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I think everyone know this Friedman quote nowadays:

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, things are not that simple. The US had emitted lots of money and has very little inflation. In some cases there's also a spiral effect. Some heterodox economists talk about lack of supply of goods too. And emission still applies only to the mid & long term.

To sum up, the questions would be:

1) Can businesses be an important cause of inflation or is it a pure monetary effect?

2) In not-so-developed countries, there might not be much competition. Can that generate inflation?

Edited. Original question: Can anyone help me understand when that quote is true and when other factors should be considered too?

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It could just be me, but this does read as: "please summarise the last 80 years of thinking on inflation & the money supply" which is rather broad. – EnergyNumbers Nov 26 '14 at 17:58
I'm disturbed by "very bad economist". It's not relevant to the question and having it here as a side note seems invective. Also: Which metric and notion of "good" are we using? Since it would likely derail the question, I removed that bit. – FooBar Nov 26 '14 at 18:38
Besides that, I agree with EnergyNumber. Not only is the first part very broad, but its two separate questions stack together without reason. I feel that if the second question would become a separate question, it would not fall under the "too broad" problem. – FooBar Nov 26 '14 at 18:40
I think you are misrepresenting what Friedman said. For sure, the quote you've excerpted does not imply that rapid money growth necessarily causes rapid inflation. Rather, Friedman's hypothesis is that it's not possible to have (rapid) inflation without the stock of money growing more rapidly than real output. – Mico Nov 26 '14 at 20:29
If you separate your "question" into two (or more) questions, you might get some more specific answers. – Mathematician Nov 26 '14 at 23:26

2 Answers 2

up vote 2 down vote accepted

The US had emitted lots of money and has very little inflation.

Are we talking about quantitative easing here? It depends how broadly you are willing to define inflation. Quantitative easing has caused asset price increases, just not consumer price inflation. Look at stock prices, which are about 50% overvalued according to some well regarded investors (e.g. Warren Buffett).

A common complaint about quantitative easing is that it is overly focused on investments and not focused enough on people (Wall Street over Main Street). It has been successful at propping up stock prices to the point that they have returned to their 2008 levels, when they were regarded as being in a bubble. Quantitative easing is heavily focused on investment assets. It doesn't seem to be getting money into the hands of consumers. Household incomes are still low.

In short, I don't believe that the current US recession has disproved Friedman's statement. The Federal Reserve has eschewed its traditional open market operations in favor of quantitative easing, which has affected investments without increasing the money supply available to consumers. A better question might be why quantitative easing is widely regarded as expanding the money supply when it doesn't seem to actually do that--at least not the kind of money supply whose expansion causes consumer price inflation.

Note: I'm sure that there is theoretical work disagreeing with Friedman's statement. I haven't tried to cover that. I was caught up in the questionable assertion that the US money supply has expanded without causing inflation. I suspect that this is too new for a consensus to have arisen. This is my thoughts on one possible explanation.

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I don't think it's helpful to refer to asset price increases as "inflation". It's certainly not the type of inflation Milton Friedman had in mind when he made his famous dictum. – Mico Nov 26 '14 at 20:55
Thanks for explanation about quantitative easing. Also thanks @Mico for your comment above "I think you are misrepresenting what Friedman said...". You're right about that :) – Diego Jancic Nov 27 '14 at 13:14

It obviously depends on who you ask, but many mainstream macroeconomists have basically dismissed the monetarist argument as incorrect and inconsistent with general economic theory. Here's a good break down of their arguments: (For the record, this is very close to what Krugman has argued as well, although his arguments have focused more on the ZLB issue as the primary reason why QE did nothing.)

But the easiest retort to Friedman's most famous work is that the money supply will never outpace the demand for money, simply because such a mechanism for forcing cash into the system does not exist. There are many reasons why banks and businesses might want to hold more cash. Uncertainty, expectations of deflation, rising prices...

In short, the idea that increasing the money supply causes inflation is based on some very strong assumptions (like a fixed velocity of money, the speed at which GDP will react to changes in the money supply, that there is some "natural" rate of GDP growth instead of it being completely endogenous, etc) which are probably not all true.

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For the record, that article makes a lot of errors. The issue being misunderstood is the type of money being created - asset money/cash which mainly effects interbank liquidity, and liability money/bank deposits which can and does influence inflation. It has also been known since the 1930's that velocity of money does not affect prices btw. – Lumi Apr 21 at 15:28

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