Area 3: Sound Money Other Information:
Money oils the wheels of exchange. An absence of sound money undermines gains from trade. As Milton Friedman informed us long
ago, inflation is a monetary phenomenon, caused by too much money chasing too few goods. High rates of monetary growth invariably
lead to inflation. Similarly, when the rate of inflation increases, it also tends to become more volatile. High and volatile
rates of inflation distort relative prices, alter the fundamental terms of long-term contracts, and make it virtually impossible
for individuals and businesses to plan sensibly for the future. Sound money is essential to protect property rights and, thus,
economic freedom. Inflation erodes the value of property held in monetary instruments. When governments finance their expenditures
by creating money, in effect, they are expropriating the property and violating the economic freedom of their citizens. The
important thing is that individuals have access to sound money: who provides it makes little difference. Thus, in addition
to data on a country's inflation and its government's monetary policy, it is important to consider how difficult it is to
use alternative, more credible, currencies. If bankers can offer saving and checking accounts in other currencies or if citizens
can open foreign bank accounts, then access to sound money is increased and economic freedom expanded. There are four components
to the EFW index in Area 3. All of them are objective and relatively easy to obtain and all have been included in the earlier
editions of the index. The first three are designed to measure the consistency of monetary policy (or institutions) with long-term
price stability. Component 3D is designed to measure the ease with which other currencies can be used via domestic and foreign
bank accounts. In order to earn a high rating in this area, a country must follow policies and adopt institutions that lead
to low (and stable) rates of inflation and avoid regulations that limit the ability to use alternative currencies.
Objective(s):
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