is excerpted from Chapter 8 of the book The
Death of Inflation by Roger Bootle.
position on inflation is a mixture of monetarism -- the doctrine that
is always caused by increases in the money supply -- and the belief in
the so-called natural rate of employment -- that there is only one
of unemployment at which inflation is stable. Both of these
are riddled with dogma. Neither finds room for historical and
The Appeal of Monetarism
problem, economists feel an urge to find a single and complete answer
will apply to all circumstances, a sort of grand unifying theory.
Monetarism is just such a temptation, and economists have fallen for
It provides a link with monetary inflations of the past, and with more
recent hyperinflations that always involve massive printing of
is no doubt
that monetary expansion plays a dominant role in hyperinflation.
Yet Philip Cagan found in a classic study of seven hyperinflations that
in all cases there were substantial declines in the demand for money in
terms, such that the rise in prices substantially exceeded the rise
in the money supply.
The Causes of Hyperinflation
creeping inflations are really the same as hyperinflations, differing
in degree. But underlying hyperinflation is almost always a huge
budget deficit which the government is unwilling or unable to finance
the ordinary way by borrowing in the capital markets. Rather than
cut the deficit, the government prints money or borrows it from the
bank, which amounts to the same thing. However, it is striking
mature and developed economies do not normally suffer from such
When they do, there is a distinctly real cause - such as war, a
revolution, or a sharp political change.
Monetary Policy Errors and
all cases of moderate inflation in the West, the literal printing of
or government borrowing from the central bank has played a minor
If expansion of the (credit) money supply is involved in the moderate
inflation, it is due to the commercial banks lending to the private
and the businesses and consumers who seek to borrow money from
And if governments and central banks are ultimately to be held
for this inflation, it must be from their encouragement of the lending
behavior of the banks by failing to set interest rates high enough --
for fear of the consequences of unemployment and lost votes.
is Not Causation
theory teaches that the money supply can be thought of as an exogenous
act of policy. Thus if you observe a strong link between money
income (or prices), the causation inevitably runs from money to income
and not the other way around. But in a modern monetary system the
supply is not under the direct control of the authorities. It
is determined by the lending criteria of the banks, the demand for
in the economy as a whole, and the attractions of bank credit compared
to other forms of finance.
if you observe
a strong correlation between changes in the money supply and changes in
national income or the price level, this does not necessarily tell you
much. You do not know whether a change in the money supply is the
cause of events in the economy or a response to them.
Why Monetarist Theory Persists
economists, monetarism's simplicity and certainty enables them to
in a fundamental law or rule of economics, which thereby lends status
the subject. It saves them from the messy world of historical
and institutional studies. Today, long after monetarism has
its high-water mark, it lingers on as the conventional wisdom, partly
a whole generation of economists, journalists, bank officials, and
practitioners have been trained in Friedmanite economics. And
because so many economists have poured so much intellectual capital
it that they cannot bear to write it off.
A Basic Cause of Moderate
is no philosopher's
stone that gives all the answers about inflation. However there
one all-embracing framework that has some appeal: Inflation is
by the struggle between different groups within society over their
of national income. Classic monetary inflation fits into this
Governments caused inflation when they tried to secure more of the
income than they were willing or able to finance openly through
In an inflation driven by private credit creation, borrowers lay claim
to more resources than are currently available without others in
giving up some of their claims.
War II Inflation
sort of inflation
we have experienced in the post-war period reflects the upsurge of
power that led to battles between producer groups for shares of the
in which monetary factors were secondary. In the largely
society of previous eras, the power of producers to affect the general
price level was limited. Small units of production and poor
made collusive behavior difficult. When circumstances demanded
prices and wages should fall, they fell almost as easily as they rose
changed all this. The price of industrial output was something to
be decided by the producers. Mass production technology limited
number of firms that could viably operate in an industry. The
of mass production favored mass organization of labor into unions,
the cartelization of the employers. The tension between services
and manufacturing sectors played a major role in the tendency toward
prices. The attempt by both capital and labor employed in
to bag all the benefits of increased productivity was resisted by other
groups, and the real income gains spread throughout society.
A Broader View of Inflationary
still be caused when aggregate demand runs at too high a level relative
to the aggregate supply. But there is no unique link between the
money supply and aggregate demand or inflation. And across wide
in the rate of unemployment there will be no systematic relation
the level of demand and the rate of inflation.
change in the general price level is being driven by two opposing
On the one hand, there is the continuing process of cost and price
produced by the struggle for income shares, inherited from the
On the other hand, there are the cost and price reductions originating
from technological advances, the organizational revolution within
the development of new producers world-wide, and the intensification of
the competitive climate. This is an unequal struggle. The
is dissipating while the latter is burgeoning. It now appears the
problem of perpetual inflation is yesterday's story.