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Money and Economic Development
The Horowitz Lectures of 1972
Milton Friedman

SECOND LECTURE: Monetary Policy in Developing Countries

Anticipated Versus Unanticipated Inflation

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 unrest.

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.

What I’ve just described occurs in developed as well as in developing countries. It’s what underlies the American recession of 1970.

As these comments imply, the distinction between anticipated and unanticipated inflation is largely a distinction between steady inflation and erratic inflation.


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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