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FOREWORD On November 28, 1978, the Center for the Study of American Business at Washington University and the Federal Reserve Bank of St. Louis sponsored aa conference on “Alternative "Alternative Policies to Combat Inflation.” Inflation." o f public policy Designed to examine the full range range of approaches to fighting inflation, the conference featured Karl Brunner of the University of Rochester, Beryl Sprinkel of the Harris Trust and Savings Bank, Bank, Sidney Weintraub of the University of Pennsylvania and Robert Nathan of Robert R. Nathan Associates, Inc. 65 guests -Over 65 -- university, business and Federal Reserve economists -- participated in -- this third annual jointly sponsored conference. Additional short presentations were given by Paul Craig Roberts of the Wall Street Journal and Murray Weidenbaum of the Center for the Study of American Business. Discussion papers were presented by Charles Webster of Washington University and Denis Karnosky of the Federal Reserve Bank of St. Louis. All papers are included in this proceedings proceedings volume in their enentirety. Summaries of the four forefour major papers are included in this fore- word and follow. "The Inflation" “The Commitment to Permanent Inflation” Karl Brunner of the University University of Rochester stated that the waves of inflation that have swept over the U.S. since 1965 have been answered each time, by by design design or accident, with with substantially lowered lowered monetary monetary each growth. Each time, however, political pressures or serious 1l misconceptions deeply embedded in in the policy making making procedures procedures of of the misconceptions deeply embedded the policy the Federal Reserve System produced a reversal in policies. He contended that these reversals ended in every case the gradual decline of inflainflation and initiated aa new surge of prices with aa deeper commitment to permanent inflation. Regarding the President's President’s intentions of reducing the budget defidefi- cits, Brunner stated that the President’s President's emphasis on government expenexpencits, ditures is probably highly appropriate with respect to aa more productive use of our resources and a correspondingly correspondingly higher real income. But he viewed it as aa peculiarly ineffective and cumbersome approach to curtail inflation. Brunner was skeptical of of the “non-control "non-control guidelines” guidelines" proposed by President. the President. Political processes exhibit apparently an inherent proproPolitical pensity to respond to inflationary waves with an an array of specific polipolitical institutions recorded under a shifting set of names (controls, income policy, guidelines, etc.). This disposition, he noted, is is parpar- ticularly remarkable as no evidence would seriously support the contencontention that incomes policies ever contained inflation in the absence of proper controls over monetary growth. According to Brunner, the experiexperi- ence accumulated with controls from diverse historical conditions overoverineffectiveness as anti-inflationary whelmingly establishes their ineffectiveness instruments. Brunner also criticized the logic of those who advocate aa policy of "permanent inflation." of “permanent inflation.” In his his view, vie1v, such such aa policy policy results results in alteralter- nating waves of increased increased inflation and retardation retardation of nating waves of inflation and of economic economic activiactivity expressed by aa decline in output and rising unemployment. 22 "An “An accommodating inflation policy may thus easily produce two or three span,'' he recessions, combined with continued inflation, over a ten-year span,” stated. Brunner disagreed with President Carter Carter that the only alternatives to his anti-inflation program are recession or mandatory and sweeping controls. ary ary.... .. Brunner stated, "This “This line is either fraudulent or illusionillusion- There is indeed only one way to lower inflation and that is to He noted that this instrument time." lower monetary growth over a long time.” of an effective anti-inflationary policy unfortunately induces aa temportemporary recession. But aa policy of permanent inflation supplemented with incantations and partially mandatory controls, i.e., guidelines, he maintained, yields the social costs associated with erratic inflation, sluggish output, and higher than normal unemployment. "The promise of “The permanent inflation inflation at cost is dangerous illupermanent at aa negligible negligible social social cost is aa dangerous illusion,'' sion,” Brunner concluded. ''Inflation -- Causes, Cures and Placebos” Placebos'' “Inflation -- and Economist at Dr. Beryl Sprinkel, Executive Vice President and Harris Trust and Savings Bank, Chicago, Illinois Illinois stated that the solusolution to breaking the inflation-recession cycle with its ever-increasing ever—increasing peaks and valleys is conceptually simple: conduct our nation’s nation's finanfinan- cial affairs in a manner designed to increase total spending in line with the increase in total production. Throughout the post-World War II period, he pointed out, spending increases have persistently exceeded output increases and inflation has become aa way of life. Dr. Sprinkel cited three causes of the current rapid rate of monetary growth: 1) the large and growing federal budget deficits (resulting in the national 3 debt rising from $31 billion in 1965 to $148 billion in 1975 to nearly $322 billion by fiscal 1g78); 1978); 2) the bias of the political process totoattenpt by the Federal ward commitment to short run growth; and 3) the attempt Reserve to choose a federal funds target consistent with money growth targets (an attempt comparable to trying to shoot a running rabbit by lagging, not leading). Dr. Sprinkel further stated that if appropriate monetary-fiscal policies are pursued, controls are not needed, and that if policies are too expansive, controls will not work. "TIP “TIP For Inflation: How" Why and How” One of the foremost proponents of tax-based incomes policy, Dr. Sidney Weintraub of the University of Pennsylvania, presented his arguments for using the government's government’s taxing authority in order to concontrol inflation. reWeintraub disagreed with Sprinkel regarding sole re- liance on monetary and fiscal policy solutions to inflation, stating liance that a stable price level and minimal unemployment will elude us if traditional monetary policies or the less efficient fiscal policy are solely relied upon. Stated in a nutshell, tax—based tax-based incomes policy (TIP) is designed Stated to levy an extra corporate penalty income tax on firms that exceed aa governmentally determined average rate for wage and salary increases. Labor would be allowed to reap some of the benefits of aa superior gain in productivity via what Weintraub termed the TIP-CAP (corrected averaverage productivity) plan. One-third of any productivity increase above One—third the national norm could be paid to the worker in wage increases over and above the governmentally pegged wage rate increase. 44 Weintraub applauded President Carter for his “better "better late than never" stated that the program 1,as never’ commitment to subdue inflation, but stated was too bureaucratic for his tastes. "Monitoring prices and costs costs smacks “Monitoring of price controls,” controls," he noted. "Inflation: “Inflation: Imperfect Markets and Government Policies" Policies” Robert Nathan, Chairman of the Board of Robert R. Nathan AssociAssoci- ates, Inc., supported President Carter’s Carter's inflation proposals "except “except for the degree of harshness of the monetary restraints.” restraints." Nathan saw the tight money proposals as increasing the odds of aa recession, but doing little to reduce inflation. He contended that it was unfortunate that the response to the President's program from the press and the financial community focused President’s exclusively on the guidelines for wages and prices. Believing that the guidelines could have a positive impact, Nathan also stated that, equally or more important were the policies and measures announced by the President concerning government spending, taxation, regulations, competition, productivity, and trade policies. Nathan challenged enterprise chalThnged those who pay "lip “lip service" service” to free enterprise and competition but practice monopoly and restraints on competition. He concluded, "If “If we are going to win the war on inflation and preserve the great free free enterprise system, we must take seriously the efforts effectively.” needed to make the market economy function more effectively." Murray L. L. Weidenbaum Weidenbaum Murray Director Director Center for the the Study Study Center for of American Business 5 5 COMMITMENT TO PERMANENT INFLATION THE COMMITMENT Karl Brunner THE DRIFT INTO FINANCIAL MISMANAGEMENT A period of remarkable economic stability ended in 1965. A The United States experienced over twenty years aa solid expansion of outoutput and employment, in contrast to the gloomy predictions made at the end of the second world war. Bursts of inflation in 1951-1952 1951—1952 and 1955-57 were successfully contained by comparatively cautious financial policies. This heritage of aa determined anti-inflationary policy was reenforced under the Kennedy Administration by an essentially modest and stable course of monetary and fiscal affairs. The price level rere- mained practically constant and interest rates reflected the absence of inflation. The prime rate stayed around 4.5 per cent until the middle of the 196Os. 1960s. AA new era opened beyond 1965. The United States entered the age of permanent inflation previously confined to the Latin—American Latin-American scene. Our economy suffered in the last thirteen years four waves of inflation 1967/69, 1972/74, with increasing duration or magnitude (1965/66, 1967/69, 1976/?). On four occasions our monetary authorities (1966, 1969, 1969, 1971, 1974) substantially lowered monetary growth by by design or accident. On in Government Policy Dr. Brunner is Director of the Center for Research in and Business at the University of Rochester. 77 each occasion the attempt at an anti-inflationary course in our policy was abandoned. Political pressures or serious misconceptions deeply embedded in the Fed’s Fed's policy making procedures induced aa reversal in policies. These reversals ended in every case the gradual decline of inflation and initiated aa new surge of prices with aa deeper deeper commitment to permanent inflation. Our policies contributed in this manner to the emergence of aa positive association, observed in the average over many years, between rising unemployment and inflation. consequences The consequences of an essentially political failure to maintain an anti-inflationary substantial time horizon were increasingly interintermonetary course over a substantial preted as signs of an intractable inflationary process “anchored "anchored in our social structure.” structure.'' At the time the Carter team shaped its policy programs in the fall of 1976 the rate of inflation had drifted to aa level of about 4.5 per cent per annum and the dollar held firm on the foreign exchange markets. There appeared aa growing chance of sustaining aa rising hope that the prevailing course in our financial affairs would produce further reducreduc- tions of inflation, halt the intermittent fall of the dollar and prevent aa new surge of the (nominal) rates of interest on credit markets. the Carter Administration wasted this opportunity. But AA persistent accelaccel- eration of monetary growth, contrasting (as usual) with the official rhetoric of the Federal Reserve authorities, and large large uncertainties bearing on the magnitude of the budget and the deficit lowered the concon- fidence in the U.S. dollar and unleashed new inflationary forces. Until the fall the rate rate of inflation had had almost doubled compared compared to to the fall of 1978, the 8 its level in and the the debacle debacle of of the marits lowest lowest level in 1976, 1976, and the dollar dollar on on exchange exchange markets evolved into a political embarrassment. The disarray in the finanfinan- cial affairs United States burdens on on foreign foreign cial affairs of of the the United States imposed imposed serious serious burdens economies and and produced produced pervasive pervasive uncertainties U.S. policies policies and economies uncertainties about about U.S. and future U.S. future U.S. postures. postures. The international repercussions repercussions confronted The international confronted economies with between large large real real burdens burdens due due to to adjusteconomies with aa bitter bitter choice choice between adjustcosts associated ments suffered by the export industries or the social costs inwith new waves of inflation produced by persistent and large scale interventions on markets. terventions on exchange exchange markets. The financial disarray was was also also rereThe financial disarray flected by the stagnation of the stock stock market. The signs of the Carter Administration's financial mismanagement thus multiplied. Administration’s eventuThey eventu- ally forced the attention of the White House to cope more directly with the persistent threat of inflation. The advisory huddle in the White House eventually produced an "anti-in “anti-inflation fl a ti on program” program" announced by the President on October 24, 1978. PRESIDENT CARTER'S CARTER’S ANTI-INFLATION AND DOLLAR SUPPORT PROGRAMS parts with very different signisigniThis announcement contained four parts ficance. It promised first to lower the increase in government expenexpen- ditures and secondly to reduce the budget deficit. AA third strand addresses aa variety of measures designed to raise the efficiency of our resource-utilization patterns and to increase the growth rate of labor resource—utilization productivity. These measures are essentially directed to raise the competitive level of the U.S. economy, to lower the extent and magnitude of monopolistic shelters granted by aa wide diversity of governmental 9 arrangements and to remove governmental impositions enforcing an inincreasingly wasteful use of our resources. The last strand introduces "voluntary" “voluntary” guidelines for wage and price increases. These guidelines are linked with an expectation that Congress will legislate aa subsidy to all workers (or employees?) accepting the limit of 77 per cent on their wage increases while suffering aa higher rate of price inflation. The announcement was not really aa “non-event.” "non-event." but all the wrong way. Things did happen, The stock market responded with aa drop in prices and the dollar slipped on the foreign exchanges. The only marmar- kets available to register voter reactions and public appraisals sigsig- naled a vote of ''no confidence'' to to the White House. House. “no confidence” Their behavior revealed in the most