The Basic Truth About Inflation

By B. R. Shenoy, HENRY HAZLITT

Summary

This April 1977 Forum of Free Enterprise booklet pairs two short essays arguing that inflation is, fundamentally, a monetary phenomenon. Part I, B. R. Shenoy’s ‘Controlling Inflation in India,’ attacks the Indira Gandhi government’s claim — endorsed by IMF chief H. J. Witteveen, World Bank president Robert S. McNamara, J. R. D. Tata and finally the Congress Party’s February 1977 election manifesto — that India had ‘reversed inflation’ during the Emergency. Shenoy traces the price-index dip from September 1974 to March 1976 to continued deficit budgets financed by Reserve Bank credit, MISA/DIR raids that forced private stocks into government godowns, food imports of 7.38 million tonnes and stalled industrial output, and notes that by February 1977 prices had already climbed back almost to peak. Part II, Henry Hazlitt’s ‘40-Year Inflation in U.S.A.,’ reproduced from The Freeman of October 1976, marshals American data showing that the M2 money stock multiplied roughly thirteen-fold while consumer prices rose about four-fold between 1940 and 1976, and warns that the lag between money issue and price response has lulled U.S. policymakers into treating an accumulating monetary overhang as if it were a benign secular trend rather than a ‘potential time bomb.‘

Essays

Controlling Inflation in India

By B. R. Shenoy

Shenoy opens by defining inflation strictly as an expansion of money that drives the General Prices Index up, then dissects the Government of India’s claim — re-broadcast in the Ministry of Information pamphlet ‘India’s war against Inflation’ (January 1976) and again in the Congress election manifesto of February 1977 — that India alone among major countries had not merely checked but reversed inflation. He argues that because households spend only what they earn, inflation cannot originate in the people’s sector; its source is the government’s secular deficit budgeting, met since 1951–52 by printing money and creating Reserve Bank credit, which is then amplified by a secondary expansion of bank credit. He shows that money supply multiplied 6.5 times between 1954–55 and 1975–76 while prices multiplied 3.86 times, and that the puzzling 18-month price decline from September 1974 to March 1976 — coinciding with record monetary expansion — was an artefact of police-state stock-piling (MISA, DIR, hoarding raids, Operation Dehoarding), tightening of bank credit via Bank Rate and Hundi Rate hikes, food imports of 7.38 million tonnes, and weak industrial demand. The fall was, in his phrase, an ‘artificially produced phenomenon,’ and the post-Emergency resumption of price rises since March 1976 confirms it; by 12 February 1977 the index had returned to 327.3, leaving the Emergency ‘incapable of continuing the price decline.’ Shenoy closes by ranking inflation as a monetary problem that neither MISA nor DIR can ‘render short work of,’ even citing a 1945 Raisman precedent for index-number window-dressing.

• Inflation is defined as a money-supply expansion in excess of output growth, measured by movements in the General Prices Index.
• Indian budget deficits since 1950–51 are financed by Reserve Bank credit, making the Government the primary source of inflation.
• Money supply grew 6.5x and prices 3.86x between 1954–55 and 1975–76; prices since 1955 typically accelerate faster than money supply.
• The 18-month price decline from September 1974 to March 1976 was anomalous because money supply rose to fresh peaks simultaneously.
• MISA/DIR raids, food imports, credit squeeze and weak industrial demand produced an ‘artificially produced phenomenon,’ not a genuine inflation reversal.
• By 12 February 1977 the General Prices Index had returned to 327.3, near its June 1955 zero-date peak, confirming the resumption of the underlying uptrend.
• Inflation is a monetary phenomenon that bottling, hoarding raids and order-magistrate action cannot durably suppress.

40-Year Inflation in U.S.A.

By Henry Hazlitt

Hazlitt’s essay, reproduced from the October 1976 issue of The Freeman, argues that most American editors and economists have been lulled into treating inflation as a phenomenon that ‘suddenly broke out in the last two or three years,’ when in fact the United States has been inflating for at least nine or ten decades. Using consumer-price and money-stock figures back to 1940 (with a glance to 1933), Hazlitt shows that wholesale prices in mid-1976 stood at 314 per cent of their 1940 level and that the 1976 dollar bought only about 25 cents of the 1940 dollar’s basket of goods. Over the thirty-six years from 1940, the money stock grew about thirteen-fold while consumer prices rose only a little more than four-fold — a gap he traces to three causes: the arbitrary choice of M1 vs M2 vs broader measures (M-2 has expanded eight times since 1949); productivity and per-capita-investment gains that have absorbed part of the monetary slack; and subjective expectations that treat inflation as an accidental rather than continuing event. Once those expectations flip, Hazlitt warns, prices may surge faster than the money stock. The essay closes by labelling the cumulative 1939–1976 monetary overhang a ‘potential time bomb’ for which it is ‘too late for continued complacency’; two appendix tables (A: 1967=100 from 1967–76; B: 1940=100 from 1940–76) document M2, the CPI and the consumer dollar’s purchasing power for the full period.

• American inflation is treated by most editors as recent (two or three years), but the data stretch back at least four decades and arguably to 1933.
• Wholesale prices in June 1976 were 314 per cent of their 1940 level; consumer prices were 11 per cent higher than 1967 over a nine-year stretch.
• From 1940 to 1976 the money stock rose about thirteen times while consumer prices rose only about four times.
• Three explanations for the gap: the arbitrariness of which monetary aggregate (M-1 vs M-2 vs broader) is measured; productivity gains; and lagging public expectations of inflation.
• Once expectations shift, prices can rise faster than the money stock — the danger of the present American situation.
• The cumulative monetary expansion of 1939–1976 is a ‘potential time bomb’; complacency, Hazlitt argues, is no longer affordable.

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