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The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it.
As a result, the price system enables people to cooperate peacefully in one phase of their life while each one goes about his own business in respect of everything else.
Prices perform three functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product—the distribution of income. These three functions are closely interrelated.
The word “pecuniary” comes from the Latin pecus, meaning “cattle,” one of the many things that have been used as money.
the quantity of money increases more rapidly than the quantity of goods and services available for purchase, there was inflation.
Gresham’s Law, “Bad money drives out good.”
money. Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation.
We know no example in history in which an inflation has been ended without an interim period of slow economic growth and higher than usual unemployment.
Price and wage controls are sometimes proposed as a cure for inflation. Recently, as it has become clear that controls are not a cure, they have been urged as a device for mitigating the side effects of a cure. It is claimed that they will serve this function by persuading the public that the government is serious in attacking inflation. That, in turn, is expected to lower the anticipations of future inflation that are built into the terms of long-term contracts.
Price and wage controls are counterproductive for this purpose. They distort the price structure, which reduces the efficiency with which the system works. The resulting lower output adds to the adverse side effects of a cure for inflation rather than reducing them. Price and wage controls waste labor, both because of the distortions in the price structure and because of the immense amount of labor that goes into constructing, enforcing, and evading the price and wage controls. These effects are the same whether controls are compulsory or are labeled “voluntary.”
less. In light of the experience of forty centuries, only the short time perspective of politicians and voters can explain the repeated resort to price and wage controls.14
policy. Emphasis shifted from the external value of the yen—the exchange rate—to its internal value—inflation.
Inflation is a monetary phenomenon arising from a more rapid increase in the quantity of money than in output (though, of course, the reasons for the increase in money may be various).
In today’s world government determines—or can determine—the quantity of money. There is only one cure for inflation: a slower rate of increase in the quantity of money.
It takes time—measured in years, not months—for inflation to develop; it takes time for inflation to be cured. Unpleasant side ...
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