unmistakable fashion that the President obtained and accepted bad advice in crucial matters of economic policy. AA second huddle assembled hurriedly and produced an additional array of money" and to reverse the the drift of the measures designed to "tighten “tighten money” dollar. A substantial increase by l1 percentage point in the discount A rate and aa supplementary reserve requirement on certificates of deposit, with large denominations impounding about $3 billion of bank reserves into required reserves, should convey the idea of aa determined determined anti-inanti-inflationary shift in domestic monetary policy. These These internal actions were reenforced with measures and operations directed to the exchange market. The Swap lines lines with the German, Japanese and Swiss Central Banks were dramatically extended. Banks The U.S. Treasury envisaged borrowing The foreign currency by the sale of special drawing rights. President CarCar- ter also announced substantially accelerated sales of gold from the Treasury’s stocks and possible issues of U.S. debt instruments Treasury's 10 denominated in foreign currency. currency. These "external measures" are designed These “external measures” on the to provide the foreign currency required for massive intervention on foreign exchange market. AN EVALUATION OF THE PROGRAM The European response to the second White House huddle appeared remarkably positive. It seems generally conceded that the announcement on November 11 reveals, at long last, aa major shift in the attitude and financial policy of the U.S. government. a positive evaluation. The bond market also signaled A A consensus emerged over the subsequent days that the change in policies was significant enough to produce aa recesreces- sion next year with falling interest rates rates and a retardation in the momentum of price movements. This evaluation of President Carter’s Carter's two packages is unfortunately somewhat erroneous and suffers from serious misconceptions about the events and the situation. II will argue that some measures misleadingly convey the impression of an anti-inflationanti-inflationary turn in monetary policy when actually no real evidence supports, so far (December (December 11), this this contention. that the the II will argue furthermore furthermore’ that external measures exert, without aa generally recognized and credible action by the Fed to maintain aa lower rate of monetary growth, at most aa temporary effect. conLastly, the domestic non-monetary approach to con- tain inflation inflation is essentially irrelevant with with respect respect to to inflation inflation and and threatens us, in the absence of monetary control, with expanding conconfreetrols over prices and wages, lowered welfare and a further loss of freedom. 11 Among the first lessons of economic analysis looms the recognition no guarantee for their that the best intentions of policy programs yield no realization. The most adroit invocations with all the appropriate "Mcluhanery" offers us no assurance that the explicitly explicitly described public “McLuhanery” offers goals are even roughly approximated in reality. Economic policy seems particularly prone to the negative association between intentions and outcome. It may suffice here to note the rhetoric and the facts bearing negaon the minimum wage legislation or the noteworthy and traditionally negaReserve's words and actions.11 The tive association between the Federal Reserve’s anti-inflation program presented by the President to the American public on October 24 and on November l1 thus deserves some careful examination. Lowering the Deficit A budget deficit would certainly yield A persistent reduction in the budget major benefits for our economy. direct effect on inflation is howThe direct how- ever a negligible component of these benefits. Neither Keynesian nor monetarist analysis implies any significant impact on the ongoing rates of inflation. The encouragement to capital accumulation in the private sector seems the major gain obtained from aa lower deficit. It reduces public's portport"crowding out" “crowding out” and shifts, over the longer horizon, the public’s folio balance towards investments investments representing productive productive resources. The higher level of real growth associated with the expanded productive facilities raises over time our welfare but lowers the inflation rate 1‘The The reader is referred for a detailed documentation of this point to the study jointly prepared in 1964 with Allan H. Meltzer on “Federal "Federal Reserve Monetary Policy-Making.” Policy-Making." The study was published by the CommitCommittee on Currency and Banking, U.S. House of Representatives. 12 by a negligible margin. An indirect effect of smaller deficits medimedi- ated by the Federal Reserve’s Reserve's traditional approach in terms of money market conditions may actually be more important with respect to inflainflation. A A smaller deficit lowers pressures on interest rates and dampens political incentives to Treasury's borrowing borrowing political incentives to "monetize" ‘monetize” portions portions of of the the Treasury’s requirement. This mechanism, linking budget deficits and monetary growth, could inadvertently, without the Fed’s Fed's deliberate intention and design, produce the crucial condition, i.e., aa falling rate of monetary growth, causing aa lasting and persistent decline of the rate of inflainflation. A increasA non-inflationary control over monetary growth appears increas- ingly improbable as large deficits persist into the future. AA reduction in the deficit does not assure, however, the required decline of monemonetary growth. Immediate and direct attention to monetary growth, so carefully avoided with great circumspection by President Carter, is still the best and most relevant guarantee of aa truly anti-inflationary policy. Still, a determined decline in the deficit alleviates at least the political pressures of "accommodating monetization" and lessless“accommodating monetization” ens the likelihood of rising monetary expansion. expansion. And Budget Expenditures President’s fiscal proposals foresee, beyond the compression The President's of of the deficit, moderation in the rate of increase of government expenexpenditures. We obtain some sense in the matter with an appropriate appropriate modimodi- fication fication of an old relation between money, expenditures and the value of output. We write for our purposes + G G == PY MV + 13 where M the money stock, VVis the circuit circuit velocity velocity based based on on pripriM denotes the is the vate sector expenditures, G goods and G expresses government outlay on goods services in the national income account sense. The right side reprerepre- sents the value of output as aa product of price level level PP and output V. Y. Government expenditures are measured as aa proportion gg of private private absorption of total output. We may thus write write the approximation 6log flog MM++ 6log flog V V ++ 6g ~g - 6log VY == flog 6log PP flog i.e., over the longer run the rate of inflation, flog 6log P, equals the sum of monetary growth, the velocity trend, the trend in the proportion of government absorption minus normal output growth. AA positive value of 6g thus raises the basic rate of inflation beyond the level determined L~g by the rate of increase in private expenditures. AA negative 6g ~g on the other hand lowers the prevailing rate of inflation below the level adjusted to the expansion of private expenditures. Consider, however, some further aspects in this matter. A A single percentage point decline of gg produces in the average aa corresponding decline in log P. implies aa rereBut this percentage point decline in g g inplies duction of approximately 44 percentage percentage points in the rate of increase of government expenditures on goods and services below the rate determined determined by aa constant g. In order to produce even a small effect on inflation, aa substantial reduction of the government sector's sector’s real absorption would qui red. be re required. The President’s President's plan foresees (possibly?) aa total reduction of gg by approximately 2 2 percentage points distributed distributed over several years. at the very most This would lower by itself the average inflation rate at 14 by 1 1 percentage point per annum over this £his time period. But this nega— nega- tive 6g ~g will occur as an essentially temporary event in the hope of confining the government sector's sector’s absorption to aa lower proportion. Once this desired level of gg is achieved 69 ~g centers on zero and the temporary reduction of inflation evaporates. It seems quite unlikely that aa neganega- tive Ag 6g would tive would prevail prevail for many years. It seems seems also highly unlikely that any negative 69 enough to moderate the Ag would be (numerically) large enough inherited inflation by any relevant fraction. The likelihood of aa neganega- tive ~g 6g could thus be be expected under the best circumstances to lower the price level by less than 11 percentage point per annum over a few years. The President’s President's emphasis on government expenditure is indeed most approapprocorpriate with respect to aa more productive use of our resources and aa cor- respondingly higher real income. But it seems an ineffective and cumcum2 bersome approach to curtail inflation. inflation.2 The most rapidly expanding component of budgetary expenditures has not been considered thus far. tion. particular attenTransfer payments need particular atten- Their explosion affects the normal rate of unemployment; the inin— centive to work, and to invest in human and non-human non—human capital; and in this manner they influence the average rate of output growth over the longer run. They do not affect per se the rate of monetary growth or the trend in velocity. A A revision of the trend in transfer payments may thus importantly shape our longer run social welfare, but we cannot rationally expect from aa lower expansion rate of social transfers any 22It may be that the anti-inflationary rhetoric is considered a It may be that the anti-inflationary rhetoric is considered a to “budget "budget tightening.” tightening." useful means to overcome the political political opposition to 15 significant reduction of inflation. Any effect on inflation emerges as output produced aa counterpart to the increase in the long term growth of output by a revision of the transfer system. The cumulative impact on our general welfare may be substantial, however, even with aa vanishing effect on the rate of inflation. particular combination of events events This particular occurs in case the revision of the transfer system essentially essentially induces once-and-for-all effect on the productive use of our human and nonnona once-and—for-all human resources. on Com etition and PProductivity ro ductivit Regulation, Competition , The need to remove the many constraints imposed by government on the efficient use of our resources has attracted increasing attention in recent years. AA new magazine addressed to the financial world rere- cently argued argued that government regulation is the dominant cause of ininflation in the United States: "The costs that have been imposed on “The private business, labor and agriculture under the rules of government regulation are aa fundamental cause -- conceivably the fundamental cause -- of inflation." inflation.”33 The President and his adviser also seem to -- -- believe that measures designed to raise competitive levels and increase productivity by removing obstructive regulations and wasteful 3Louis Kohlmeier, “New "New Analysis of Regulation as Fundamental InInflation Cause,'' Cause,” Financier, September 19, 1978. 1978. The thesis advanced makes little sense. It means that regulations simply raise nominal costs, i.e., prices of inputs, without without change in the real cost of proproduction. "Regulation “Regulation inflation" inflation” is then simply aa special case of ''cost-push inflation.” inflation." But this is hardly the relevant issue. The “cost-push range of government activities alluded to actually does raise real costs and this implies aa fall in the level and growth rate of normal fail in output. The effect raises the aic! price level in proportion proportion to the fall acthe level of normal output and also raises the rate of inflation ac-cording to the lower rate of real growth. 16 impositions effectively lowers inflation. But this approach to to cope with our inflationary experiences is again futile. It fails to distindistin- guish between once-and-for-all consequences on the price price level and perpersistent effects on the rate of inflation. It fails moreover to assess adequately the relevant orders of magnitude. magnitude. A successful removal of A successful obstacles to productivity would would probably raise both the level of proproductivity and the longer run rate of growth in productivity. The level effect permanently lowers the price level level relative to any given monetary decline of the inflation rate. stock and appears in form of aa temporary p~p~a~y The longer run effect lowers on the other hand the prevailing rate of inflation by an amount equal to the increase in the normal growth rate of output. It appears in my judgment highly unlikely that the PresiPresi- dent’s plan would lower inflation via this route by anything even dent's approximating 1l percentage point. But the welfare implications propro- duced by an "opening economy" to more efficient production production propro“opening of the economy” cesses exceed by aa wide margin the negligible impact on inflation. The once-and-for-all level effect supplemented by by the long run effect effect on productivity growth would raise real income over the years substantially beyond the level otherwise achieved. The Guidelines But what about the “non-control” ''non-control'' guidelines imposed on price and wage setting of the private sector? inPolitical processes exhibit an in- herent propensity to respond to inflationary waves with an array of specific political institutions recorded under aa shifting set of names (controls, income policy, guideline, etc.). This disposition disposition is parpar- ticularly remarkable as no evidence would seriously support the 17 contention that "income policies" ever exhibited much success measured “income policies” in terms of the anti-inflationary intentions or rhetoric in the absence of adequate monetary monetary controls. of Controls over prices and and wages by by themthem- selves never moderated the the rate rate of inflation inflation beyond beyond aa shorter shorter period period without unleashing over time rising social costs and aa loss of freedom. The experience accumulated with controls from diverse historical condicondi- tions overwhelmingly establishes their ineffectiveness ineffectiveness as anti-inflaanti-inflationary instruments and their dangers to our welfare. The impairment of welfare follows from their effect on the