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Money and Economic Development
The Horowitz Lectures of 1972
Milton Friedman

SECOND LECTURE: Monetary Policy in Developing Countries

The Rate of Money Creation

I come finally to the rate of monetary creation. Given that a country is going to rely on inflation to finance some governmental expenditure, what’s the proper rate of inflation? The proper rate of money creation for a developing country depends in the first in-stance on whether the objective is primarily the health of the economy or the revenue of the government.

For the health of the economy, in the most abstract sense which takes minimum account of friction, the optimum would be to have a price level declining at a rate that would make the risk-free nominal rate of interest close to zero.

A more pragmatic judgment, allowing for some friction, would regard as best a roughly stable, or slowly declining price level of final products which would mean a moderately rising or roughly stable price of labor.4

For a country like Israel this latter solution will still mean a rising quantity of money. As I’ve already indicated, that latter solution would probably mean a quantity of money rising at an annual rate of something like 15-20 per cent per year for Israel.

Maximum governmental revenue would generally, though not necessarily, be yielded by a higher rate of monetary growth than is desirable for economic health. This is a technical question that I have considered in detail elsewhcre.5 Here I need only say that the most fascinating conclusion from my detailed analysis is that many developing countries in fact increase the quantity of money at a faster rate than would give them the maximum revenue over a long period.

One reason seems to be that the initial yield from a high rate of monetary growth is always greater than the ultimate yield from that rate of monetary growth, because until people come to anticipate the higher rate of monetary growth, they do not economise fully on cash balances.

Governments, being shortsighted, are led by the short-term gains to accept lower long-term yields. One very widespread misconception about economic development is that governments are generally assumed to be long-sighted, to look a long distance ahead, and to represent the long-term interest of the country. Nothing could be farther from the truth. A government’s perspective, especially in democratic countries, is limited by the period between elections, and generally it’s even shorter than that. Individuals in planning their own lives take a much longer view than governments do in planning the country’s life. As a result, short-sighted governments, seeing that they can get some more revenue in the short-term, are inclined to be very inefficient in their use of 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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