Milton Friedman, a Nobel
Prize winning economist, once said that "inflation is always and
everywhere a monetary phenomenon". I believe that there is validity in his
statement if one examines economic trends over a sufficiently long time span.
The basis for his monetary view of inflation is anchored in the equation of
exchange that is highlighted below:
M • V = P • Q
Note that M is the money
supply, V is the velocity of money (i.e., the rate of turnover of money in the
economy), P is the general price level, and Q is real economic activity.
Transforming each variable into a growth rate and rearranging the terms results
in the following equation:
• • • •
P = M – Q + V
The price level P is the
price of goods in terms of money. Its inverse, 1/P is the price of money in
terms of goods or the value of money. Like any other commodity the value of
money is determined by the supply and demand for it. An expansion of the money
supply, holding the demand for money constant, will cause the value of money to
fall and the price level to rise. An expansion of the demand for money, holding
the quantity constant will cause the value of money to rise and the price level
to fall. All price level changes--- and, hence, all inflations and
deflations---can be analyzed within the framework of the demand and supply of
money. For this reason, inflation is obviously a monetary phenomenon.
It is probably reasonable to argue
that Friedman, under the circumstances in which he made the statement, meant
somewhat more than this. He also tended to argue that inflations of any
significant magnitude and duration are always money supply phenomena in the sense
that they are caused by excess monetary expansion---i.e., increases in the
money supply relative to the normal growth of the demand for money that would
result from growth of real income and the trend rate of change of velocity.