use of our resources. The more stringent and “effective,” "effective," at least in intention, the controls are are designed, the greater loom losses in welfare associated with the resultresulting distortions in resource utilization patterns. Controls systematicsystematic- ally obstruct the adjustment of relevant prices and costs to underlying market market conditions. This obstruction distorts the pattern of resource utilization away from the optimal usages approached approached by by the operation of open markets. Stringent controls create create moreover socially undesirable short and long run incentives on the supply side. AA persistent inability to adjust prices to the realities of the market place fosters implicit rationing schemes. Personal idiosyncracies, personal and political connections, political weight, and the skill to manipulate manipulate non-market institutions or non-market relations tend to determine under the circir- cumstances the suppliers rationing behavior. The "controlled" “controlled” price raises in particular the cost of search and transacting transacting exchanges to the consumer. The resulting arrangements imply a shift from wealth maximaxi- mizing behavior by business firms (executives) to behavior more 18 utility-maximization. attentive to the executives utility-maximization. reThis involves a re- distribution of wealth from owners and employers to the management level le’~el and selected customer groups. This redistribution offers no incentives for productive applications of resources. This effect is reenforced by repercussions affecting shorter run supply patterns bearing on quantity and quality. The constraints on price adjustments direct direct attention to costs of production and the nature of the production process. lowerAdjustments are thus concentrated on lower- ing the quality of the product. There also emerges under the circumcircum- stances aa strong incentive to invest in political activities designed to influence the political institutions surrounding or representing the apparatus. control apparatus. Such investments produce at aa positive social social cost, aa positive (expected) private gain but actually yield aa vanishing social product. We obtain thus aa classic case of negative externalities and "market “market failures" failures” imposed by policy arrangements. The nature of this externality reflects the loss of welfare associated with aa socially wasteful use of resources induced by the political institution. The expolitical reality surrounding the control apparatus increasingly expolitically manipulated ploits these arrangements for purposes of aa politically wealth with little concern or interest for the initial redistribution of wealth "inflation controls." and official purpose of “inflation controls.” of The social cost of "pol iti cal investments" “political investments” tend to be reenforced by pervasive incentives to search for means circumventing the prevailing mode of controls via maradjustments in product classifications, production operations or marketing and exchange arrangements. But such adjustments require the investment of valuable resources and impose aa social cost. 19 Controls also lower the incentive to invest and explore new productive opportunopportunities. Evaluations of investment projects involve returns and costs over a larger horizon. The administration of controls unavoidably unavoidably propro- duces aa diffuse uncertainty and aa pronounced instability pertaining to the rules of the game confronting the private sector. The assessment of future returns and costs associated with any given project becomes substantially more risky. Business will be increasingly more hesitant under the circumstances to commit resources for projects with longer horizons. The volume of investments enlarging our productive potential thus stagnates and the rate of normal growth declines. We note in sumsum- mary that the consequences of an anti-inflationary approach based on controls essentially threatens to offset any gains potentially achievachievable by attempts to raise efficiency and productivity via "deregula“deregulation." tion.” The reality of controls will suffocate the promise to raise the competitive edge and to improve the use of our resources. 44 44Marxist or socialist intellectuals occasionally claim that inflainflation reflects the "inherent contradictions and the basic vulnerability" “inherent vulnerability” of capitalism. Socialist economies experience either, as in the case of Yugoslavia, a permanent inflation at aa rate exceeding the corresponding suffer from all the symptoms of magnitude in most Western countries, or suffer severely repressed inflation. An excellent article in the Neue Zurcher from Zeitung Zeit~j~ from December 9, 1978 summarizes the state prevailing in Eastern Europe with the following points: “forced savings.” i) There occurs aa substantial volume of "forced savings." Price controls imply that portions of the income cannot be be used to "infinite." acquire goods. The marginal price becomes “infinite.” ii) Large differences between unregulated prices (e.g., on the “peasant markets”) ''peasant markets'') and regulated prices iii) The pervasive existence of long queues iv) Prepayments with long waiting periods for durable goods v) A A pervasive occurrence of side payments vi) Special supplies in special stores for privileged groups 20 Three aspects associated associated with the current control program should also be noted in this context. The program was presented as aa voluntary exercise in self-restraint addressed to the private sector. emphasis suffers however 5 political market place. place.5 This under the fraudulent language pervading the The legal form and legal basis of the controls is of comparatively minor importance in this context. The relevant conditions confronting the producers in the private sector are reflected by the actual cost of non-compliance. Business firms failing to coopcoop- erate and comply may expect "attentive treatment" by aa wide range of “attentive treatment” federal agencies well beyond any procurement offices. It seems seems most likely under the present circumstances that "voluntary controls" or “voluntary controls” guidelines really involve substantial cost of non-compliance for large and well-known corporations. corporations. 66 Smaller and particularly non-corporate business or agricultural producers will hardly be seriously troubled by the guidelines. The cost of non-compliance is probably sufficient sufficient for most of the large corporations to assure some measure of careful cooperation. For this group in our economy guidelines are for all 55A in early December on some television A revealing event occurred in program. judiciously and earnestly the difprogram. AA commentator discussed judiciously ficulties encountered encountered with the enforcement enforcement of voluntary controls. At “newspeak” we are proceding well on our Orwellian least in terms of "newspeak" time schedule. 6A useful the political the useful description description of of the political mechanism mechanism governing governing the cost of non-compliance can be found in an article published in the Wall Street Journal on November 29, 1978, 1978, by Congressman Congressman Clarence J. Brown on “The "The Servility of Business." We note in particular: "The Business.” “The excuse for such pusillanimity (by the business sector) is that the 15 foot shelf of Federal regulations passed by Congress has put aa vast punishment in in any administration’s administration's hand.” hand." arsenal of weapons for punishment 21 21 22 .a. :3 Di CF .a. 0 :3 B Di CD CD B U’ 0 CD U’ . 4 The effect on the CD CF o 0 CF CD -4, CD CD r :3 0a. .- .4. C ..- &~ ‘C ~ C CO ~5 o ‘C C CD ~5 .a. U’ At a rate of inflation of 9 per cent per annum, government CF B CD CD c 0 CO .‘ B C Di CD .5 ~0 CD :3 CF C, CD .5 13 CO 0 -h Di CF — 0 :3 -4~ . -h 0 .5 Di CF CD Di CF ~ CD CD )< C, CD CD 0. U’ = 0 -‘. 4, ..a Di CF ..j. 0 -4, Di CF CD CD CF CF ~ Di CF 13 0 .a. :3 CF CD CF Di CO fl CD ~5 CD ‘C C CD posal currently provides about $9 billion worth of subsidies to employ. B ‘C 0 13 CD CF 0 ..a. CD U’ a U’ .a. C U’ C 0 -4, CF ~ ~ 0 .5 ~ — 0 C — t’ CO Di C 0 C CF CD U’ a .5 0 C ‘C .~. CF -5 CD 0 C ~5 .~ The pro13 “5 0 CD —4 ~ • B C Di .5 13 CD C, CD :3 CF 13 CD ~ a 0 :3 ‘C C CD ‘C .- Di . CF U’ C C U’ CF Di 0 CF ... Di ...a -h .a. 0 -h CD C CD Suppose monetary growth continues to raise the CD CF -a U’ CD .~. .5 Di CF 0 C CD U’ -‘. 0 0 :3 CF CF ~ Z CC .5 0 ‘C CD CF Di .5 ~ o B 13 13 0 U’ CD C U) • 0 .J. CF CD CF rt Di CO Di U’ U’ — -o CD U’ 0 B a 0 C CD U’ a CD U’ CD B Di .5 0 CO .5 13 U’ - CF CD a CD U’ — 13 .5 CD ~ CF :3 ..~. a CD a C ..~ C, .a. U’ Di ..a “0 ~5 0 13 ‘C ..a. U’ C C The subsidy proposal included in the President's program deserves U’ CD —4 -a to our crucial malady. • Di 3. ‘C Di B ~ ..a Di C C, ..~. .5 0 -5 = 0 CF 0 The current program thus imposes social costs to no avail with respect C CF C, CD U’ 13 CD -s CF ~ .~. ~ ..~. Di C Di :3 0 CF 0 C, 0 U’ CF U’ C) .a. Di 0 U’ 13 0 U’ CD U’ B .a. U’ CF ~ B ~5 Di CO 0 13 ~5 CF CD .5 C, C —4 ~ CD • U’ CD C, CF 0 a. ..a CD —i a CF .5 o I C, Q CF r CD 0 CF a. CD ...J 0 -s CF C, 0 CF 3. CD B -h .5 0 -4, CF ..i. ~ U’ U’ CD C .a. CF a CD >< 0 CD :3 expenditures shift from the controlled to the non-controlled sector. U’ 0 ~0 0 U’ Di CD U’ .4. o o 13 o .4. Di CF -4, — CF .a. Di 0 C U’ C C 0 U’ a C .a CF ~ • CD .4.~ 0 .5 13 0 U’ Di -a level of inflation substantially beyond 7 per cent per annum. -S ~0 CF ..J. C, ..J. ~0 -a CD U’ :3 CF CD a. ~0 “1 CD U’ .a. CF :3. CD -h 0 C Di :3 C, CD CD c -4, CD C, CF CD B U’ CD CD ~ 0 U’ CD Di .5 ‘C ees for every percentage point that the rate of inflation exceeds the CD CD U’ Di U’ CD a — CF C CO Di B a Di a CD CD U’ 13 .5 CD Di CF CD .5 CO ~ ‘C CO .a. r a CD U’ 13 0 C, 0 .5 Di ~ CF — Z a 0 CD U’ 13 .5 U’ -s sectors respond with a correspondingly greater speed and magnitude as U’ CD 0 CF 0 B Prices in non-controlled a 5 0 ...a ..~ CD CF , C) 0 0 .a. 0 CD U’ .~.. “0 .5 CF • CD C CD B 0 —J Di .5 CD CD I,n CF 3. CD CO fl ‘C -. -4, ~. a 0 B ‘C ...a CF Di ~ C, .a. -4, U’ .a. CO significantly modifying the general movement. -S .0 C -S CD B .5 Di Co 0 -S :3 13 0 Di CF -a. -h CD .a. -S .5 CD — -~ o CF .a. C, ..~. CF C .5 -~ B :3~ 0 C CD some passing attention. :3 — CF Di Di C ‘C .5 Di CD ..a Di CD -h a a CD (0 CD CF budget deficit seems obvious. CD >C 13 a expenditures would rise by roughly $18 billion. 0~ C benchmark. B .5 CD o Di CF ..-a. 1J ~ CD porate subsector lower the relative prices of this subsector without ~ — CF ~ 0 C CF -5 U’ C C U’ CD C, CF 0 U’ -“ r CF 0 -4, .a. C, CD U’ -s 13 CD C Di CF .a. CD ~ CD CF ~ CD ~5 0 .5 C, CF 0 CD U’ C 0~ U’ Di CF CD 13 0 0 0 a CD ~% 0 ..a :3 CF 0 C, CF ~ CD ..J. CF U’ CD B a C..j. C U’ CF Di CD 0 .... 13 .5 0 U’ C C, CF a. 0 CD U’ CD 5 C CD .-J CD .5 Di m CD a .5 0 C C ‘C a C, CD a c 0 13 CF ~ Z CO -5 0 ‘C :3 CD CF Di ~5 o B -s CD Obstructions on price adjustments in the controlled corU’ CF CF ~ (7 ‘C a Di CF CD ..a. B 0 a dominated by the monetary growth produced by our Federal Reserve 0~ 0 • Di C CF ~ 0 .5 .a. CF .a. CD U’ authorities. :3 The remarkable irrelevance of the President's explicit proposals :3. CD —4 The Rationale of Ineffectual Anti-Inflation Policies —4 continues in accordance with the momentum of private expenditures . CF C .5 CD U’ ... a ~ CD CD )< 13 CD Di CF C ..J. 13 .5 3 -h B CD CF C B 0 B CD r CF CF ~ ~ CD 0 Di :3 a 5 0 Di 0 C, .~. C CD U’ ..~. CF fl 0 The inflation, represented by general price movements, . CF U’ CD B CD 0 C B C, CD .~. 13 Di .~ ~5 :3 CD ~fl CD C ‘C a CF CD CD U’ CD CD 13 ‘. 0 :3 .a. :3 -~ Di CF —4 7 CD .a. CO .a. C —j CD ~ CD CO negligible. Di U’ Di CD :3 CF B C Co Di ~1 a But the effect on inflation still remains quite ~ .0 C ..j. CF CD U’ B Di CD ..~ ~ .~. U’ CF Di CF ..a. 0 :3 :3 -4, ..J .~. 0 CD -4-, -h CD C, CF CF -a CD 07 C CF . ‘C B 0 :3 CD C, 0 .5 C 0 -4, o CO CD .5 Di range of our economy. ND ND and argument as an anti-inflation program requires some examination. Di :3 vious paragraph would gradually appear with the lapse of time in this ~ ..a. U’ CF -‘. B CD ~. CF 0 -4, a Di 13 U’ CD CD CF .a. CF Di 13 13 CD Di ~< -~ C Di ..a a CO -5 Di a 0 C Z r 13 Di ~5 Di .5 Di (0 -o 0 C U’ -li C follows therefore that the consequences of controls traced in a pre.5 CD 13 Di ..i. a CD CF 5 Di C, 0 ...a U’ -s CF C, 0 -4, 0 U’ CD .0 C CD :3 C, CD U’ C, 0 CF ~ CD CF ~ Di CF ..h 0 .5 CD CD .5 CD CF ~ U’ 4, 0 -a —j 0 5 U’ 0 C, 0 :3 CF ‘C a Di CF 0 Di B CF 0 Di B ..J. U’ ‘C CF .a. Di CD U’ U’ CD 13 0 U’ CD U’ ~5 C 0 C, Di ~0 .5 Di fl CF practical purposes essentially similar to mandatory controls. It The explanation lies probably with aa mixture of various beliefs about the nature of the inflation process combined with aa specific perception of the White House team concerning the comparative political advantages associated with different policy options. The President’s President's presentation of the anti-inflation program on television contained aa noteworthy imputation of responsibilities. He claimed credit for his Administration having raised the level level of employemployment and lowered the rate of unemployment. The responsibility for inin- flation was subtly assigned to the private sector. There appeared some acknowledgment that government may contribute to inflation only via purchases, public employee wage settlements, higher taxes, and the FedFederal Reserves push on interest rates. But the context and tone of the presentation clearly conveyed to the listeners that the private sector dominates the mass of transactions unfolding in the economy, coneconomy, and consequently bears the crucial responsibility responsibility for the evolving evolving price-wage patterns. Inflation, in the President's President’s view of the world, forms aa social problem essentially caused by the private sector independent of monetary policy and just marginally related to the government's government’s fiscal affairs expressed by the direct impact on output and labor markets. This vision of the inflation problem naturally produces aa program assigning some some minor minor significance significance to to the the budget, budget, no no significance significance and assigning no attention to monetary policy, with most of the attention expressing the "Moses syndrome," i.e., exhibiting exhibiting aa disposition to wave a stick “Moses syndrome,” to make the surrounding world behave according to one’s one's enlightened insights. Controls of one sort or another are the natural consequence consequence 23 of this vision. The prevalent semi-socialist conceptions cultivated by by members of the Carter team on operational levels in various departments influence moreover the direction of controls and their concentration on the "corporate sector" of the economy. 