The cost of public construction

From chapter 9 of Free to Choose by Milton (and Rose) Friedman (starting at the bottom of page 267):

Financing government spending by increasing the quantity of money looks like magic, like getting something for nothing... The workers who build the road get their pay and can buy food, clothing, and housing with it. Nobody has paid higher taxes. Yet there is now a road where there was none before. Who has paid for it?

The short answer is "Supply creates its own demand" or, alternatively, "the more men can produce, the more they will purchase." Friedman goes with the long answer:

The answer is that all holders of money have paid for the road. The extra money raises prices when it is used to induce the workers to build the road instead of engage in some other productive activity. Those higher prices are maintained as the extra money circulates ...

One word from Friedman's answer troubles me: "instead". They write:

The extra money raises prices when it is used to induce the workers to build the road instead of engage in some other productive activity.

If, instead, they had written

... to build the road in addition to other productive activity...

they would be describing the increase of output rather than the increase of prices.

 

Friedman's famous graphs show the price level increasing on a path similar to the "money relative to output" (MRTO) ratio. Given that calculation, if money increases then prices go up, but if output increases then prices go down. The increase in output (which you would expect, if more people are working) undermines Friedman's argument that the extra money raises prices.

To make his argument work, Friedman has to assume there is no increase of output. So he says the workers build the road instead. It's a little bit true, Friedman's argument, and a little bit bullshit.

In the real world, at least in the US for most of the period after WWII and before the 2008 financial crisis, government spending on public construction was a plan to put additional people to work. It was never a plan to have people set aside productive work and do government work "instead".