Name: Pratikantham Siva Rohit

Macro Economics: Assignment 3

Roll No: 1501091

1a. According to Nobel laureate Milton Friedman, Inflation is an old, old disease. We have had
thousands of years of experience of it. There is nothing simpler than stopping inflation from the
technical point of view. If inflation were a disease, then what is the cause of the disease? How do you
cure the disease? What are the effects of this disease?
Causes of Inflation:
It is a monetary phenomenon. It is caused by the rapid increase in the amount of money in the
economy than output created. Inflation increases when money is printed more than required (output).
This is evident from the graphs of several countries where CPI and quantity of money per unit of money
go with each other.
3 Reasons:
1. Govt. spending (people ask Govt. to spend more, and decrease taxes). So, Govt. prints money to
spend more or increase taxes. Inflation is also like a tax. It can cause indirect taxes. If both
income and inflation grow by same %, we will be in new tax bracket, so we are pushed down
economically.
2. To provide full employment. When unemployment rises, Govt. prints more money.
3. As decrease in quantity of money lead to 1929 depression, so Federal Reserve increases money.
Cure to inflation:
Quantity of money per unit output should be increased in other words productivity should be increased.
But if growth and inflation is decreased, then variation in quantity of money is more as variation in
output and productivity. So, the better way is to Govt. spend less and print less. All the money Govt.
spends comes from tax payers, so if they spend less, taxes will reduce and no need of printing. This will
lead to slow growth and low inflation.
Effects:
When Govt. prints more money, good comes first, economy boosts and output expands. And Bad effects
affects later. Inflation rises and cost of goods rises, so salaries will be raised, and it is a vicious cycle,
there will be high level of unemployment.
But when curing the disease, bad effects first and good affects later. An initial slowdown in economy
and Low unemployment is a side effect for effective cure to inflation. Initially there may be high
unemployment but in a long run, there will be low unemployment.
When productivity increases, output increase; people buy more, so more demand and cost increase so
prices increase. It takes 2 years to price increase.
So, if output grows slower, it is reverse process.
In slow run, side effects are there so gradual slowdown is good. So decrease inflation slowly.
Average rate of inflation has no relation to average rate of growth or average level of unemployment.

Name: Pratikantham Siva Rohit

Macro Economics: Assignment 3

Roll No: 1501091

1b. Policymakers in the 1970s saw that inflation was costly, but failed to grasp that to get inflation under
control; they needed to use monetary policy, and only needed to use monetary policy. The fact that
todays policymakers do understand this reflects the profound impact of Milton Friedman on monetary
economics. Do you agree with the broad statement that only monetary policy can cure inflation?
Explain.
Yes, I agree that only monetary policy can cure inflation. If we consider other policies like fiscal policy or
wage or price control, they are effective initially but are unsuccessful to curb inflation. A budget deficit
is inflationary if, and only if, it is financed in considerable part by printing moneythat is, only if fiscal
actions are accommodated by the monetary authorities. This is said by Friedman and it is valid still and
followed by todays policy makers. Increase in interest rates will decrease aggregate demand in the
economy which will lead to slow growth which is required for low inflation. This can be done with no
intervention of fiscal policy. Increase in money supply will have late reaction on inflation and as such
Decrease will also have late reaction in reducing it. But good effects are on long term. Slow increase in
monetary growth will have initial bad effects but long term good effects like low inflation and achieve
healthy economy. Friedman also said, Monetary policy is an appropriate and proper tool when directed
at achieving price stability or a desired rate of price change. He rightly said that at achieving price
stability or a desired rate of price change, monetary policy is proper tool as it is fast to achieve pricing
and have impact on its stability. But when comes to curbing inflation it takes times as we can see from
graph of inflation and quantity of money in US during 1960s and 70s, the effect of efforts of decreasing
quantity of money really decreased inflation only after 2-3 years.