77 This concentration is reenthe “corporate sector” of the economy. This concentration is reen- forced by administrative advantages of the procedure. Lastly, the Lastly, governing perception explains the ingrained failure to appreciate the real effects of controls occurring in various disguises. The view from the White House overlaps with the "sociological “sociological conception" (exemconception” of inflation extensively used by the intelligentsia (exemplified by the New York Times), cultivated by sociologists, and argued by large groups of economists in Europe and even in the United States. Inflation appears in this vision as the necessary outcome of social factors and processes deeply embedded in the contemporary social strucstructure. autonoInflation is governed according to this conception by an autono- independent of monetary and fiscal mous social process essentially independent po l 1. cy. 8 Lower monetary growth is policy. is useless under the circumstances and harmful in terms of our welfare. It lowers employment, raises unemployunemploy- ment and forces output into stagnation without lowering inflation. The 77senator Senator McGovern argued in the late fall of 1978 on television that the Democratic Party should make inflation its own issue. He He proproposed in particular that mandatory controls be imposed on the "corpor“corporsector." We encounter here aa remarkable example of how the polipoliate sector.” tical scene favoring "some “some anti-inflationary" anti-inflationary” action can be exploited for substantial substantial changes of the “system.” "system." 8Mr. Kahn seems to advance such aa view: "Mr. “Mr. Kahn sees inflation inflation problem .... " "'Inflation as aa fundamental social problem... “‘Inflation is aa symptom and aa reflection of aa society that is.. is ....in in aa state of dissolution....’’ dissolution .... "' Wall Street Journal, December 11, 1978. -1978. .“ 24 24 only solution lies in aa reform of the social structure associated with aa new array of political institutions controlling price and wage setting. Such a view would support the President's President’s guidelines and confirm a policy of mandatory controls, but hardly approve or find relevant the proposals bearing on the budget. Some versions of the “sociological ''sociological approach," offer support for a shot-gun approach to approach,” however, seem to offer the inflation problem. problem. the inflation diffuse social process with with pervasive pervasive and and ununAA diffuse social process certain ramifications in all directions may suggest that random combincombinations of larger and larger programs raise the likelihood of “doing ''doing the 9 right thing.•• thing.”9 There is a third and distinct view vaguely centered around the Brookings Institution, which also provides an intellectual basis for the President's anti-inflation program. program. President’s anti-inflation This view recognizes recognizes that This view that in in the the long run monetary growth dominates the average rate of price movements via the momentum of private expenditures. The relevant time horizon seems to involve, according to this view, an extended calendar time reaching probably up to ten years. Within this extended time horizon price levels move for appearances in autonomous fashion. Prices move over the shorter run, so it appears, independently of monetary evolution. General price movements are controlled by an inertial process subject to intermittent explosions. It is fully acknowledged that a lower monetary growth would ~y~u~jl eventually reduce the prevailing rate of inflation. But the time required is judged to be very long and certainly beyond any 9This position seems to describe Robert Nathan’s Nathan's pleaded in the discussion that the President’s President's program aa chance. 25 view when should be be he given ''realistic “realistic political considerations.'' considerations.” The responsiveness of inflation by the history to lower monetary growth is not conditioned in this view by of inflationary policies and the credibility of anti-inflationary polipolicies. Any attempt to combat inflation with lowered monetary growth propro- duces under the circumstances aa serious and persistent persistent loss of of output, aa fall fall in employment and aa heavy burden of unemployment. An anti-inflaanti-infla- growth implies aa protionary policy executed via control over monetary grOwth protracted recession with a heavy loss of welfare. The argument concludes that a wiser course avoids monetary contraction or fiscal restrictions. AA policy policy of permanent inflation supplemented with an array of political “advising” institutions shaping, guiding, supervising, supervising, “controlling” ''controlling'' or ''advising'' the private sector’s price—wage behavior appears therefore more appealappealsector's price-wage ing. claim that the This recommendation is moreover supported by the claim social cost of a policy of permanent inflation is really quite neglig— negligible. i bl e. AA Critique of Some Views of the Inflation Process The three views summarized in previous paragraphs are fundamenfundamentally flawed. The first two conceptions are in conflict with the best established parts of economic analysis. The claim to to aa total autonomy of price price movements independent of monetary growth is substantially disconfirmed by by evidence from from many different countries or historical episodes, based on data generated under widely different institutional arrangements. We note in particular that upon careful examination most of these views yield no explanation of relative magnitude or direction of inflationary movement. They offer essentially essentially untestable ex post 26 facto interpretations interpretations which fail to satisfy basic requirements of aa 1O relevant scientific hypothesis. 10 relevant scientific hypothesis. Attempts to explain inflation in terms of money wages offer some instructive material in this respect. underlying real and nominal shocks. Both wages and prices prices respond to With real shocks dominated by nomnom- inal shocks wages and prices jointly and simultaneously reflect the domdominant monetary impulse. Occasional perturbations in real conditions produce, on the other hand, as the French episode of 1968 vividly proprotrayed, aa wedge between price and wage movements. It follows thus that in either case, i.e., in situations accompanied by real shocks, or in states experiencing overwhelming nominal impulses, money wages yield no satisfactory explanation of the inflation phenomenon. phenomenon. The correlation between wages and prices substantially breaks down in the first case. This failure of correlation reveals the causal irrelevance of wages per se and reflects the prevailing pressures of nominal impulses on price price 11 It also reveals that the solid correlation between wages movements. movements.~ and prices observed in the second case simply results from the 10 lOThe The reader will find aa more detailed argument in my forthcoming Sociologipaper "The “The Political Economy of Inflation: AA Critique of the SociologiforInflation." The fact that many of these ideas and forcal Approach to Inflation.” mulations yield no propositions about the very phenomenon under considconsideration is particularly noteworthy. 11 It is is occasionally occasionally argued argued that that ''correlation “correlation does does not not establish establish causation." Indeed, but it seems overlooked that every causal hypothecausation.” hypothesis implies the occurrence of specific correlation patterns. The obobserved absence of such correlation patterns thus disconfirms quite ununambiguously the causal hypothesis. The reader is also referred to the Carnegie—Rochester Volume 99 on Public Policy. The chapter on the Carnegie-Rochester French inflation is particularly instructive in this context. 27 simultaneous adjustments of these variables to the driving causal force expressed by the nominal impulse. Some major observation patterns cannot be be reconciled with the sociological approach without adjustments destroying all relevant concontent. We observe for instance in all countries major surges of accelaccel- erating price movements and extended phases of substantial retardations. We also observe large variations in observed inflation across time bebetween countries. Any procedure which reduces this variety, in the abab- essentially sence of real perturbations, to wages or unit labor costs is essentially equivalent to an explanation of inflation in terms of inflation. thus thus offered words with essentially no explanatory power. array of “sociological "socio 1ogi ca 1 ideas" fa res not much better. ideas” fares We are The sweeping It fails to cope with the observed patterns for a simple but basic reason: The occuroccur- rence and magnitude of inflation is essentially random with respect to any of the social entities ever adduced in this context. Inflationary experiences are on the other hand not randomly associated with the evoevolution of monetary growth. In particular, no inflation ever emerged without prior monetary acceleration and no inflation was ever curbed without a lower level level of monetary growth. We should should note in aa similar vein that the variations in the rate of inflation across and over time are not randomly related to corresponding differences in monetary evol ution. evolution. The third view requires separate examination. It suffers from a faulty perception of the shorter run aspects of the inflation processes moveand the failure to link the alleged shorter run autonomy of price move- ments with the longer run conditioning by monetary growth. 28 It fails lastly with aa thoroughly inadequate analysis of the social costs assoassociated with aa policy of permanent inflation. The first two failures follow from an inadequate analysis of the private sector’s sector's price and wage setting practices. These practices occur in aa social context conditioned by systematic evaluations on the part of economic agents of the policy regime prevailing in the future. moneIt follows that the responsiveness of inflation to variations in mone- tary growth depends on the length and magnitude of observed inflation, the frequency of aborted anti—inflationary anti-inflationary policies and the magnitude or speed of experienced reversals in policy to aa renewed inflationary course. The responsiveness of inflation to aa lower monetary growth depends thus in general on the inferences made by economic agents per- taining taming to the prevailing interaction of transitory and permanent real and nominal shocks operating operati ng on the economy. This inference is influinflu- enced by the observations noted above and other information signalling ime. the nature of aa policy reg regime. This analysis implies that the course of our policies, followed over thirteen years, systematically weakened the responsiveness of infl inflation ation to aa lower monetary growth. It also ness of inflation to rising monetary growth. accelerated the responsive responsiveness The increasing appearance of relative shorter run autonomy of price movements with respect to monetary evolution should be recognized as the rational outcome of a policy implicitly committed to permanent inflation expressed by a long run pattern of monetary accelerations, interrupted by intermittent phases of retardation. This argument implies furthermore that the social cost of an effective anti-inflaanti-infla- tionary policy persistently rises oover ver time with the accrual of 29 30 0 12 Martin Feldstein recently objected in an unpublished paper that the traditional computation overlooks that the welfare loss should be considered as a stream over time and should be properly discounted. The relevant net discount factor is the time discount minus the rate of real growth. Feldstein thus concludes that the traditional argument severely underestimates the resulting welfare loss of a steady and fully anticipated inflation. ~ ~C-..aCD Di CF CD~ C~ Di — r CD CF :3 .~. a Di CF CD a ..~ .~. Di -C CT CD I CD 0 )< ~0 CD (0 CD :3 CD -S Di Cr Di CO CD -~ 0 0 C :3 CD 0 :3 Di CF .-a :3 -h .~ CF CD ~ 3 Di 3 -a CD -5 ..4, ‘C 0 5 -a CF CD Di C CD ..a. CF — CD CF -~ 0 0 0 4~ Cr CD Di B Di Cr Di (0 CF CF CD Cr n CD -‘. -s -c a Di Di CO CD —5 -h 0 Cr CD CF — CF -S 0 -c 0 -o CD ~1 0 -o x CD CF 0 9 Cr CF CD ‘-C Cr Di .4. Cr a 0 CD CF CF 0 .a. CD Cr C .4. 0 CD CF .4. CD An accommodating policy of persistent inflation introduces perV CD Cr CD C 0 o a -~ CF — o :3 Di CF ..a. -h CD CF Cr -~ Cr CD -c o 0 CC -a. -o o CO -~ Di CF o o B B o 0. C_’ Di = = -J. inflationary policies. . Cr CD 0 -a. -~ -a. V 0 CC ~1 Di :3 0 -J. Di CF -~ -4, cost components associated with an erratic and unpredictable pattern of -5 -h 0 -~ CF CD V Di CF CD CT _a Di 0 CF .~. CD 0. -~ V C Di a. 0 CF -~ Di CD Di 3 CF .a. ~ CF CD a ..a. Di 0 0 Cr Di Cr Cr :3 CD :3 CF 0 ~0 B 0 fl Cr CF 0 C., The welfare loss derived from lower real balances is supplemented by --a ‘-C O CD 0. CF -o .-~ CD B CD Cr C V Cr .4. Cr CD 0 cr Di ....a Di Di _a _5 CD CD -5 ~ 0 5 0 _5 ~4, a CD -~ ..~. C. CD Cr Cr 0 CD Di ~1 ~, -~ ~ CD -~ 3 CD 0 component of the total loss of an actual state of permanent inflation. :3 0 CF Di 4, CF CD Di 9 CD -t V 0 CD Di CF CF Cr Di -a 0 CF c Di Di 0 -h Cr 0 Cr -~ Di CF 0 CF :3~ CD CF -h 0 CF = CD 0 B -o ~ o CD C Cr CF Ca. Cr S o -5 -h -t Di CF o :3 .4. -0 Di CF CD a CF 0 3 Di ‘C C -~ ‘-C Di a a CF CD Di Cr Di o Cr Cr fare loss of a steady and fully anticipated inflation forms just one o ~t Di 5 CD 0 Cr Cr N) CD ~ CD :3- W C CF CF • Cr Di 0 CD ...a CT Di ..a CD 5 -5 CD Di .-a B Di Cr CF a. ~ a CF CD Di ..~. cr C CF CD a V C -1 CD CC CF 0 -5 CF CF Di Cr CF ~ C Cr ..~. 0 :3 .~. -h ..-.~ Di CF :3 .~. :3 CF CD Di ‘C ~0 CD -1 3 CT Cr Cr 0 0 CD a C Cr Di Cr Cr 0 CF 0 Di 0 0 Di 4, Di .—~ .~. 0 social cost caused by permanent inflation is thus attributed purely to the welfare loss associated with smaller real balances. 12 But the wel-5 CD ~ CD ~t CD CF :3~ CD -~ Di -o CO :3 0 r C CD (0 .4. Cr Di .5 0 0 C CD Cr CD Di ..a. -5 CF t Di -5 CT CD ~1 Ca CD -~ 3 Di ~c r Di CF CF a. ..-. CF 0 5 CD Di are told that "many Harberger triangles cover a single Okun gap." ~~CDCD~j CF ...4 ~. -o 0 CF =~ CD CF -a~ 0 . ..-. ~ Cr ~O Di CF CF CD -s Di (0 CD Z CD i 0 i .4. V (0 .4. A policy of permanent inflation encourages general expecç~ V 0 (0 .4. CD 1 Di CF vasive incentives into the social system to explore opportunities for Cr Di C CF 0 CD Cr 0 Cr CF 0 :3- Cr C 0 -h .4. 0 Di 0 CD CF (0 :3 Cr 5 Di Cr CD < 0 a 9 -o Di ~5 Di CF CO -~ Cr Cr Di Di 0 -c typically assign comparatively small significance to such costs. fl~ii 4,CCDCrCrCD CS 0 a .~~CD-50Cr -~~flDiC3-V ‘-CCFCF:3oDi CDCFCV DiCr CD~aCD CDOaa—s CFC-F. ..a.CD 0CF O~-.a.Cr~ .—. CD x -0 CD Cr .4. 0 .4. V 0 ~ Di CO CD fl CD .4. ~5 -c .a. Cr 0 ..a. CF CD -0 ..~ 0 -s Di ~ CF CF CD CD 5 CD -i (0 - Cr -t CD -s accelerating wage and price setting as a means of competitive wealth ..~ Di 0 0 CD Y Advocates of permanent inflation 0 .4. Di CF -.4, — CF CD Di 9 V CD 0 Cr 0 0 Di CF CD ~‘ a C CF CD 9 CF — 5 9 0 0 Cr ~. CF 0 -4, CF Cr 0 0 Di o Cr 0 CD CF the social cost of this commitment. DiDiOCDCD aC Di Cr-a-VZ:3 CFCFCFICD CD-’. 0-ac Di00-I-, a:3-.a.CDDiti CCDi:3-s-sc C-aCDtr Di Cr~C ..4 Di .a..3. a.sCFaoCr —hCrCF —ICC Di ~Di0 5CFCD300 CDr a,v0 DiCF CrLa. 4 ... CFCr CD o 3~CF0 CrCFCD0~CF Cr~ CDiCD CDa.-aCFa o .~.a -hCFCr CF Such explorations in price-wage policies exploit the political C 0 Di CF transfers. Cr CF 5 Di CD B — CF CD -S C 0 Cr CD Cr .4. 1 Di Cr 0 ..a Di 0 — Di CF ..4 -h — CF CD :3 Di 9 -1 CD 0 -o CF CF CD CF B .~. 9 3 A commitment to permanent inflation also raises over time 0 0 > -~ a (0 CD CD CD CF -a the ledger. 0 4 CFOCD ~C-a.-a.C:3 CDaCrBCDCF ~ CD5-4 average. (I’ tations that the emerging price-wage patterns will be validated in the Cr CF Di CF .4. 0 These policies, however, also affect the other side of 0 -4, a CD — Cr CD ~5 0 CF CF ~ CD 4~ CD 0 CF 4, Di 0 ...a Cr Di ~s -a CD C ~ 0 ~ CD Cr CD .4. 0 a. ...~ 0 V CD Cr CD —I ~ • :3 0 ~4 .4. -~S :3~ 0 .5 CO CD 0 :3 ...~ longer horizon. CCr—4, Di-.a. Di0CF CF00<_h ~.OCFCDO_5 ~305CD Di C CD -~ Di CO CD • It is largely the consequence of the policies pursued over a Di CD C 0 Cr C CD a -o C -5 CD Cr 4. 0 .4. 0 V CF ~ CD -I, 0 Cr CD .0 C CD 0 CD :3 o (5 CD ~ CF ~C CD ..a Di -5 Co Cr .~. CF — • CD C -5 CF ture. Ca) VC(0_5flCF Di~5CD0~ CFaO.~a:3CD CDCDZCDCr a-SCFC-a.CF CD~Dia-1 ..~.Cr CDDi ..a 3CF CF-saN) —~9-n:3aCFDi DiDiCDCD ..a.5 CFCF~.aCFDi0CF ..a.CD~ Cr-4. OCrCra 4 Di 4CF- Di--’ -n CFCDCr ~- .0Cr0CD CD0CF0_a C-isa SCFCDVCr CDCFDiCCF CrC BCFCD I Cr CF -5 C 0 -~ Di Cr 0 0 0 C Cr B Di C CF 0 :3 0 Di 0 ‘C a 3 CD .4. 9 a CD CF CD 5 CF :3 CF Di Cr 0 ~ Di CF :3 0 — Cr () 0 Cr CF Di social cost is not a constant determined by an autonomous social struc.4. 0 0 Cr 5 — Cr 0 — Di CF :3 -4, CF Di :3 CD 9 -~ V CD CF 0 CF CF 3 CD 0 0 CD r CF :3 (0 -1 9 .~. -4, 0 0 a -a. Di CF 9 -1~ 0 .4. information confirming the commitment to permanent inflation. This We The process to produce under appropriate pressures an accommodating stance in financial policies. perIt follows under the circumstances that aa per- manent policy of accommodating inflation will experience repeated waves of increased inflation. Every surge in price movements introduces new political opportunities and raises political rewards for the supply of ''leadership inflation.'' “leadership in the fight against inflation.” obThis pattern has been ob- served on repeated occasions and all over the world. The resulting shifts in financial policies unleash unavoidable retardations of econeconomic activity expressed by aa decline in output and rising unemployment. A policy of permanent inflation produces, therefore, sequences of subA substantially accelerated price movements interrupted by retardations with declines in output and higher unemployment. An accommodating inflation three recessions, combined with policy may thus easily produce two or three continued inflation, over aa span of ten to fifteen years. The current value of the costs determined by the future series of recessions forms an important component in the relevant social cost of permanent inflainflation. This series may already balance the social cost of aa determined policy designed to lower monetary growth gradually and predictably over 13 four to five years. years.13 13 13One one may object that the comparison is incomplete. Fluctuations in output and unemployment under permanent inflation should should be be compared with similar fluctuations emerging in the absence of inflation. This is, however, not the relevant comparison. comparison. We need to compare the real fluctuations produced by shifting nominal impulses typically associated with the alternative policy regimes. The crucial point emphasized in the text is the comparatively higher higher variance of monetary growth under a regime of permanent inflation. The almost explicit refusal by the FedFederal Reserve authorities to consider monetary control or implement apappropriate control procedure, combined with the Fed bureaucracy’s bureaucracy's traditraditional notions, will most probably produce an erratic course of permanpermanent inflation. 31 32 CD U’ V 0 3 .4. Di :3 a Di V .~. CF Di C, 0 . 0 -5 CD ‘ U’ .4. a C, .~. .-‘. V to ..J. U’ 0) CD .5 C, :7 ..4. 0) 0‘C U’ • CD .a. CF ..~. V 0 5 CF C 0 V 0) .. .... CF .5 V 0 CF CD U’ U’ CD a ..J. ~5 CD CD .—‘ Di 3 V U’ :3 0. 0) r C, CD Di 5 CF CD 0 CF .... )< V CD U’ CD C, ..~. -~ ~O CD C .~. CF Di —J CD U’ 0 CF U’ CD C) 0 C CD U’ Households will find it advisable to invest more time, effort ct -s 0 r CD -~ The -4 H~ CD .. CD 3 .~. CF 0 .5 CD 3 CD U’ CF C ..J. 0 CF CD —~ CT Di a C ..~. U’ 0) CF .~. a :3 -.. t -~ ~ U’ 0. ..~ 0 ~ CD U’ C = 0 • 0 :3 U’ ..~. 0. ..~. CF raises the cost of acquiring given information levels about market con~r I 0 C, CD CF .5 3 Di CF Di CT 0 C CD ...J U’ C CD ~J 0 .a. 0) CF ~ -1, 0 .5 3 ..~. C CD .~. to :3 to .~. ~5 .4. C .0 Di C, -4) 0 CF U’ 0 C) CF CD CD U’ U’ -a. .5 Di larger inflation lowers the information level of economic agents and = a Di U’ CD :7 CF 0) to C, ..~. 3 0 0 C, CD -.4, 0 —~ —~ CD C CD 0 CF Di 3 .5 0 1) .~. CD r CF U’ CD 1 ~ 0 ~ 0 .~. CF 0) :3 -4, ..~ — to CD ~5 Di ..-‘ But the greater dispersion generated by ‘C CT a Di CF CD CD CD to 0 .~. U’ CD .5 ~ U’ ..J. 0. .5 Di CF CD CD to ~5 CD ~ CF CF C CC] • :3 0 .~. ...~ Di CF -4, :3 ..~. 0 -h CD CF .5 Di ~ CD .5 0) to CD positive association between the dispersion of individual prices and the CD .4 CF ~ a Di U’ CD C, V 5 ..~. ...J Di C a ..~. C -a. a .4. -h 0 V CD -s U’ 0 U’ .~. 0. ~ CD CF CD CD Z CT CD CF 0 -a. CF Di -a. C, U’ 0 U’ C CD Di .4. ..~. CF U’ V 0 Some recent work indicates a 7 Di U’ CD CF C, Di .~. a -4. 7r 0 .5 CF CD C, 5 CD CD 0 3 (1) :3 . 0 .~. CF CF CD CF Di CD 0 3 U’ U’ C CD .5 CD U’ CD 0. 0 ..J. 0) CF ..~ -4, .~. CD :3 CF Another dimension of uncertainty produced by a regime of perman- manent inflation. U’ ‘ :3 3 Di CD 5 V -4~ 0 CD 3 .4. CD to Di ‘C CT C C, CD 0. a 5 0 V CF ‘C .~. CF , .5 V CD CT ‘C CD 0. C, a C 0 .5 V CD CF Di ~5 >< Di CF ..j. C CD C, CD H, CD -b :3 Di CF Di to 3 Di -s CD CF :3 CD ~ >< Di -1~ 0 0 ..~. CF Di CF C, CD V CD CD CF ‘C CT C) CD a 1 0 -h CD CD -~ CD 3 Di ‘C CT CF C, CD -h CD C CD .~. CF C, ~5 CD Di U’ CD C, ..~ U’ .~. 0. U’ -~. —4 r This disincentive effect may be reenforced by the expectation of a -~ C, .4. 0) CF 3 U’ CF CD ‘C ..a. • r 0 .4. Di CF ..a :3 -4~ .a. CD :3 CF Di systematic increase in the marginal effective tax rate produced by per- ~s CD C, C :7 -,, 0 0 .~. U’ CD 3 -J. 0. CD .5 > 0 CF 3 C, • CF ‘C .~. C, 0) V Di C, C CD .~. CF C, a C 0 V 4, 0 0 .J. U’ Di V >< CD CF ~ CD -5 a U’ -5 CD CF Di a Di 0 .~. Di CF ...4 3 C C) C 0) <) .4 CF Di -J. Di V capital accumulation and retards the expansion of productive capacity. U’ CD C, V C CD .4. U’ 0 CF V Di U’ — 0. CF CD CD Di .5 to Di 0) :7 0. U’ 0 :3 CF CD Di ..a. fl 0 U’ CD .5 0 ..~ CD to 5 .~. -h CF U’ .~ ‘C CD a ...J ‘C 0 ~5 3 0 CD Z a -.. Di V CD 3 CD U’ C, C .~. U’ CF -.4~ ~ U’ CD -5 larger shifts in relative prices expressed by an increasing price dis- (0 and resources to search and sample their potential opportunities. 0. 04 The higher level of risk affects investment and lowers U’ 0 ~ CD ~5 a Di CF CD 3 CF U’ CD -C .~. U’ CF C, -4, CD -4, Di 7Z~ ~s .~. U’ -h 0 c CD CD ..~ to ~ CD .5 .~. CD r 7 —4 . r tr 0) ..3 C) CD 3 CF -5 0~ behavior of specific socio-political institutions centered on the CD ~ CF 0 a CD -s CD CF CD C, U’ 0 .~. CF CF C ..J. CF U’ ..J. Di C, .~. CF .~ . 0 i -o 0 ..4. C, U’ 0 C, ..~. -4, C, .a. CD 3 .a. CD CF 0 CF ..... CD CT 0) CF C CT CF CF .5 Di U’ CD CF .-~. r .5 CF Di ..~. CD C, C .-‘ Di :3 o .J. CF .~. O~ ‘C Di a a a CF CD :7 CD (0 c 0) -o CD U’ Di -~ .. CD CF r Di 5 3 market, are augmented by additional uncertainties attributable to the -4~ 0 0 -J. 0) C • CT CD nature, including the tastes and propensities of people revealed on the . ~ CD CF :3 0 a CD ~ C CD CD .5 CD ..-. 0 V V CD 0 -4, U’ ..~ CD U’ .4. CF V CD 0 V 5 a Di Di U’ CF CD U’ CF CD CF ~ 3 to ..~. 0. C .... C, .~. ~5 CD c Di CF ating on the social system as a result of the real shocks unleashed by CT ‘C a T CD U’ CD Di C U’ C, 2C ~ 0 U’ Di ... .5 CD CF ~ CD 0 CF .‘ C U’ -5 CD 0) 0) CF CD 3 Di U’ U’ ‘C Di .~. C, U’ 0 CD r CF 0 :3 ~ tfl Di CF CD The basic uncertainty oper- :3 ‘ CD ~5 V 0 ‘C CF ..J. CF Di CD C, C C, .~. 0) U’ CT -4 ~ CD . CD U’ C, :7 Di CF U’ c 3 C, .5 .~. C, ~ CD CF -~ CD 0. C U’ CD U’ 04 C) ~5 .a. ‘C ....~ 0) -‘. CF tially increases under the circumstances. CF More rapidly or more widely shifting relative prices 0 ~ • U’ CF a 0 C, U’ ...~ 0) — 0 :3 U’ persion also induces more social tension and a greater disposition for -4~ 0 C, .—~ . 0) ~5 ent inflation deserves some attention. o 3 0) -J. Di -s ~ CD general rate of inflation. C 3 C Di CF CD a C, C, o -h Di Di ‘C C, social conflicts. C, Central Bank. 0. CD 2V~ C, C U’ 0 ditions. .0 0) ...~ C CD o 7 C future returns and costs resulting from longer range projects substan‘ 0) CF U’ CT C U’ CF U’ C, CD C.j. 0 5 CD V to :7 .5 Di :7 to CD .5 0 ..4 0 3 .-4, ~5 to :3 CF ... ...a C U’ ~5 CD U’ CF U’ 0 C, 0. 0) U’ ~5 C CD CF -5 CD -4, C CF C CF The penumbra of risk associated at any moment with CF .~. ~ CF CD 3 0 3 ‘C 0) Di CF a Di CF CD .4. 0 () U’ U’ Di 5 CF CD C, C -,, 0 .-J C CD CD .. T CD CF U’ CD U’ ..3. 0) .5 0 ..). 7C Di 0) CF U’ .~. -4, .~. CD -~ 3 Di ~ CD CF V -4, 0 CD 3 ..J. (0 CD .4. C, 0 U’ In Di ~ ‘C Di C, CF U’ CD .5 CF C, 0) ~5 Di C, ~ ‘C C, .4. 0 V Di -~ ‘C CD CF 0 3 -4i 0 CD U’ 5 C C, 0 C, .4. CF Di .5 CD -S .5 Di ~ —4 -~ CF 0~ CF CD 0. ated with a regime of permanent inflation raises the level of uncertain..~. -4, 0 c 2 CT .5 0) V CD :7 CD ~ —4 • 3 ‘C 0 0 C) CD CD r CF ..~. ‘C ty in the economy. (.3 involve a quick decay of accumulated information capital and impose .~. The erratic course of monetary policy characteristically associ- heavier and unexpected adjustments on various social groups. widenThe widen- ing price dispersion means substantial wealth transfers between shifting social groups. The social tensions fostered by this process are not ''labor'' and based on systematic transfers between broad groups, e.g., “labor” "capital." “capital.” The transfers are almost randomly distributed between many smaller and changing groups. This random impact is particularly prone to encouraging diffuse social unrest and tension. The permissive regime of permanent inflation may also contribute contribute to raise the average (i.e., normal) rate of unemployment. A A pattern of accommodating policies unleashes incentives fostering aggressive wage setting policies. about monetary accommodaWith given expectations about accommoda- settlements become an instrument of shorter run tions, aggressive wage settlements wealth transfers. Organized suppliers are systematically induced to overestimate the most probable degree of accommodation and risk some measure of additional unemployment. The possible wealth transfer still still affects aa large majority of the organized suppliers and the social cost of the unemployed minority is shifted via the welfare system to the rest of the community. The social costs resulting from an open inflation do not exhaust the problem. The discussion, presented in aa previous section, of the real effects associated with controls over prices and wages circumcircumscribes the nature of the additional costs. These costs emerge in resummary as a consequence of the distortions in the utilization of resources, augmented by the effect on the short run supply of of output in terms of quality and quantity, reenforced by the allocation of resources of the political process involving a (socially) negative sum game of 33 34 a CD Di CT ‘C 5 0 v CD CT CD CT Di 0 Di — Cr 0 0 I Di — V C Di 9 0 C Cr _a 9 — Di 0 — -4, Di Di C CF 0 :3 Di ‘C — — 0 5 CD Cr C t 0 -5 0 ~ Cr ~ Di -4, 0 5 CD CD ..4 ~ - ~ — 0 Di CF -h -4. CF Di :3 CD 9 V CD 5 , CC (0 ~ — Cr Di CD o 5 — Cr Di 7T CD 9 ‘C — 0 0 -a 0 C CD CT Di CD 0- CF CD Cr CD V Cr ~ CD 4. C CD CD . -a CF CF ~ CD 0 CF C 5 CD a — x I 9 Di CT ‘C a ~ CD 0 C CD 3 CD — (0 CD .5 0 ‘C — V 0 Di :3 .~. CF r Di CF ‘C Di Cr CF ...a 0 CF CD 0. 0 C -a Cr r CD - a CD ~a. Cr ~ CD 5 0 CF CD -a CF 0 Cr CF 0 0 Cr Di — Cr 0 0 0 CF ~ CD . CF — ~ a CD CD ~ CF (a 9 Di C (0 Di V Cr 0 ~çC 0 CF ‘C — n —• V CF C 9 Di a Di Cr ~ a CD CD 0 CD CF 0 ~ (0 5 0 ~ CF Di ~ ‘C CF CD 0 :3 9 CD Cr CF Di CT 0 —4, ‘C 0 — V 0 Di 5 ‘C o . Di CF I -a. 0 ~ CD a — ~ CD CF CD 5 9 Di -a CF ~ ~ Di CF CD — fl I Di Cr Cr 0 V Di CO C r 0 CD CO — Cr Di CD ~ CD CD CF CT .4 ‘C Di CF CD 0 V -s Di V V 0 -i CD 3 Cr CD 5 Cr CD 0 . . CF 0 Cr >< CF Di C-a. C . 4 CD C Di CF CD 5 ~ CD - CF — V 0 Di — C n 0 CF ~ CD Cr Cr CD Cr a. 9 ~0 Di 0 ~ C (0 ~ -~ ~ ‘C Di ~ Di CF r ~ r CD Di . I — ~5 CF 5 (0 CD -~ CF ~ C Cr CF -5 CO C 3 CD ‘C Di ~ Di 5 • Cr 0. CD — Cr ‘C V Cr C V CD -a CF 0 ~ 0 CD Cr .0 C CD CD CF 5 0 Cr 0 CF 3 CD 0 CF CF V CD 0 5 CD Cr -a CF — Z 0 Cr -a. C CF CD 0 ~ CT CD 0 0 (0 (0 CD a 0 CF ~ CF CF CD 5 9 CF CD CD C CD 0 CF CD CF Cr — CD 1 Cr CT ‘C V C Cr CD a Di 0 : Di 9 0 a CD Cr CF 0 -4, Cr 0 —‘. 0 0 9 V Di ~ CD CF CF ~ Di CF Cr CF Cr CD Cr C ~ (0 ‘C C CD -a~ CF Di c-I- CD CF —a. 0 5 ‘C 0 I CF ~ CD Di 0 s 3 Di — CD Cr ~ CD ‘C 0 t Di a CD Cr CD 0 a Di CF CF ~ Di V 0 CD Di a .-a C 0 Z CF — • ~i — CF r CD 9 ~i 0 .~, :3 Ca — CF Di CD 9 Di 0 0 Cr CF Di — Cr 0 0 CD ~ CF ~t 0 :3 CF 5 CD CF 5 CD Di CF Di 0 Di Cr C -5 — CD CF :3 Cr Di CD Cr _a. CD )< 0 0 V 0 Cr Cr — 0 — 3 0 CD CF a Di ~ — 0 Di CF -4, — CF V CD ~5 9 Di 3 CD -h 0 CD Cr Di CF Di a C 0 0 CF ~ CD ‘C CT a CD a (0 Di 5 Cr -5 CD — 0. CD CT CF 0 CD Di 5 Di V V CF Cr 0 -h Di —4 r CD Cr CD • Cr - 0 0 ~ CF fl -a CF — ~ :3 CF Cr 3 CD 0 C CD B 0 CD .. V 1 —4, 0 Cr CF — 0 Di -~ CD CD Di 0 CD CF CF CD CF .~- 5 3 CF CD — CF 0 a CD Cr V 0 CF 0 0 CD Cr Cr o V Di 0 — CF -a. 0 V ~ CF 0 -4~ CF a. 0 0 Cr V Cr -a. a CD a C Cr CD i 0 CT I CD CF ~ ‘C a ~ 0 0 CD Cr Di Z a CD Cr Cr 0 -a -s 0 ‘-~ 0 Di CF V 0 ~ CD CF -4, 0 CD -~ Di CF C CD ~ CF ‘C CT V -5 0 a C 0 CD a ess, and seco ndly , the obproduced by the natu re of the pol itic al proc to respond to inte rmi tten t served disp osit ion of the pol itic al process s. These fact s appear to acce lera tion s of pric e movements with con trol t infl atio n and the omission be disr egar ded by the advocates of permanen al cost emanating from the ir exp lain s the ir casual trea tme nt of the soci Keynesian macro-theory poli cies . It would appear that decades of equences on the supply side clogged the visi on with resp ect to the cons trol s. My argument thus caused by pers iste nt or even inte rmi tten t con a modest "Harberger tritent ativ ely sugg ests that the comparison of ial poin t. The rele van t angle" with a yawning Okun gap misses the cruc een a sing le Okun gap asso juxt apo sitio n seems more app ropr iate ly betw cy of stab le monetary ciat ed with a determined non -inf latio nary poli Okun gaps augmented with growth on the one side and a mul tipl icit y of . Cr 0 (5 -a. Di CD >c V 9 0 0 Di — CD 0.. 0 Di 0 ‘C .. a CD CD V 0 -h i ~ ‘C r CF CD CF CF V Di Di 0 CF = — CD Cr 9 — 0 0 0 CD . — .4 CT Di 0 CF Di 5 CF — CF -0 Di 1 CD V Di Di CF r CD 0 0 :3CF (0 5 0 CF Di 5 ‘C CD 0 B a Di 0 — Di CF 0 -4, ‘C CF -~- CT — Di — Di 5 C C CD a _5 Cr CD CT 0 CD CF Cr CF — -4, -h Di 0 CF Cr 05 B Di Ca. 0 3 CF Z 0 -h C Cr CF 0 ~ Cr 0 0 — Di CF —1s . CF CD Di -s B V CD 0 4~ 0 0 Cr CF Di Cr 0 0 CD —I ws thus from two major The soci al cost of permanent infl atio n follo infl atio n and monetary growth fact s: firs t, the observed var iabi lity of a • ~ CF ~ 0 (0 ‘C 0 m CD CF Di CT CD a 3 0 Di a V 0 Cr CD a 3 — — 9 CD 0 CF Cr . CF ‘C — .. -s CD (0 0 ‘C Di a CF 0 I 0 CD ~ Di V 0 CD CT CF Di CF ‘C CD Di 0 3- CF ~ CD ~ 0 ‘C CD 5 (0 CD Cr 3 CD - 0 C CF V C CF 0 4~ CF ~ r- 1 0 (0 5 C -~ CO CD a longer run growth of outp ut. CF 0 CD CF C CD CT — Cr CT 0 a C 0 CD a CD a -a CF C CF ~ ~ CF -s Di 0 V 0 — Cr a CF — CD Di 0. • C Cr )< CD CT - 3 0 — CF CD - CD CF ~ 1 -t Di othe r soc ial cost s on the othe r side . e governed by a mixWe should note last ly that in a poli cy regim cy makers incr easi ngly ture of the thre e views pres ente d above, poli anent infl atio n. There lock the ir economies into a patt ern of perm anchored in a complex soci al emerges an apparent intr acta bili ty "deeply cial ) fina ncia l manipulanexus beyond the reach of shallow (or sup erfi sed by an autonomous soci al tion ." But this intr acta bili ty is not impo and can be broken by a defate . It is produced by the poli cy regime lled monetary growth. And termined and cred ible retu rn to a wel l-co ntro CF CD 0 CD CF 0 CD 0 CF CD -h -h CD -a CF CT ‘C CF CD a 9 CD CD Cr C V V ‘C Di Cr CF a Di 0 CF Cr — —i -t 0 CD — C C CF — CT Cr CF a -S CD nted by the effe ct on the red istr ibu tive con flic ts, and last ly, suppleme whatever the level to which the social cost of anti-inflationary polipolicies drift as aa result of the previous long-time mismanagement, the social cost of permanent inflation probably drifts even higher. But the selective myopia fostered by the incentive system prevailing in the political process, so clearly represented by the Carter team, disdiscounts heavily the future cost accruing from the permanent inflation and concentrates on avoidance of the contemporary short run cost of an effective anti-inflationary policy. This vision influences the "pro“pro- gram” offered by the President, aa program disregarding monetary policy gram" and offering the appearance of judicious and concerned leadership. Once the unavoidable failure of such aa program becomes generally acknowacknowledged on the public scene the President may safely invoke either one of the first two views of the inflation process and accuse the private betrayal” or "inadequate “inadequate cooperation" cooperation” in the governgovernsector of “social "social betrayal" ment's ment’s attempt to cope with inflation. Mandatory controls supplemented and bank credit will be probably with controls over interest rates and possibly presented at the time as imposed under the circumstances and poss1bly the "moral equivalent of war" (or the the “energy "energy crisis”). crisis"). the “moral equivalent war” (or And so we we would would And gradually sink ever deeper into the Latin-American swamp. What About the Discount Rate and Reserve Requirements? Some readers may object and insist that aa turn in the trend of monetary policy has been clearly signaled. The discount rate was raised by aa whole percentage point and supplementary reserve requirements on certificates of of deposit with large large denominations denominations were were introduced. introduced. certificates The The change in the discount rate was indeed large by historical standards and the reserve policy action lowers the monetary base (by itself alone) by 35 36 r • Low interest rates were CD CD U’ CF CD .5 Di CD 5 CD U’ CF CF .5 CD a to CD Di U’ CF — CF C, Di C C-a. U’ .5 Di ~ H, H, Di ‘C Di 5 CD CF 3 0 H, 0 0 Di CF — .~. H, —4 ‘C — to ~‘ U’ ‘C Di H, 0 CD C, . Di U’ C C U’ ~ Di 0 — CF 5 CD CF Di 5 to CD CD CD 3 CF -a CD CD CF -s V CD CF .a. ...a Di — • 0 — U’ U’ CD C, 5 CD CF CD -~. V C, — CD -a CF ‘C CT a .5 CD U’ CF CD -4, 0 0 U’ — CD CD 5 V V Di ...a Di C, ..~. CF — .—‘ 0 V to ..a. U’ CD Di .5 C, — CD CF ~ -s CD :3 a C U’ .5 CD CF C Di 5 .0 CD -a 5 CD CF y — CF ~ — CD 0 C 5 U’ C, ‘C Di -~ 0 -‘. CF Di -a CD a CD U’ 5 C CD -5 CD CD CT .~. .-. ~ ‘C C, _a — V 0 Di CF ~ CF U’ U’ CF to CD C to U’ 0 .4. CF — CF C CF U’ — C, ‘C V 0 ..a ..~. • CF CD CD ~ CF a Di ‘C 0 1 U’ CF ~ .a. 3 0 H, CD C, CD 0.. — CD C CD CT — ...a Di Di C Di CD CF ~ -~‘ Di :7 CD .4 CF -. 3 Di CF -s CD CF ~5 Di C) CD ~ ‘C CT ‘C CD a CD C 0 C, U’ -5 CD U’ U’ .a. 0 V 3 — CD CF -a Di ...a ...a 0 CF Di -s ‘C -5 :3 CF 0 C, . ~ 0 ~ CD C CD -~ CF Y -s ~ -5 0 to ‘C .5 CD CF Di r 3 monetary growth, however, contrary to all the impressions conveyed by 0 In case the Fed actually reduces U’ CD C, 0C CD -s ..a ‘C .-.~ CF C Di C, Di 0. CD -ri ~ CD CF CD Di U’ C, — • U’ V -S 0 to .5 CD U’ U’ CD —4 ltD —. ...a 10 -.) 03 -4, 0 ~5 CF CD — :3 ~ CD ~ CF The probability of moderating monetary growth thus declines as U’ Di CD U’ ..a — C, a CD U’ C -a CF CF ~ ~ 0 to ‘C CF Di CD 3 0 to Di CF .a. CD a 0 3 H, 0 ‘C CF -. -~. V 5 0 CT Di CT CD r —4 • ~ 0 tO —~ ~. recession threaten to determine the climate of the Presidential election 0 — CF C, CD CD ~ .J Di -. CF CD a —‘. CD U’ 5 D -a CD CF H, 0 CD 3 Di CF .a — C, CD ~ CF CD :7 — 3 CD CF CD -5 a 0 CF CD Di CF CD 5 r CF 0 -J. U’ U’ CD C, .5 CD monetary growth, the more probably the consequences of the resulting to -a CF — C U’ CD 5 CD ~ CF H, 0 CD U’ C, :3 CD C .0 U’ CD 0 C, CF ~ CD CT ~ ‘C Di CT 0 ~5 CD V .5 3 0 CD CF CF ~ -5 0 (0 ‘C Di CD CF 0 3 The longer the Fed delays in effective control over 5 5 C CD 0 0 ..~ CF 0 C, CD CF — C C, CD -4, H, CD — 3 U’ ‘C CD ..a Di a a CD t1 CF -a CD CD to 0 .-J CD -4 • .a. 0 Di CF —‘ H, :3 — 0 duce a recession reaching into the year 1980 with initially small effect CF C, CD H, H, CD ..~ . Di 3 U’ ..-a ‘C Di — CF — — -a CF — ~ 0 ..~ tO CO •s CD Di ‘C CF r CD 0 CF -‘- to 3 -). ~ C, CD Di -s — 0 U’ U’ CD C, CD -s Di CD C, C 0. The lower monetary growth would proI -s 0 V a ....J C ~ 0 CF r ~ 0 5 to ‘C Di .5 CF CD 0 3 CD 5 ~ 0 .~ CD —4 • -S CD Di ‘C -a — U’ CF H, 0 0. CD CD ~ CF ‘C CT CD .5 to CD 3 CD Such a change is not impossible and appropriate evidence may ‘C 3 Di CD C, CD 0. -.. C CD CD V 5 — Di CF .5 0 Di V V a Di CD ...J CT U’ — 0 U’ V 3 — 0 CF — U’ to CD Di C, Di C, C (/) • CD U’ CT Di that the Federal Reserve shifted gears to a lower trend in the monetary ‘C CD CF Di :7 3 0 CD CF ~ .a. a ) CD ~s CF .5 CD Z 0 .~ Di 0 CF U’ .5 Di to CD 0. CD CF H, U’ -a — C CD U’ CD CD a Di .5 a CD CD -‘1 CD CF CF Di CF —4 ~— CO tO _a .s (7, .~. 5 CD CT 3 CD C, CD r— C) CD 3 .~• CF ~ — U’ CF CF Di — 0 CF Di C, — a — CD Di ..-~ -i 0 U’ ..~. CD There is no real indication at this time (December 15, 1978) 5 —4 ~ CD • U’ CF 3 CD overwhelm and more than offset the action bearing on reserve require5 I CD — C .0 CD CD C CD -5 CD U’ Z 0 to :3 5 — CD Di CT 0 -~ CF C, Di CD CF CF CD U’ H, H, 0 ~ Di CF 3 0 -S CD a Di 3 -a CD ~ 5 0 C CD ‘C U’ — a Di CD 3 0 5 CD CD C -5 CF r H, a C They could furthermore easily C, 0 ‘C —4 ~ CD • CD CF 5 Di CF 0 C U’ C, — 0. U’ CD 0. .~. CD C .5 CD ~ CF H, 0 CD CF — U’ V -.4. substantial open market purchases could raise the growth of the base Di U’ CD CT T CD CF H, 0 -a 0 ~ CF to .5 CF -a CD CD 5 Di — U’ a C ...~ 0 C, U’ CD Di U’ V C .5 C, r ~r CD CF 3 Di 5 CD V 0 -a Di CF — U’ CF Di r U’ C CT 0 -5 7C U’ Di CT ..- Di -‘. C, 3 3 CD .5 C, 0 CF 0 U’ r ~ Di CD U’ .5 C CD ]3 CD CD 5 Di ..~ m CD a CF ~ CD 0 3 -s H, U’ 0. -4, C ‘C C U’ Treasury funds from the Federal Reserve Banks to commercial banks or 4 1 CD Di Di Large shifts of H, 0 U’ CF H, .-‘. r U’ CD (0 -s C Di • ....~ ‘C V U’ 7. Di .5 ‘C 5 C CD CD CF .a CD 5 Di CD C, C, Di CD C CD a Di 0 -a. CF C, a — 5 CD ‘C any direction and even accelerate very sharply. -). 0 ~ CD ~5 V CF — U’ CF 0 to — Di — CD CF 0 CF - -‘. 0. Di CF U’ H, 0 0 H, the Carter team, then all the available evidence from history and the CF in spite of the revised discount rate. U’ Di CF CD This interpretation was usually geared -~- —4 ~ • -a CF 0 to V :3 U’ 0 Di CF — C .5 CD U’ m CD 0. H, — Di CF C 5 CD nature of the policy institution suggests that policy will be reversed Di the winter of 1978/79 progresses. .5 .5 ‘C CD CF Di 3 0 (0 CD -5 CD to an inflationary course within three quarters under the increasing 0 CF emerge by the end of this year. .5 CD U’ CF CF CD — 3 5 CD CF 5 CF ~ 0 U’ H, CD Z .5 ~ The Fed's traditional interpretation of monetary affairs justiCD 5 U’ U’ C CD on inflation. 0 —‘ CD .) 0 -1 pressure of political apprehension fostered by the incipient recession. V in 1980. C CD 0 3 CD U’ U’ CD ments. ..) — 0 fies some reservations pertaining to the emergence of any significant — H, base. CD r CF C, Di action lowering monetary growth. CF The growth rate in the monetary base could still move in . — C CD 0 3 ..-‘ — ..~ CF U’ a .~ C 0 C, U’ CD Di CT ‘C CD CF Di .5 3 0 CD CF :3 CD CF Di 1 CF -a to 5 0 ~ —4 ~ CD • U’ CD CD — C CD 3 U’ CF ~ themselves. 0) to the level of short term interest rates. CF 0 These measures mean unfortunately very little by CD CT ‘C CD .-~ CF CF ‘C C ‘C D Di CF CD 0 , CF C H, C 3 CD Di 3 U’ CD C U’ Di CD 3 CD U’ CD —1 r 0 — CT (.3 CF Di CT 0 C about $3 billion. always understood to reveal substantially expansionary policies. expansionary policies were generally indicated by lower rates. More The FedFed- eral Reserve authorities thus concluded in 1930 that aa highly expansionexpansionary policy had actually been initiated to counteract the cyclic decline. The same behavior and interpretation persisted over the decades into this year. The Federal Reserve authorities reenforced in the spring and summer of 1978 the media's media’s impression that monetary policy moved on aa comparatively restrictive course. The facts were unfortunately just the opposite of the traditional interpretation. During 1930 monetary growth receded and revealed aa weakening monetary thrust in aa downward sliding economy. A A similar pattern occurred in 1960, whereas in the current year, monetary growth accelerated when policy was claimed to have become more restrictive. Our experience demonstrates moreover that monetary accelerations yield aa much closer approximation to the monetary thrust exerted on the economy than the level of interest rates. But the FederFeder- al Reserve authorities still believe at the moment that they shifted to to a cautiously moderated policy in early November. The rapid increase in short term rates in October and early November is, however, quite conconsistent with even an accelerated monetary thrust expressed by by aa rising rising trend in the growth of the monetary base. We note here in passing the consensus appearing among financial analysts. This consensus accepts the Fed’s Fed's accustomed interpretation and expects therefore that the econ— econ- OmY omy will slide during 1979 into aa recession irrespective of monetary 4 perspective is however fundamentally faulty) faulty. 14 evolutions. This perspective ‘4The institutional innovations of the recent past lower substan- 14 The institutional innovations of the recent past lower substantially the information content of the traditionally measured monetary 37 38 CO Cr CF_a.-... ,cCr a. ~5 CD Di a ~ ~ CD CF ~ CD —‘- 0 -S CD Di Cr CD CD a 0 CD -a- I :5 Cr CF Di CD ~ CF 0. CD 5 C 0 CF CD a CD -4, -h 0) C a ~ Di :3 CD -5 -a 0 CF CF ~ CD 0 Cr -~. The monetary base in — Di Cr CD CT ‘C CD CF Di 5 0 9 ~ CD —I • ~ :3 Cr CT Di CD a ~ C CF ~ CD Di CF CD — —a Di V ~ (A CF Cr .-. 0 :3 0~s Di ~ Cr The monetary base and the money stock expand in Germany whenever 0 C CD CD ~ CD $L ‘C 9 Di C) CD — a Di CD >< V 0 lr Cr CF 9 0 :3 CD ‘C CF ~ CD a Di Di Cr CD CT ‘C CD CF Di 5 ~ O CD - • CF — V 0 The case of the Swap arrangements may be used to elaborate the CF ~ CD CD CF Di a~ 0 5 Di CD CF 0 a CD C Cr CT CD ‘C 9 Di CD :3 CF Cr 9 5 Di (0 CD Di ~ Di V CI) CF ~ CD 0 -4, 0 Di Cr CD CD r —1 movements. • Cr CF CD 3 3 0 C CD 0 CD -a. 5 V :3 (0 — CF 5 CD Cr C CD ~ CF :3 — CF Di :3 (5 0 CF 0 a CF ~ C Cr Di -_.- <C V V C Cr C CD — Di CF —J 5 CD -S 0 — 0. demand (or relative supply) and thus to contain the resulting price :3 a CD 9 Di supply is executed in order to offset market induced shifts on relative 0- CD — C Di CF - 5 CD 0 CF Cr — —4, Cr ~ CD 0 :5 a C -a. CF 7r 5 CD Di 3 0 —4, -4, Cr CD CF CF 0 0 ..5 a CD ~ —a. CD >< CD 0 C CF CD 0.. Cr ~a. ‘C w C V V ~-a This modification of relative demand and Di a :3 Di a Di 9 a CD C CD a• Di CF -5 CD 0 -4, :5 Q — CF 0 .4. -h — 0 0- 3 Y — Cr — • Di 5 Cr 0. 0 0 -h ‘C Cr C V V Cr CF 0 0 7r Di :5 0- also be stated as a means to influence the relative stock demand for ‘ 4, 0 5 0. a CD 9 Di ?c- Cr CF a 0 C CD — Di CF 5 CD CD CF 0 CD C CD -h — CF 0 Cr 9 CD Di Di Di Cr Di CF CD 0.. CF Cr CT CD Cr 0 -‘ •Di Di ‘C 3 a Cr CF 1 Di 0 The common strand may 0 0 9 9 —4 ~ CD - Cr Di 0 0- 0 -4, Cr 3 CF CD -S — CD Cr — (5 0 C 1 -S CD — (0 CD -h 0 -5 0 -i, ‘C V formly addressed to modify the relative stock demand for and stock supCF I Cr C V 7r Cr CF 0 o 0. Di -h 0 .5 0- 0. CD 9 Di 0 0 r Cr CF C CD — Di CF .-a -S CD CD ~ ‘C -h — 0 a 3 CF 0 Ci. Di 0a 5 CD Cr Cr CD ‘C ~ i 3 —4, 0 5 They are uniI -a. C Di 5 CD —4 r CD ‘C • a 03 Cr CF 9 0 3 0 (5 Di CD -s Cr ~ Di ..a ..a Di ‘C ~ CD CF CD Cr 3 B CD Di Cr C 0 C Cr — C Di -s CD ~ 0 -4, CF of the various measures, they all share a common strand. Cr x V CD CD CF rCD 0 -4, -4, Cr CD CF Cr CF ~~5 CD Cr C Cr 5 CD 9 Di Di CF CD Cr CF CI) CF CD a the Fed draws on its Swap line at the Bundesbank. CD 0. CD ~‘1 CF ~ ply of foreign currencies in terms of dollars. I ~ Di 5 r Cr This result offsets the experienced increase in the -a- —4 ~ the United States remains on the other hand unaffected under the stan-~. CD C CF ~ Whatever the detailed differences in the technical execution 5 CF 0 — CD )< CD 0 C CF 0 Di —a. CF CD 0 ~ CF r CD — 3 0 CD Cr CD CO CD 0 ~ Di )C CF r CD :3 0 1 Di —‘ .-a a 0 CD 1 0 0 CD 0- 0 C Di :3 CD Cr 9 CD Di Cr C —a CF ~ Di 0 H~ CD 0 t CD :3 (0 .5 Di CF ~ CD CF 0 a CD )< CF CD 0 CF Cr CD a 0 0 — CF tion does not extend to the range of external measures announced on )< CF CD .5 5 CD 5 — -4~ -t CD CF 0 0. CF CD Cr Cr CD Di a a a Di . CD CT 9 C CD Z 0 November l and addressed to the support of the dollar on the exchange ~ CD Cr C V V 0 CD a a — Di 0CD CF CF ~ CD Di CF CD C CD i -a • CD CF Cr r5 3 Di I Di —~ 0 5 5 CD () C CD — CF . V 0 Cr Cr This positive correla— —4 ~ - 9 Di 5 ~cCD CF ~ Cr CF 0 0 D 0- Di 5 Di 0 0. 0 Cr CD Cr 5 CD Cr V 0 (0 — r C 0 CF "voting responses" on dollar and stock market. 0 0 -4, 0 CD -a. V ~5 Di a 0. 0 CD =~ CF a Di -~ Di 5 7r 0 I - CD 5 dard procedure. V 5 0 0 CD a C 0. Di .5 a point. -t 0 0. CD 9 Di :3 a a -S ‘ and stock supply of dollars. CDCFCDOO aCra~C -. CD Cr 0-Di-S Di0 ncaCFn.a. OCDiOCO CFC~ O CF CD—s CFI VDi—4Cr-S CFCF~ CD Cr-~CD0V 0 0 Di3 Cr Di0> a-a:3-n CD—4CT 3VCF CD CDODiDiCF Di—a-50E Cr-i.’COCD CO OCD .5’CCTC:3 CD Di 39CrCFCT CDDiCDCrDi Z world demand for 0-Mark, and the dollar price of 0-Marks is held near 0 markets. Ca) CD0-CC0CD a CD.50CO C15CD5Di -sCD-a CrVCF CD.0 OCD CrCCF.5Cr -a.orDi 5CFCDCF~ CD ...a...a DiCrO Di- -~-:3Di 4, -4,COCr CFCD a rfl—’.Di 0CF-h:3~ -SCD.a.aN) 00-0 • C DiCF COCT~ r’COCD—4 CD ~ OCF 0-CD COCD CDCD—4,CCD Cr CDC ~CDCr-.a0 Di 00 4 Ca9VC CDCD3CF CD-AC 0 CDVO —CCF CFOCT ~V—00 CD3-.-i,-*, CDCr fl..afl)fl -s aggregates M1 and M2. The evolution of "overnight-repos" between banks and corporations and the development of NOW accounts or AFT accounts obscures the significance of some published data. The monetary base is, however, not affected by these developments. But rational policy making would require a thorough overhaul of the Fed's concepts and measurement procedures. V~r0DiDi 500CTCO 0C~Cr0-(0 domestic program announced on October 24 seem well correlated with the CF r CD CF ~ — Di CF CD 0. CD —~ 1 0 0 ~ CD 3 Cr CD CD 42~a N) 1 CD CT 0 0 CF 0 0 (5 CD a 0 C Di 0 CO -s Di B V 0 — Cr CF a 0 9 CD The reservations noted in previous sections with respect to the 5 — — CF ~ CD CF 0 5 CD Cr V CD 0 CF -a CF Cr 0 — Cr CD 0 CF C Cr 0 V 1 CD C — 0 CF CD 0- — 0 3 Cr C Di CF CD Cr CD D CD - ‘CF 0. ‘Di -5 CD Cr CD Di Cr C Di -S :3 CF CD 01 CD H The External Measures and the Support of the Dollar the inherited level. The use of an IMF loan would actually reenforce the relative shifts in stock supplies, as the operation per se would simultaneously raise raise foreign money stocks and lower the U.S. monetary aggregates. Similar patterns hold for selling special drawing rights, gold or the issue of U.S. debt denominated in foreign currency. The crucial aspect of these operations is their essentially trantransitory character. two circumstances. They could be accepted as rational procedures under We may suspect that the exchange markets suffered aa shock since the fall period the transitory shock fall of 1977, raising for aa short period relative demand for foreign currency (or lowering the relative demand for dollars). presOne would rationally expect in this case that the pres- sure on the dollar vanishes in due course. The external measures iniini- government express in this case the determination of tiated by the U.S. government an official speculator to stabilize the price over the transitory shock. Official counterspeculation is particularly designed under the circumcircumstances to penalize the private speculators producing or magnifying the transitory pressures. An entirely different situation prevails on the other hand in case exchange markets reflect aa permanent drift conditionconditioned by underlying nominal or real shocks. The operations executed under the external measures are designed under the circumstances to prevent aa further fall in the price of the dollar in the expectation expectation that suitable policies modify the underlying conditions causing the drift. In parpar- growth and the budget deficit be be ticular, this would mean that monetary growth (most permanently lowered in the United States, or that other countries (most particularly Germany, Japan and Switzerland) permanently permanently raise their particularly money growth and budget deficits. Such modification in the basic 39 40 9 • 0 -h ‘C O — 0 V The CD —4 - 0. 1 0 CD CF ~ CF 0 5 CD CF C — CD 5 Cr C Cr 1 CD V 0 Di — CF — 0 V -4, 0 CD C Z Di CD Di ... C CD Di CD ~ —‘ — - (A • C — :3 Cr 0 C — Cr — 5 CD Di 5 ‘C Cr CD 0 CD Cr CF Y CD -4, 0 Cr Di .-a :3 .. CO Cr CF C Di CD 5 CD 0 0. Di CD r As the CF > Cr - CD Cr CF Di (A CF a CD CF — C CD CF ~ :3 ..a. CF — fl — 4, CD a CT C a CO CD CF CF ~ CD a :3 Di r ~ CF 5 0 CO ~5 ‘C Di CD CF attend under the circumstances of diffuse uncertainty to the control of J Hi 0 a CF 5 0 0 CF ~ CD 0 CF CF ‘C — 0 CD 5 CF Di C CD C Cr -h — H, 0- -h 0 Cr 0 CD Di 5 (5 C 9 Cr CF (5 — CD ~ CF -S CD a C a CF CF CD Di A rational course should a 0 C r Cr CD C 5 Cr 0 0 .-~ Di 0 — Di CF 5 ~ • Cr CD ... 0 ..a. 0 V .—‘ Di 0 — Di — -h 5 0 C — Cr CD :3 CF 9 CaC Cr CF a Di 5 CD C 5 CF —~ tial credence only to the assumption of a transitory shock requiring no 0 Q CO 3 — :3 .. C .0 1 CD 2S 0 ~ Cr 5 ‘C CF 0 -‘- Cr Di CF 5 Di -4, 0 0 CF — 9 V C Di Cr Cr CF ~ CD CF 0 ‘C —‘ 0 0 CD CD 5 CD 0- 0 CF ..aDi dence or relevant information suggesting that we should assign substanI Di CF ‘ Cr C CT Cr Cr Cr — CO 0) a C 0 ~ Cr CD Z CF CF ~ Di CO — Cr CF CD CO C CO Cr 0 CF — 0 5 9 Di Hi — CF Di CD C —~ CD -5 0 -i 0 CD CD a We have no eviI CD C — 3 0 ~ Di C CD CD E - 5 Di CF CF CD 9 Cr CF ~ — CD CO a CD 0 ~ r 3 5 ,-‘- -4, ‘C Di :3 Cr Cr CD V 0 Cr Cr CF a 00 ~ CD .-.. ‘C —‘ Di CF CD CF C 3 Unfortunately, -1i 0 C - Cr CF CD 7~ Di 5 9 CD CO Di -a >c 0 CD ~ CD CF :3 —.- CF -h 5 a. a CD ~ CF CO — Di V :3~ Cr Cr CD 0 5 a -h ‘C — :3 CO The crucial question bears of course on the nature of the under5 I CD a C CD ~ CF 0 .4, CD C CF Di CD -a CF 0 Cr CD C 0 0 -h 0 Cr Di CD CT 0 r CF Cr CD C .0 -~ Di .. C (5 5 0 CD ~ —4 ~ • 5 CD Cr C 9 CD Di Cr Di 1 CD CF )C CD CD ~ CF CT ‘C CF CD —4~ -t Cr 0 ‘C Di 3 CF — 0 Di 5 Di CF — 0 . policy conditions converts the current pressure into a transitory deviI — C CD a 1 ICr I-’CF IC I-S CF IDi hS Di 0 CF — 1 CD C Cr Cr CD -~ V CF 1 CD C (5 CD CF S CF Cr CD C r 0 0 Cr Q 0-a. CF — 0 n ‘C 0 -a- V 0 The expected change in relevant CF Di C CD 5 CD — CO CD Di -a 0 V CD 0 CF CD a Ix CD ~ CD —4 • 3 CD — CF — Di 5 a ~ 5 0 -h CF 5 c CD Di 3 Di 5 ...J 0 .-a a CD CF ~ 0 ternal measures offer thus an opportunity to shift the eventual outcome CF 3 CD 0 fl CF 0 C CF C Di :3 CD C CD CF r CD -t CF ...a. Cr -a CF 0 ‘C — C 1 CF V 0 0 V Di Cr C ~ CF 5 CD -t -*, 0 Cr C 5 CD Cr CD Di 3 :3 Di ~5 CF CD I x The exCD ~ CD —1 - 0 Di 0- 5 CT Di 0 5 Cr CD Di CF (A CF a CD CF — C CD ~ CF — CD Cr 0 Di 9 Cr CF C 5 o — 0 .~ CO CD Di ~ 0 CD CF ~ the change in circumstances in the United States or abroad. .a Z r CD — 0 ~ — Di —5 7r CD CF 3 5 Di .4 0. 0 CF ~ CD .. CD 5 CO CD 3 CD 5 Cr Cr CD Cr Cr V Di ~5 CF CD monetary growth and the budget deficit in the United States. 0 9 lying forces shaping the drift in the exchange markets. Di CD CF ~ CD 0 CF CO CF Cr CD 3 00 CF ~ CD CD Cr a 5 Di —~ .—i — CF CD 9 0 V ..-‘ CD C -4, Di , Di — Di (5 Di ~ winter passes and no relevant signals of the necessary revisions in U.S. — we do not possess any firm knowledge in this matter. CO CD a CF CD 3 — 0 0 C 1 Di CO CD a This development will raise the domestic political pressure in 0CD ~4 -a — Cr - financial affairs emerge, the dollar market will reveal a new wave of — -4, further adjustments in our financial policies. Di CF CO 0 C CD 5 • (A • C CD Di CD -s — CF N (A ~ 0- Di V Di Di C-a ‘C Di 3 C) CD 5 0 C CT CF a ation rationally offset by the external measures. —‘ CT CD 5 0 C 5 5 CD 0 0 Di ‘C CT ~ CF ‘C CT CD a Cr V 0 3 — CD 5 Cr C 0 0 ‘C Di 5 :3 —‘ -+, inflationary course imposed by the U.S. government on the world. Di CF — 0 West Germany, Japan and Switzerland, encouraging the return to the CD Cr CF ~ on the dollar market forward in time. 0 C CD 0 -4, V Cr ~ — r CD a 0. CD Di Di C Cr r CD CT ‘C ...a CD Di CF 9 ..4. CF ... C ‘C Di CD~ ...a CD ~ CF ‘C CT 0 CF :3 a Di :3 3 Di -S .a —‘ —‘- doubt. a inflation and not by the "leadership of November l." Di CF — 0 a dollar may ultimately be "saved" by a concurrent and general policy of 0 change portfolio commitments without some credible signals bearing on 0 CO 5 — CT CD Di Cr Di —a CO — Cr CD CD 0. — CT 0 1 CD 9 0 Cr CF C 0 — CF -a Z :3 CF Cr CD 9 — CF 9 9 0 0 0 — —‘ -4, 0 CF 0 5 V CD 0 ~ Di :3 (0 1 ‘C — 0. ~ Di C .a a ~ Q CF Cr — V Di 0 5 CF — V Di CF 5 Market participants would hardly r CD Di :~ • Cr ‘C Di .-.. 0CD CD 9 Cr 0 ~ — CF Z ‘C —‘ 5 0 CT Di CT V -S Di 0. 0 dollar probably with some delays. 0 .. r r -a CD CF 0 CF Cr CD Di —I, -t Cr CF CD 9 Di .3 CD CO Di 0 CD >C CF r — —s 0. r CF CD Di $ CD V CD CF CO — V Cr ~ Di Cr 0 — CF — a 0 0 conditions shaping the "permanent drift" of exchange markets affects the FINAL REMARKS FINAL In the days following the second package announced on November l, 1, officials of the Carter Administration assured the public that their anti-inflation program is the “only "only way." way.’ The alternatives are either recession or mandatory and sweeping controls. or illusionary. This line is fraudulent The juxtaposition between “recession "recession or guideline programs” programs" misleads attention. There is indeed only one way to to lower inflation and that is to lower monetary growth over aa long time. This ar effective anti-inflationary policy unfortunately ininstrument of ar, in- duces aa temporary recession. supBut aa policy of permanent inflation sup- plemented with incantations and partially mandatory and unpredictable controls (i.e., guidelines) yields the social costs associated with erratic inflation, sluggish output and higher normal unemployment. The promise of permanent inflation at aa negligible social cost is aa dangerdanger- ous illusion or an irresponsible fraud committed on the public. The juxtaposition between voluntary guidelines and mandatory concontrols also obscures the relevant issues. It obscures the fact that It guidelines are in reality selectively applied mandatory controls. Moreover, these guidelines will fail in aa context of permanent inflation policies. Such failure leads unavoidably, as aa result of the persistent persistent refusal to adjust our financial affairs to the requirements of aa nonnoninflationary course, to sweeping mandatory controls. We should hope that the American public eventually rebels against the persistent irresirres- ponsibility of our financial policies which endanger our economic welwelfare and ultimately our basic freedom. 41 42 N) a - -. INFLATION--CAUSE, CURES AND PLACEBOS Beryl w. Sprinkel INTRODUCTION Inflation is a rise in the average price level, inevitably brought on by too much money chasing too few goods. Since most of us prefer stable prices, either for equity or confidence-enhancing reasons, the solution should be obvious. Conduct our nation 1 s finan- cial affairs in a manner designed to increase total spending in line with the increase in total production. Yet, throughout the post-World War II period, spending increases have persistently exceeded output increases, but by varying degrees, and inflation has become a way of life. Each economic expansion has ultimately brought greater inflation, follov~ed by recession and lower inflation n.tes. But there has been a persistent tendency for each inflation peak to exceed the prior peak, and each inflation trough to exceed its predecessor. There is no shortage of views concerning why spending increases have exceeded real growth, thereby bringing inflation. They include too much money, too large deficits, slow productivity, excessive wage increases, monopoly in labor and business, too high taxes, currency depreciation, rapacious oil sheiks, high farm supports, higher minimum wages, higher interest rates, higher social security taxes, etc. It is Dr. Sprinkel is Executive Vice President and Economist at Harris Trust and Savings Bank in Chicago, Illinois. 43 unlikely these explanations are equally valid and certainly not all have been rigorously tested. 1 want to discuss my views as to why we have serious and accelerating inflation and whether recent policy initiatives will help, and at what potential cost. The Essence of the Problem Inflation has been for all known times and all nations a matter of too much money creation. The following chart plots the rate of monetary growth per unit of real output against the rate of rise of inflation for the U.S. from 1915 to now. but is very close. The correlation isn't perfect, There is good reason for the high correlation in the U.S. and for other countries. When more money is created, it inevitably gets spent, and when spending rises faster than real output, inflation ensues. The reasons for excessive money creation are numerous and have varied from war, to gold discoveries, to excessive spending on domestic programs, to misunderstanding of the lag effects of monetary policy, to support of weak currencies by central banks, to inappropriate operating techniques of central banks. The Proximate Causes of Present Inflation In the spring of 1975 the Open Market Committee of the Federal Reserve System accepted, under some pressure from the Congress, the objective of gradually reducing monetary growth until it was commensurate with real growth. That was, and is the correct policy stance. Each subsequent quarter, the Fed has reported to the appropriate Congressional Committee its progress as well as its objectives for the 44 I 0 Money, Real GNP, and Inflation C 0 CU) C 25 .. I I I I I I HC UU) C) LU — a o — N- NC) a U) d -~ a -~ — ~0 U) — a 0) m S -C C C U) 0 U) C 0 a C C Tnken from: B.Sprinkel and R. Gene!ski, Winning With Money. (Dow Jones-frwin fnc., Spring, 1977) I I 70 ! I I ! I 75 I I C Di 65 I U) N- 60 C=:J Peak to trough of business cycles I 0 N- LI) 55 I (0 50 -1 C (0 U) 45 ' ' ,. ' 1 U) " '' C U) 0 CO U) 40 35 CO . U’ 0.4 t 40 ···-~ C ~ I U) U) (o~ I - ! - - - - I 11 I ,l I I I 30 U) (‘4 U) 0) 25 20 — — I I I I 55 ---M.,,, ,. I I I I 70 a) C.) E C) ✓ . I I I I I 1915 100 85 N. ••L. In -C- 0 U -~- -- -=-- _,. ... Consumer Prices c\ \j -~\ / I] Iill ‘ -7~ I) , PH II I "' /'/ / .,r.,' - / / L~ ~_____ I -, , ........ ----' I'\,,, ,,_ r--~,' 130 V I/ / 1 / ~Di 0~5 ~ ~ 0.~ ~ 45 - ' 190 160 / Money 2 ·• Pet Unit of Output ,,-- I _I ,- I w/ CCC 1/ I / 0.40(0 C~J’’- 220 -s--— t----·-• 80 to enjoy the short run benefits of accelerating money growth while 46 CD CT — E Cr CF Di CF — 0 3 V CD CF — C CD Cr Cr Di 3 ‘C CF Di CT a CF .-a. :3 c- 9 Di 0 CF 0 0 CT CD CT CF ) 0 CF i CD C CT CF 1 0 Z CO ~ 0 Cr Cr .~. CF 5 CD Cr CD CF CT a Di 0 CF CT CT CD CD 0 3 H, 0 CF 0 CD CD H, Hi CD Di CT CF a. C CD — CD CT CF CT — CF m CD 0- ‘C CT ‘C Di ~ Cr ‘C Di CD ‘C ~a Di (5 .a. — CF 0 V CF CT CD 0 CD 0. Di H, a. CT CD Di ‘C ‘C 3 CF CT CD a CD Z 0 Cr Cr CT Di CF CT 5 0 Z CO CC CF — C — CF C 0 s 0 0- V 0. Di CD 0 Di 0- a CD Di C CD 5 0 i 0 H, ,r Di CD ~ CD CD CT CT Di Cr 0 .a. Di CF Q —5 3 H, .a Di V — CF Di 0 CF CD Di 5 — C -o CD Hence, private capital formation has been CD 5 0 r - fl CF — 0 Di 0 95 H, — Di <-j. — Di -o 0 (7 have been financed by absorbing savings which cannot then be used for H, 0 5 a C Cr CD CT CD CT CD :3 CF 0 CF :3 0 Di CT — 0 CT Z Cr CO Cr Di C — CO — CT Di CT Cr 0 a cr ‘C 0 CD Di H, — :3 CD CD 5 a Di CD CD They may be and ‘C 9 Di ‘C CT -4 - 0- 0 CD Di :3 — Hi CT CD CF Cr C 3 Cr a. (5 — CF CD H, C - 0 — —a -a ~ O~ — • 4~ Di 3 ‘C CD Cr 0 Di H, — In 1976-77 alone deficits amounted to $125 billion, and last a :5 Cr CF Di a Di — 0 — CT N) 01 ~ 0 CF a CF CD C 0 9 Di Cr CF (5 — — Hi CD a CD 0 —~ Di ~-4 —4 I .~.4 CO — • 0 — CT — In the next decade the cumulative total was $148 Di CO a -a k~ Cr Z Di CF CF c -C CD — Di CF C 3 0 C CD CF CT CD 0- CD 0 Di 0. ~ CD >( CF CF CT CD — • 0 .-a- ..a — CT .—a (A) t~ ‘C —~ 0 CF 0 — 0. CF CD C 3 0 Di CF 0 — 0. CD Hi .—~ Di 5 CD a CD CD Hi — -C CF Di C 3 C 0 CF CT CD (Ti (J1 -a CO ._a — CO — 0- :3 CD a CD 0 Di 0CD CD Y In the decade ending in 1965, the cumulative federal deficit amounted CF — .1 characteristic of the U.S., their size and persistence have expanded. . . - a CD Di 0. V >C CD C CD ~ Di 0 CD CD CF Cr Cr — V CD 5 a Di — NI CD Cr 5 CF CT CD - (11 • C CD CF CT 0 Hi 0 Cr CF — CD 5 CF 0 Di 0 -a Di 5 5 3 CD CD CO CT 0 C CD CT Di — 0 CF Cr — Hi 0. CD .~ Di CD Hi CD 0. CO CT C Although federal deficits have long been CF CT 0 > • CF —j 0 C — Hi H, — 0. 0 ~3 CD $ CF CT -5 0 ~ CO ‘C CF Di ~5 First, large and growing deficits made the job of limiting moneCD I :3 0 CO 3 — CF — 3 — —J H, 0 0 CT C-a- CF CT CD CD 0. Di 3 CF Cr a• 0CD H, — 0 CO — 0 CO a Di i CO CD Di -~ Cr CF -~ m • CF CT ~ CO 3 0 -3 ‘C Di ri- monetary growth. CD 0 3 on three fundamental forces as the proximate causes of recent excessive CD -c — Cr Cr CD 0 CD CF CD CD 0 0 Hi CD Cr 0 Di C Cr CD CF Di $ V 5 0 >< — CF CT CD Cr Di Hi 0 5 0 CD Cr CF Di CD $ Di a C Hi CD CD 5 CF 0 I will focus 0 C Cr H, 0 ~ ~ — — - Di 5 CO CD CF Cr CF Cr CD 0. Cr H, CD 0 V 0 H, Cr Cr 0 CD >c CD .a Di Hi Di CF CD Di -4 —4 -. ~ Di 5 a —~ ~ 0 -S World War II, a rate far in excess of professed targets. CT 0 Hi 9 0 CD -5 C Cr 0 CD CT CF CD Di CF CT CD ‘C —s CD Di CT CD CF Or, they may be financed the politically easy way by 5 0 .-a ‘C CD rf CD -a Di < C 5 Recently, we witnessed the highest rate of monetary growth since CD 0 — Cr CT CF ~ CO 5 0 CD CF Di 5 ~C 0 3 0 Hi CF CD Di 5 CF Cr CT — CO CT CD CF CT CD CD 0- CD Cr Cr CF — Z ~ CD ‘C 0 CD CF CD - CD Di ‘C actual rate of monetary growth accelerated in 1975, and each subsequent CF CD m C .0 CD Cr Cr C CT CT CD Di 0 Di 5 a -. 01 CO —4 5 a• a CD CF CD 5 Di Di 0 0 CD CT ~ CF 0 5 CO Di 5 ‘C CD CF 0 Hi 3 Di CF CD 0 -~ — Di C Di 0 rF But alas, the Di CT CD CF -a Cr .a Di CF 01 C • .3 5 CD 0 CF 0 0 CD 0) Cr CF Cr CD CF Di 5 — 3 0 CD CF CT — Hi CD 0 0 i CD CT a CF 0 C 5 Di Cr CF C Cj. just around the corner, if the monetarists are correct. CF ..a Di 0 CF — 0 V CD CT a. Cr CF -a. Cr ~5 5 CD Rather, they are the source of massive CT 0. 0 CD C Di c~F a a Z ‘C CD :3 0 • — C CD C Di 5 — V Deficits must be financed. 0 5 CO ‘C :3 CD 0 $ CO — 5 Di CF CD 0 0 CD -a. Di CF ‘C H, 0 Cr Cr CF — - We've done both and the result is slow growth CD ~ - 0 — CF Q) 3 ‘C Di a. 0 relatively weak for over a decade and productivity growth has slowed Di r+ CD -s private capital formation. CF 25 Di Deficits are not the boon to mankind that my 0 H, a. . C) CD - 0 a. H, :3 :3 CD CO .J. Cr CF s Di a tary growth more difficult. CD ~O Di 5 • CD CO CD —a Di 0- Cr Di CF H, creating nevi money down at the Fed, v1ith the inevitable effect of more Di CF 5 CD 0 fiscal year $48.8 billion. H, — CF CD Di -o - Cr 9 CD 1 CD .a. CF CD C .0 Cr CD subsequent inflation. CD Di CD CD CF CT — r -a. CO -a. r C 0~ Cr to only $31 billion. CD C CF 5 0 0. H, Di Cr -J- and high inflation. 0. Di drastically. CT Cr ~1 0 Q~ V 0 3 — Keynesian friends allege. CD 7Z CD ‘C billion. CD Second, there are apparently irresistible political temptations 0 0 CD (11 economic problems. 0 CD 0 0 year. CF ‘C 0 Ca. CD 0 Hence, it would appear that stable prices must be Di CD CT C Cr CF $ — 0 CD Cr V 1 CD CF Di CT Cr Di CF CT CF V CD Di 3 -o 0- a C ~ 0 — CF 0 CD CD :5 • ‘C - CO CT CF — — Cr 0. 0 CD 0. C duced slightly. a 0~’ CF At most quarterly meetings the planned ranges were reI 5 CD ~ CD 1 CD CO CD Cr Di CD a Di ..a V CT CD CF Cr CO CF CD CD -s ‘C 9 CD CF -s C Di .0 CF 0 Cr $ CF - CD Di ‘C CO $ 0 0 coming year. ignoring or disbelieving disbelieving the inevitable inflationary consequence. higher monetary growth in the short run brings many goodies. interest rates will briefly decline. True, Perhaps Certainly spending will go up, incomes v;ill will rise, employment will increase, unemployment will decline, decline) profits will spurt, and financial markets may be buoyed. In the inevitinevit- able longer run, i.e., i.e., one to two years later, inflation will pick up. re now in the long run, and we are not dead as Keynes once sugs ugWe aare ges ted. gested. Until at least recently Carter Administration economists argued that widespread excess capacity would assure positive economic benefits from stimulative policies with only minimal inflationary consequence. Clearly they were wrong. Excess capacity measures are notoriously notoriously in in- exact, and even if they weren't, weren’t, Keith Carlson demonstrated in the September 1978 Review of the Federal Reserve Bank of St. Louis that aa rapid stimulus likely to to bring bring higher higher inflation with only only policy policy of of rapid stimulus is is likely inflation with very short run benefits to production and employment. Third, the Federal Reserve System has chosen aa technique for implementing aggregate policy objectives that nearly assures aa pro- cyclical, not aa stabilizing stabilizing money growth pattern. The attempt to choose aa target for the Federal funds rate believed to be consistent with money growth targets nearly assures excessive money growth during expansions, and weak money growth during recessions. The facts are that the Federal Reserve money desk in New York has done an excellent job of achieving Fed funds targets while almost consistently overover- shooting money targets targets since since 1975. 1975, The Fed Fed funds funds target target chosen was was too too low to be sustained without intervention. Hence, purchase of Treasury Hence, securities by the money market desk increased bank reserves and the 47 1 Z 48 CO CT a. CT a Di CO Di Cr CF .— CO 1 Di Cr CD >< CF Di ‘C CF CD 0 C 1 — Cr ..a — Di 0 Cr 0 5 CD 5 Di 5 C CF C 0 — Di CO CD ~5 CT CO .a CT a Cr Cr CD CD Di Di CT ‘C CF C 0 Di CT CT CF CO -5 0 C CT Cr CD 0 CT CF C 0 CT Di Cr Cr 0 CD Cr .5 V CD C a. CF Di CD 5 :3 — Cr CO CD - 5 C CD ~ This simply ‘C V $ ~• Cr Cr CT — —4 • 0 :3 a Di ‘CF Hi — CD Cr 0 Di C 3Cr — CF CD Di 5 ~‘ C 0 .a CF Di V :3 0 Cr CD CO CT Di 0 0 CD a 1 V The philosophy of wage-price controls is based on the assumption 0 — CF V 3 C Cr Di Cr CF CT CD 0 CT Di Cr CD 0- Cr — Cr CF 5 0 .a 0 fl 0 5 — 0 CD I V Di CO CD 0 H, CT ‘C V 0 0 Cr V CT — CT CD 1 -— c ~ 0 5 CF - 0 :3 ~L Cr —s 0 CF 0 0 .. Cr — C CD Di CD >< V - CD 1 CF 0 0 -5 CD Di Cr — CD 0 .-a• —~ V 0 Hi ..a. a a CD CD 0. CD CF - Di 5 CD Cr ..a 0 . Cr C CD 0- ~5 C V 5 Di Cr CD a. — 0 V 0 .~ fiscal policies are pursued, controls aren't needed; if policies are 0 Di H, -a. Cr 3 If appropriate monetaryDi 5 ‘CI Di CF CD 0 3 CF CD — o V 5 5 V V Di — H, - CF — C CD CO Di CD _a Di Di 5 CD Cr :3 5 C CF CD 5 CD CT -H - 5 ‘C 0 0Di CF Di and price guidelines, standards and controls, either voluntary or 0 5 0 5 ‘C Di CF C ~ C ~5 CD CD — CF CT Cr a ~ 0 1 CF 0 0 0. Di Cr a 0Di 5 CF Di Cr Cr CD a CD CO C — 0. V 5 — 0 CD a Di CD Di CO H, 0 CD Cr Cr — C CD CF H, CD 0 Hi CD CD CF CT 0 CD 0 a CD C — CD 0 H, CD CF CT 0 5 Di — V Di Cr CF Cr CD >< — CD 5 There exists a plethora of evidence on the effectiveness of wage CT CD —I ---) CD Cr C — :3 — CF — Di CF — — 0 _a a CF :3 25 CD 0 CD CF 0 C > CT CF Di 2: CT - Cr Cr 0 CD 0 Cr C 0 H, CD V CT 0 CD CF .~ — CF _a — Cr CF CT CD 5 CD 5 Di CF CD Cr a C H, -11 CD 0- CD CF a Di 1 appropriate Fed funds rate, there is little hope of success. 1 0 V V Di V sary to promote a stabilizing monetary policy, rather than lagging the 1 9 CD CT CF CO a CO Di CO .~ CT Di CF 5 Di CF CT CD 5 ‘C _s — 0 0 V 5 ‘C CF Di CD 3 0 :3 CO .-j. .-a — N -‘- Di CT Cr CF Di 0 CF CD 0 V 0 CF ‘C Di 5 Cr monetary execution zeros in on the growth in the monetary base necesCr I CD 0 CD CT Di Cr CD ‘C Di CD CF 0 3 CD CT CF — CT ~ CF 0 CO CD CF CT 0 :3 — 0 Cr CD N 0 C CF — 0 5 ‘C CD >C CD CF Di CD 0 3 Until ...a — CF C :3 -— 3 CD — CF CD Di 3 CF CT CD — :3 03 — CF — C $ 3 Di CD a C Di CT C Di CD 0 3 0 CF —~ Di 0. CD 0- CD V CD r CD —‘ ‘C Cr C 5 surely expended a lot more valuable ammunition in the meantime! 0 3 — 0 CD 0 0 0 :3 CF CD 0 Hi CD H, Cr — 0 C 0 — V CD 55 Di 5 0. CT C Cr — Changes in relative prices such as those brought about by a weak CT Di CF CF that price changes on particular items cause inflation. CF CF 0 0 The returns are all negative. CT 0 CF Di C CD Cr a CT — CO CT CD CO Di CT 0 .3 — :3 5 ~ CD V 0 ‘C _.a 0 0 V 0 $ ‘C ~. 0 - Di CF CT What About Recent Policy Initiatives? 0 CT t ...~ C ~ Di $ C 3 a — 9 CO CT CD —5 CT — CF Cr C V V 0 5 CD currency, monopoly power in labor and business, higher agricultural () isn't true. Cr ..-a. too expansive, controls won't work! a CF C CF C CD .0 H, 5 CD CD Cr C 5 5 0 .a — CT C CF ‘C CF Di 0. CD Di 0 0 CD 3 Di CO CD CF CT 0- CT Di CO CO CD Cr CD CF — 9 CD $ 0 I sometimes bagged the game accidentally, but I Cr — * CO . CD Di 0- CF 0 CO .a. CO Di CO a farm in Missouri, when I sometimes tried to shoot a running rabbit by CT ‘C CF CT — Di CT . -s CO 3 C 5 Di CT 0 0 CF Cr 0 CF a CD 5 — CF CD Cr a. $ 0 3 CD CF Cr — ~ CT CD :3 C 5 — Cr a Cr ..a. M ... H, Di Di $ The process reminds me of my youth on 0 0 CT C CF ‘C ‘C 3 0 Hi CD $ 0. Cr — 5 3 CD Cr Cr CD V -5 0 0 CT CD -~ - CD 0- Cr 0 Di 1 CO 1 0 ~ CF CT ‘C CD 0 3 CD 3 V Di a 0 CF to dampen money growth soared. CT 0 9 0- 5 CD CD CF 0 CD Cr 0 CD i 5 0 price supports, higher minimum wages, higher social security taxes, — V lagging, not leading. Hi 0. Di CF ‘C V 0 — CD 5 CT CT — higher oil prices, etc. frequently have a pernicious effect on economic CO mandatory. 0 V 3 CD CF CT 0 inflationary expectations increased and the Fed funds rate necessary Di 5 ‘C Cr Cr CD CD n CD Di CF 5 0Cr Hi C 0- m CD CD CT CF Di 3 0. CD 0- Cr CD Di 1 0 ~. Cr V CD 0 CF Di CF — 0 CD )< Di 5 ‘C Di CF — 0 Hi .a. As the money supply accelerated, credit demands rose, Cr CD —~ 0 0. Cr Di a CD $ 0 5 CD 0— CF - CF CD 0. Di Di 0 0 CD ..-~ CD 5 V -a ‘C Cr C V ‘C 0 :3 CD 3 CF CT CD Cr > - CO ~-J ‘-.1 ‘C CD Di 5 early 1977. a CO growth, employment and freedom, but do not bring lasting and high CO rate is now about 10% but the gradual escalation began at 4-3/8% in .a ~ w ~ CO I a CF Di CT CD CO Di Di CF — 0 a Di 0 Cr 0. C Di ..a CD Di i CO CF CT CD CF CT C ~ 0 C CF 0 CT Di ~ 0 Cr — CD 3 Di CF -S The Fed funds Cr a H, C 0. CD -n CT CD -~ a CD 1 Di CF CD CD Di 0 CF CT CO 1 0 Di 1 ‘C CD CF 0 $ (5 CD CT CD 3 a Di CD Cr CT Di ‘C CF Di CD 0 3 monetary base and hence monetary grov1th accelerated. inflation. Only excessive money creation can do that. Factors limitlimit- ing productivity growth such as government controls and low levels of capital formation reduce real output growth and add to the inflation resulting from any given level of monetary growth, but the contribution is moderate--perhaps one per cent per year. Slmv improveSlow productivity improve- ment is the major factor limiting improvement in our real living stanstandard, while monetary growth has little effect on long term growth, but is the major force bringing out near double-digit inflation. “voluntary” conIt requires no great insight to predict present "voluntary" con- trols will fail because the self-pol icing incentives are all wrong. self-policing Unless fundamental correctives are applied, mandatory controls will follow. Controls are an attempt to shift shift blame for inflation from Washington, the source of our difficulties, to blameless labor and business. business - The recent massive moves to support the dollar will also fail unless reduced monetary-fiscal stimulus develops. Germany, Switzerland, and Japan expended billions of dollars of resources buying dollars during recent times, to no lasting benefit. Perhaps policies are tightening. Vetoes of spending bills bills have been sparce, but apparently stringent efforts to slow spending increases are now underv~ay. underway. Let us hope so. The recent one per cent boost in the discount rate and the $3 billion rise in required reserves may do the trick, but only if Open Market purchases of securities don't condon’t continue to spur growth in the monetary base. The motto of my native state, Missouri, should serve us all well on that score: “Show me!” "Show me!" Careful monitoring of Federal Reserve purchases of securities and 49 resulting growth in the monetary base and M-2 will yield the answer as to whether recent actions were fundamental or merely another attempt to provide placebos. If monetary growth is slowed in the months ahead as I expect, I fear our inflationary economy is now high1y vulnerable to recession by late 1979. The short run effects of tighter money are adverse to real growth while promising less inflation only after the slowdown begins. The slowdown is worth the cost if massive stimulus is avoided on the other side of the peak. I fervently hope that next time we will have learned from past mistakes, but recent history provides few favorable omens. \~hat should we have 1earned from more than a decade's repetition of go-stop economic policies? The one word that best summarizes our enhanced knowledge should be moderation. Rising monetary and fiscal stimulus does not bring lasting real growth benefits, but merely insures accelerating inflation. A continuous moderate trend toward less stimu- lus would eventually restore price stability with only minor short run restraints on growth. Continuous attempts to follow policies that limit the scope of private economic decision making while enhancing the government sphere of activities, promotes inefficiency and slow growth. Pursuit of placebos such as wage and price restraints promotes inefficiency while yielding no cure for inflation. Perhaps we have learned our lessons. The recent political cam- paign emphasized the benefits resulting from reduced government spending~ lower deficits and less government regulation. When exposition of the lasting benefits of slower monetary growth is added to our political 50 lexicon, we will have come full circle. Finally, when political promprom- ises are followed by performance, II will then conclude that policies of financial prudence have become good politics. 51 TTP FOR INFLATION: TIP WHY AND HOW Sidney Weintraub Our credibility as aa nation has been jeopardized by inflation and aggravated by the accompanying unemployment. Every age faces setbacks to test its resolve for historical evolutionary survival. l93Os The 193Os grappled with unemployment, and the not unrelated march of dictators. The l94Os 194Os saw the war, peacetime conversion, and the Cold War. SubseSubse- quent traumatic episodes, as the Cuban missile crisis, Vietnam, and Watergate can be cited. now appear paramount. Energy and inflation, or inflation and energy Blot out the inflation blight and, barring barring nucnuc- lear war miscalculations, we should again be able to resume the free world leadership that our military might compels and our economic power commends. My position remains that (except by by happenstance) aa stable price level and minimal unemployment will elude us on traditional monetary policies, or on the less efficient fiscal policy except in extraordinary circumstances such as the l93Os. 193Os. digression to develop this. At the moment, it would entail some To those who see monetary policy as ample ample for the desired price and job stability, and in aa relatively noninternoninterventionist framework, II hope my own proposals will be assessed as at least aa necessary ~j~jent supplement to monetary policy. I would even go furfur- ther: on the assumption that an effective and largely nonbureaucratic tax-based incomes policy (TIP) is adopted, II would see no difficulty, Dr. Weintraub of Economics Economics at the University University of Dr. Weintraub is is Professor Professor of at the of Pennsylvania. Pennsyl vania. 53 54 a 01 CrCD 0 — CT3 Cr0—“0. CF—” ