Here’s Megan McArdle, stating a famous old monetarist maxim:
I think McArdle is 75% correct, in the sense that 3 of the 4 plausible interpretations of this ambiguous statement are true. Here are the 4:
1. Inflation is always a fall in the value of money. (Tautologically true, but uninteresting.)
2. Inflation is always caused by an increase in the money supply. (False)
3. Periods of sustained and high rates of inflation are always caused by rapid money growth. (Probably true)
4. Inappropriately high inflation is caused by bad monetary policy. (True)
Don Patinkin assumed that Milton Friedman had the first interpretation in mind, and criticized the claim for being tautological. Actually, Friedman had the third interpretation in mind.
In my view, policy counterfactuals are the most useful way to think about causality questions related to inflation (and NGDP growth). If the lowest cost way of preventing high inflation is with monetary policy, then a period of high inflation can be said to be caused by inept monetary policy. If the lowest cost method of controlling inflation is with restrictive fiscal policy, then overly stimulative fiscal policy can be said to have caused high inflation. I believe that monetary policy is the lowest cost solution for high inflation (at least in the US).
READER COMMENTS
dlr
Jul 14 2021 at 5:53pm
okay, but the line is always and everywhere right? many countries with fiscal shocks/spirals and high inflation have had very debatable lowest cost counterfactuals. and the US is not guaranteed to always and everywhere be immune from these fiscally driven inflationary experiences. if you are going to define cause as a cost benefit counterfactual then either you have to dislike the phrasing or you have to argue that it is impossible for fiscal restraint to ever be the lowest cost lever, right?
btw, there is another scenario you didn’t mention. tighter monetary policy could be lower cost than fiscal restraint or debt default but still higher cost than unwanted inflation given the fiscal equilibrium sans restraint/default. not sure it’s useful to call money the cause in that case. in trolley language, it’s like seeing two people on the road and being faced with a choice to swerve into one person (tighter mon-pol) or a ditch (inflation). did the one person really cause your accident here?
Scott Sumner
Jul 16 2021 at 12:34pm
Good points. Certainly Friedman was talking about “proximate” causes when he used the always and everywhere phrase. He recognized that fiscal excess can trigger money growth.
Thomas Lee Hutcheson
Jul 14 2021 at 10:39pm
But what monetary policy is implicit in “restrictive fiscal policy?”
Philo
Jul 15 2021 at 3:20pm
Note that no particular fiscal policy is assumed in “inept monetary policy,” because the monetary authority “moves last.”
Michael Sandifer
Jul 15 2021 at 1:01am
I think Friedman was right, and the data, as I’ve seen it, seems to strongly support his view. It’s very strong for inflation rates at about 10% or greater.
Rajat
Jul 15 2021 at 5:41am
Since your conclusion is highly relevant to the debate around MMT, I think it might be worth explaining what you mean by ‘cost’. Is it economic welfare, and if so, for what reason? Is it that ramping government spending, taxes & transfers up & down continually & rapidly leads to poor resource allocation and costly risk management by households & businesses (which I guess also involves poor resource allocation)? Or is it that political considerations & lags will make it more difficult to hit a nominal target using fiscal policy than monetary policy? It may help those sympathetic to a stronger stabilisation role for fiscal policy to better understand what it would mean at a practical level.
Scott Sumner
Jul 16 2021 at 12:38pm
Rajat, You asked:
“Is it that ramping government spending, taxes & transfers up & down continually & rapidly leads to poor resource allocation and costly risk management by households & businesses (which I guess also involves poor resource allocation)? Or is it that political considerations & lags will make it more difficult to hit a nominal target using fiscal policy than monetary policy?”
Both.
“debate around MMT”
Have MMTers put together a coherent model that is capable of being debated? I know that Krugman tried to debate MMTers, but wasn’t even able to engage with them. He’s pretty smart. How smart does one have to be in order to understand MMT?
Michael S Rulle
Jul 16 2021 at 12:44pm
Your blog title—-borrowed from Irving Fisher—–explicitly states (okay, virtually states) that inflation is a monetary phenomenon. I am so bad at economics, I cannot understand how it could be anything but a monetary phenomenon.
Michael S Rulle
Jul 16 2021 at 12:50pm
And obviously, many things can screw up an economy—an almost infinite number of things—–it still does not change the nature of inflation.
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