Is inflation always a monetary phenomenon?
By Scott Sumner
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).