is how i was raised and this is how i raised my kids.
If you don't have the money to buy something and it's not a necessity - don't buy it! As simple as that.
My house? Goes to them. All paid. This is called transferring the generation wealth. Another concept which is a bit foreign to American families who kick their kids out at 18 to teach them trickle-down economics or something like that.
So, this means that on a country level, we don't need to spend another gajillion dollars on military or we should not allow military contract vendors to charge $150 for a hammer when we could get it at home depot for $10.

Good to see you again Ted and i brought some espresso coffee for lunch today.

Hi @Eli1

Well, that's all well and good philosophical musings. Yes, we all need to change our spending habits to more frugal and thrifty. But that wasn't the question my friend. I'm speaking to the 'how' that anyone who thinks we need to be on a gold backed currency would get that done. Make it happen. You would either have to inflate gold or take most of the money out of circulation. Which do you do?

I don't care about the after effects of either plan or the 'how over the next 50 decades if we could train people to... If you believe we should be on a gold supported currency, then how do you make that happen.

First step: Congress passes a law that all U.S. currency must be backed by a gold deposit held by the country.

What is the next step?

God bless,
Ted

But this isn't a philosophical musing, this is a real practical application to back commodities with real value as opposed to thoughts, which is FIAT-based currency. FIAT currency is philosophical because it's backed by thoughts.
So, how do you change the habits of a population? By creating limits which in turn eliminates all the fat and the bureaucracy. Right now you got useless people in useless positions of every level of society making crazy money because ... there's no limit.

How do you make this happen? Well, this part is the dream-part Ted and the philosophical part which requires some imagination and more coffee.
I think this will happen naturally when people have exhausted a lot of limited natural supplies and they will have more money then goods. Soooo maybe in a few centuries i'm guessing, i don't know.

I so love this post, very nostalgic or me, it is how I was raised as well and how I raised my children.

In some ways it is hard to feel bad for Americans since they have caused a lot of their own problems.

I do not think it is possible to go back to a gold standard unless there is a huge economic global disaster.

Yeah and in 2008 we applied a cheat-code for the system. "Too big to fail" was the code.
Free market?
More like Bail Markets with taxpayers money.
Hey i thought that this system was sink or swim?
Yeah, for you who has a mortgage not for me who has a yacht.

Hey @Eli1

So then, you don't have an answer to how you'd do it except to come up with some set of laws whereby you could make people handle their money as wisely and frugally as you do. Got it! Likely zero possibility that's ever going to happen. So you don't know how you'd be able to get the economy of the United States back to a gold valued currency. Got it! Thanks.

Right! That's exactly right. The U.S. cannot get back on a gold standard system without one of those two events that I spoke of. Either gold has to be super inflated to like $500,000/oz, or we have to take $21T out of our money supply so that our current gold reserves will equal our money supply.

So as I see it, all of this crying and positioning over a gold standard economy is about equal to all those still crying that the Confederacy lost. Look, it's over! Real life has happened!!! Now we have to live within the system that exists and pining for some supposed good old days isn't ever going to take things back to how it was 100 years ago. Or 1,000 years ago. LIFE HAPPENS PEOPLE!!!!!

Things change and yes, when things change, and especially over any reasonable period of time, you can't just go back to the way things were back when you were a kid and the ice cream guy in his white Borden's truck with that cow's head sticking out of a sunflower was your best friend.

The gold standard, for all practical purposes is gone. It was a technology that seemed to suffice for a while. But then governments realized that making the value of their nation's prosperity linked to how much of some metal they could dig up out of the ground and shape into ingots didn't really work. So they untethered the money supply from their ability to hold some vast mountain of some metal that they dug up out of the ground, and let it go freely and be freely traded based on whatever value people would give it. And that's ok. Just as long as we, as a nation, have a system of trade whereby some common item that everyone can get, can be used to buy the things that we need to live our lives and feed our families and keep a roof over our heads and our bellies full. Trust me please! In Jesus' day Rome didn't have a storehouse of some valuable metal that backed the coins that were being handed about for trade.

But for any of those who think we can or should get back on it. How? It seems such a simple question. Can anyone answer it. Or is this just a bunch of grousing about the past even though you know in your heart it's never going to go back to that way. What a foolish life to live. Arguing that we should all live in the impossible.

God bless,
Ted