Milton Friedman Says Inflation Heading Toward 1 Percent
MILTON FRIEDMAN says inflation should be coming down to somewhere around 1 percent in the next couple of years. That's startling. Most economists figure on about 5 percent inflation. Since most economists regard inflation as a ``monetary phenomenon,'' that is, largely the result of the creation of too much new money, Dr. Friedman has a special knowledge of this topic. He and Anna J. Schwartz are the authors of ``A Monetary History of the United States, 1867-1960.'' That monumental work, first published in 1963, showed the tie between money and prices.
It also helped win Friedman a Nobel prize in economics, and is cited more and more frequently in scholarly economic journals.
``This is clearly the hallmark of a classic, since the citation rate for most articles and books in science generally peaks within three years and then gradually tapers off,'' notes economist Michael D. Bordo, writing in a new book of essays honoring Dr. Schwartz.
Friedman, though prominent as a leader of the ``monetarist school'' of economics and renowned for his work on economic theory, is not so highly regarded as an economic forecaster.
``My record [of forecasts] is not as good as I would like it to be, to put it mildly,'' Friedman noted in a telephone interview from the Hoover Institution.
Friedman is, however, more confident of his forecasts for inflation than for the gross national product (GNP).
His predictions are based on what is known as the modern quantity theory of money. Its key proposition is that a change in the rate of growth of money will produce a corresponding but lagged change in the rate of growth of nominal national income, or, looking at the other side of the ledger, national output expressed in current dollars. In the short run, changes in money growth lead to changes in real output. In the long run, usually about two years, monetary change will be fully reflected in changes in the price level.
Since the Fed cut back the supply of money to the economy to about a 4 percent annual growth rate between the first quarter of 1987 and the first quarter of 1989 from a much higher 8 percent to 10 percent rate in the previous two years, Friedman figures inflation will drop to a range around 1 percent for the next couple of years.
Economic history tells him that. History also says the economy will slow down and both long-term and short-term interest rates will decline.
Friedman sees the Federal Reserve as aiming for zero inflation. But he believes the Fed is moving too fast in this direction.
``I would not have reduced monetary growth as radically as the Fed has in the last two years,'' he says.
The result is ``an increased danger'' that the slowdown will become a recession. But having cried wolf before without the wolf showing up, Friedman is careful not to firmly predict a full slump.
He does worry that if the wolf does make an appearance, the Fed will again be frightened, reverse monetary policy, pump too much money into the economy, and thereby renew inflation.
During the 1950s, '60s, and '70s, economic growth tracked closely with a lag of nine months or so the growth of money. But that relationship broke down after the deep recession of 1981-82.
Friedman says that monetarists didn't pay sufficient attention to the consequences of a decade (the '70s) with accelerating inflation, followed by a period of sharp deceleration in inflation. When the Fed boosted the supply of money sharply to pull the economy out of the recession, there wasn't as much inflation as monetarists anticipated.
``People were persuaded that disinflation was here to stay,'' says Friedman. In making price decisions, they acted accordingly.
Friedman emphasizes that the short-range relationship between money and GNP or inflation is not predictable, though the long-term relationship is more certain. Thus he advocates that the Fed increase the nation's supply of money at a steady rate to avoid the risk of worsening the business cycle rather than alleviating it. His Monetary History offers many examples of the Fed causing economic damage.
The Fed has never fully bought his argument.