Last week I posted about an article in the NY Times entitled Monopoly, the Milton Friedman Way. It was about a game of Monopoly played according to rules derived from Friedman’s monetary theories. The relevant part read:
Prices shot up, which we all knew, even in that inebriated state, was the consequence of expanding the money supply. (After all, the great economist told us, “Inflation is always and everywhere a monetary phenomenon.”)
The inflation became so extreme that we eventually voted to alter the rules again: we’d cut the money supply. Any money we printed that came back to the bank would be taken out of circulation.
A severe depression kicked in, of course. Prices plummeted and it was a race to liquidate assets. One by one the players quickly went bankrupt, and sometime around 4 that morning the game was over.
Now according to at least one economic analyst we are on the verge of seeing this play out in real life:
A Republican plan to sharply cut federal spending this year would destroy 700,000 jobs through 2012, according to an independent economic analysis set for release Monday.
Zandi, an architect of the 2009 stimulus package who has advised both political parties, predicts that the GOP package would reduce economic growth by 0.5 percentage points this year, and by 0.2 percentage points in 2012, resulting in 700,000 fewer jobs by the end of next year.
"Significant government spending restraint is vital, but given the still halting economic recovery, it would be counterproductive for that restraint to begin until the economy is creating enough jobs to bring down the still very high unemployment rate," Zandi writes. "Shutting the government down for any length of time would also be taking a big chance with the recovery, not only because of the disruption to government services, but also due to the potential hit to the fragile collective psyche."
This is the exact lesson that I have taken from my, admittedly very limited, reading of Friedman - Deflation is worse than inflation and the way to avoid deflation is to keep the monetary supply at a steady level. If inflation has occurred suddenly decreasing the monetary supply will cause an economic contraction. We may be in a position to test those theories again shortly.