Chapter 3
Why Prices Have Not Skyrocketed
It is common knowledge that the Fed created huge sums of money in order to shore up the balance sheets of financial institutions during the recent financial crisis. The assumption by many then as now is that this would lead to a burst of inflation. So, why aren’t prices skyrocketing?
For the purpose of this discussion I will define inflation as too much money chasing too few goods, resulting in an across-the-board increase in prices. Credit is a derivative of money and must also be considered since it also has a claim on goods. Deflation would be the exact opposite: Too little money and credit chasing too many goods, leading to falling prices. Milton Friedman originated the definition, more as a way of simplifying an understanding of inflation for the layman than as a serious theory of the value of money. That he did elsewhere.
The Quantity Theory of Money, or monetarism, is the accepted monetary theory of our day. Most investors, economists, and political pundits, and probably you yourself, hold that a major increase in money and credit is inflationary and will inevitably lead to higher prices. Irving Fisher formalized the theory in the 1920s and Milton Friedman expounded on the theory in the 1970s. Friedman’s clear and simple way of explaining the nature of inflation was grasped easily by professionals and laymen alike. Milton Friedman almost single-handedly waged and won the war against inflation during the 1970s, a period when we needed ...
