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Money and Economic Development
The Horowitz Lectures of 1972
Milton Friedman

FIRST LECTURE: A Survey for the Evidence of Monetarism

The Key Proportions of Monetarism

Finally, let me summarize what I regard as the key propositions of monetarism.3

1. There is a consistent though not precise relationship between the rate of growth of the quantity of money and the rate of growth of nominal income. If the quantity of money grows rapidly, so will nominal income and conversely. That is the proposition on which most of these charts I have shown you bear most directly. I suspect that, after seeing those charts, you will have little doubt that it is a correct proposition.

2. This relation is not obvious to the naked eye over short periods, because it takes time for changes in monetary growth to affect income and how long it takes is itself variable. The rate of monetary growth today is not very closely related to the rate of income growth today. Today’s income growth depends rather on what has been happening to money over a past period.

3. On the average, a change in the rate of monetary growth produces a change in the rate of growth of nominal income about six to nine months later. This is an average. Sometimes the delay is longer, sometimes shorter. But I have been astounded at how regularly an average delay of six to nine months is found under widely different conditions. I have studied the data not only for the United States but also for Israel, for Japan, for India, and for a number of other countries. Some of our students have studied it for Canada and for several South American countries. Whatever country you take, you almost always get a delay of about six to nine months between the change in money on the one hand and the change in income on the other.

4. The changed rate of growth of nominal income typically shows up first in output and hardly at all in prices—that point is brought out by Chart 10. If the rate of monetary growth is reduced, for example, then about six to nine months later, the rate of growth of nominal income and also of physical output will decline. However, the rate of price rise will be affected very little. There will be downward pressure on the rate of price rise only as a gap emerges between actual and potential output.

5. On the average, the effect on prices comes some nine to fifteen months after the effect on income and output, so the total delay between a change in monetary growth and a change in the rate of inflation, averages something like 15 to 24 months. That works both ways. A speeding up of the rate of monetary growth tends to have its effect on inflation 15 to 24 months later; a slowing down of monetary growth has its effect on inflation 15 to 24 months later. That is why it is a long road to hoe to stop an inflation that has been allowed to start. It cannot be stopped over night. That is really the main reason why you shouldn’t let one get started.

6. Even after allowance for the delay in the effect of monetary growth, the relation is far from perfect. There is many a slip 'twixt the monetary change and the income change.

7. In the short run, which may be as much as five or ten years, monetary changes affect primarily output. Over decades, on the other hand, the rate of monetary growth affects primarily prices. What happens to output over the longer period depends on real factors: the enterprise, ingenuity and industry of the people; the extent of thrift; the structure of industry and government; the nature of competitive institutions; the relations among nations, and so on.

8. It follows from the propositions I have so far stated that inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. However, the reason for the rapid increase in the quantity of money may be very different under different circumstances. It has sometimes reflected gold discoveries, sometimes changes in banking systems, sometimes the financing of private spending, sometimes—perhaps most of the time—the financing of governmental spending.

9. Government spending may or may not be inflationary. It clearly will be inflationary if it is financed by creating money, that is, by printing currency or creating bank deposits. If it is financed by taxes or by borrowing from the public, the main effect is that the government spends the funds instead of the taxpayer or instead of the person who would otherwise have borrowed the funds. Fiscal policy is extremely important in determining what fraction of total national income is spent by government and who bears the burden of that expenditure. By itself, fiscal policy is not important for inflation. What is important is how the spending is financed.

10. A change in monetary growth affects interest rates in one direction at first but in the opposite direction later on. More rapid monetary growth at first tends to lower interest rates. But later on, as it raises spending and stimulates price inflation, it also produces a rise in the demand for loans which will tend to raise interest rates. In addition, rising prices introduce a discrepancy between real and nominal interest rates. That is why throughout the world interest rates are highest in those countries that have had the most rapid rise in the quantity of money and also in prices—countries like Brazil, Chile, Korea and Israel.

In the opposite direction, a slower rate of monetary growth at first raises interest rates but later on, as it reduces spending and price inflation, it lowers interest rates. That is why interest rates are lowest in those countries that have had the slowest rate of growth in the quantity of money —countries like Germany and Switzerland.

This point needs little stress in Israel where linked bonds are common and where the Bank of Israel recently offered a development loan which incorporated an expectation that inflation would be at least 6 per cent a year for the next five years. Since the Bank of Israel controls the money supply, this is one prediction it can surely make true if it wishes!

The two-edged relationship between money and interest rates explains why monetarists insist that interest rates are a highly misleading guide to monetary policy.

Those are the key propositions of monetarism, viewed as part of positive economics. The policy implications that can be drawn from these propositions are by no means unique. Some people who accept these propositions draw the conclusion that monetary policy should be used as a sensitive fine tuning instrument to adjust the economy. Other people, like myself, draw a very different conclusion. We think that the looseness of the relationship, the ignorance about the details of the relationship, means that the most important thing is to keep monetary policy from doing harm and that that can best be done by producing a steady growth in the quantity of money. I shall discuss those issues more fully in the second lecture. Thank you.


1. Nominal income is net national product; money is currency outside commercial banks plus all deposits (time and demand) of the public at commercial banks.
2. Each rate of change is computed as the slope of a least squares straight line between the natural logarithm of the variable (income or money) and time fitted to three successive phase averages.
3. This summary is adapted from Milton Friedman, The Counter-Revolution in Monetary Theory, Occasional Paper 33 (London: Institute of Economic Affairs, 1970), pp. 22-26.
4. See my "The Optimum Quantity of Money" in The Optimum Quantity of Money and Other Essays (Chicago: Aldine Publishing Co. 1969).
5. "Government Revenue from Inflation, "Journal of Political Economy, Vol. 79 (July/August, 1971), 846-856.

Reprinted from Money and Economic Development The Horowitz Lectures 1972 by Milton Friedman, copyright © 1973

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