Something Besides Money Growth Causes Inflation?

Some economic phenomena can result from a variety of causes. A temporary increase in unemployment, for example, might be caused by a sudden, disruptive change in production technology, or in trade patterns, or in labor or tax laws; or it could be caused by natural disasters or wars, or by recessions due to monetary or fiscal policy. In such cases the exact cause is unclear.

By contrast, a few economic phenomena have one and only one root origin; when we see the effect, we can be sure of the cause. One of these is inflation. Its root cause is a settled matter for most economists. In the words of the great Milton Friedman, whose masterwork with Anna Schwartz, A Monetary History of the United States, did a lot to settle the matter, “Inflation is always and everywhere a monetary phenomenon.”
Unfortunately, many educated commentators have not learned this important truth. One of these is Robert Samuelson, who wrote in the Washington Post (“The Upside of Recession?” April 25) that government subsidies can increase inflation and that recessions can reduce it. But that ain’t so.

Growth of the monetary base is the primary reason for inflation, but there actually are other factors. It's easy for collapsitarians to focus on that one issue and fail to recognize the complexity of the situation.

To understand Friedman’s aphorism, let us consider this thought experiment: Suppose tonight, as we sleep, Harry Potter flies across the country and waves his magic wand to cast a money-doubling spell. The spell has no effect on the amount of goods and services; it affects only money. Every nickel becomes a dime, every quarter becomes a 50-cent piece, every dollar becomes two, every ten-dollar bill becomes a twenty, every checking account doubles its balance—in short, the money supply doubles overnight. What would we expect to happen to prices over the next day or two?

Even if no one knew that everybody else’s money holdings had also increased, we would expect to see prices rise very fast as sellers discover that they can charge more for their goods than they could yesterday. Picture automobile dealerships. As people perceived an apparent sudden increase in their “wealth”—it’s not wealth, it’s just money, but they don’t know that yet—many of them would head out excitedly to buy a new car. The dealerships would see many more customers than yesterday, all willing to pay much more than yesterday. The dealers would quickly raise their prices, realizing that they can charge more for their cars (which are no more numerous than yesterday). A similar process would occur at every store, market, online retailer, and real-estate agency in the land, and soon the price of just about everything would (to oversimplify a bit) approximately double.

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