Commentary (The Times)

Monetary policy: "How to deal with inflation" (Hayek article)

Document type: Press
Source: The Times , 26 Mar 1980, p16
Editorial comments:
Importance ranking: Major
Word count: 643
Themes: Conservatism, Monetary policy

How to deal with inflation

That inflation can be stopped at any time, and can be stopped only by cutting down increases in the quantity of money, I have no doubt whatever. What I said nearly 40 years ago in the very first lecture I was ever allowed to give in this country appears to me as true as ever: that "it would be one of the worst things which could ever befall us (but which John Maynard Keynes has unfortunately brought about) if the general public should ever again cease to believe in the elementary propositions of the quantity theory."

I will admit that in its classic form, as now revived by my friend, Milton Friedman, this theory grossly oversimplifies things by making it all an issue of statistical aggregates and averages. Unfortunately the quantity of money is not a measurable homogenous magnitude but consists of a wide range of mutually more or less substitutable things of varying degrees of liquidity.

Secondly, the value of money does not depend simply on the total quantity of it being available, but also on the variable demand for it. And thirdly, the harmful effects of an excessive supply of money consist not merely in the changes of the average price level but quite as much in the distortion of the whole structure of relative prices and the consequent misdirection of productive effort which it causes.

Nevertheless, I have no doubt that inflation is caused solely by an undue increase in the quantity of money and that it can be and must be prevented tinder the prevailing arrangements only by the restriction of the basic money supplied by the central bank. There is no such thing as cost-push inflation; all inflation is brought about by what that agency of government is made to do. Nobody else can do anything about it.

The chief practical issue today is how fast inflation can be and ought to be stopped. On this, I am afraid, my difference from Friedman makes me take an even more radical position. The reason is that I believe that the artificial stimulus which inflation gives to business and employment lasts only so long as inflation accelerates, that is, so long as prices turn out to be higher than expected.

Inflation clearly cannot accelerate indefinitely, but as soon as it ceases to accelerate, all the windfalls due to prices turning out higher than expected, which kept unprofitable businesses and employment going, disappear. Every slowing down of inflation must there- fore produce temporary conditions of extensive failures and unemployment.

No inflation has yet been terminated without a "stabilization crisis". To advocate that inflation should be slowed down gradually over a period of years is to advocate a long period of -protracted misery. No government could stand such a course.

If we want to stop inflation we must do it here and now. It can be done, after the First World War the United States brought prices down by a third in six months (August 1920- February 1921). The suffering was great, but another six months later a new boom was under way.

There is no question now of bringing prices down, but merely of stopping any further rise. If this is not done by a determined government like the present, it will not be done before after a vain attempt to conceal inflation by price controls (called an "incomes policy") the pound finally collapses entirely.

The practical difficulties are due to the fact that. because of the alleged beneficial effect on employment, we have been led into the practice of increasingly financing government expenditure by borrowing - and that at the moment we just do not know how to maintain the existing apparatus of government without continuing to inflate.

F. A. Hayek

This article is an extract from a lecture to the Monday Club last night