the world has become comfortable with the new standard and enjoys the
flexibility it accords policymakers.MONEY AND PRICES
In 1950, President Truman startled the nation in his State of the Union
address with a prediction that the typical American family income
would reach $12,000 by the year 2000. Considering that median family
income was about $3,300 at the time, $12,000 seemed like a princely sum
and implied that America was going to make unprecedented economic
progress in the next half century. In fact, President Truman’s prediction
has proved quite modest. The median family income in 2000 was
$41,349. However, that sum buys less than $6,000 in 1950 prices, a testa-
ment to the inflation of the last half-century. So instead of the typical
family income soaring over 12 times, from $3,300 to $41,349 in roughly
half a century, real incomes have only doubled, from $3,300 to $6,000, be-
cause of the inflation bite.
Inflation and deflation, which is defined as falling prices, have
characterized economic history as far back as economists have gathered
data. However, in the last 60 years there has never been a single year in
which the U.S. consumer price index has declined. What has changed
over the past half century that makes inflation the rule rather than the
exception? The answer is simple: control of the money supply has
shifted from gold to the government. With this shift, a whole new sys-
tem has come into being that connects money, government deficits, and
inflation.
The overall price level in the United States and Great Britain over
the last 200 years is displayed in Figure 1-3 in Chapter 1. It is striking
how similar the general trends are in these two countries: no overall in-
flation until World War II and then protracted inflation after. Before the
Great Depression, inflation occurred only because of war, crop failures,
or other crises. But the behavior of prices in the postwar period has been
entirely different. The price level has almost never declined: the only
question is at what rate will prices rise.
Economists have long known that one variable is paramount in de-
termining the price level: the amount of money in circulation. The ro-
bust relation between money and inflation is strongly supported by the
evidence. Take a look at Figure 11-1, which displays money and prices
in the United States since 1830. The overall trend of the price level has
closely tracked that of the money supply normalized for the level of
output.CHAPTER 11 Gold, Monetary Policy, and Inflation 189