Let me turn from open or suppressed inflation to the second distinction
I want to talk about, between an inflation that is anticipated and
one that is not.
An inflation that is not anticipated produces both unnecessary economic
waste and unnecessary social disruption. The signals given by the
price system are distorted. Entrepreneurs, labourers, and other
economic actors are led to believe that the prices of their services
have gone up relative to the prices of other items, when all that
is happening is that all prices are destined to rise. Some prices
respond more rapidly than others, so production is encouraged that
will prove to be a mistake and methods of production are adopted
that turn out to be inefficient.
Socially, unanticipated inflation produces an erratic and disruptive
redistribution of income and wealth. Persons who have in-vested
their savings in forms offering a fixed interest return, lose. Persons
whose wages and salaries are fixed by custom or long-term contracts
lose. On the other hand, persons whose incomes adapt quickly gain,
and among them always are highly visible classes of new rich regarded
by the population as profiteers and speculators.
The so-called profiteers or speculators are in fact generally performing
a valuable social service by speeding up the adjustment of the price
system to the inflationary impulse, but that does not prevent them
from being the object of public opprobrium and the source of social
Both the economic and social effects of inflation are far less
harmful if inflation is widely anticipated, which is likely to mean,
if it has been proceeding fairly steadily for a fairly long time.
Under such circumstances, as you all know from experience very well,
wage arrangements will have escalator clauses, either formal or
informal, interest rates will be high enough to allow for the anticipated
inflation, and similarly exchange rates quoted for future dates
will allow for the differential inflation anticipated in the interval
in the two relevant countries.
An anticipated inflation is inconvenient because it requires changing
the numbers written on price tickets. It produces inefficiency because
it leads people to waste real resources in order to keep real cash
balances low. But an anticipated inflation produces nothing like
the amount of harm that an unanticipated inflation does.
Once an inflation has become anticipated, an unanticipated slowing
down of an inflation will have extremely harmful effects as well.
For a time prices of commodities and wages of labour will continue
to rise at the earlier anticipated rates, both because of long-term
contracts and because the anticipations will affect new prices or
wages being set. Many debt contracts will bear high interest rates
that allow for the anticipated inflation. Until anticipations change,
and until long-term contracts expire, the effect is likely to be
a severe set-back to business activity, with unemployment of men
and machines and discouragement of new capital investment.
As these comments imply, the distinction between anticipated and
unanticipated inflation is largely a distinction between steady
inflation and erratic inflation.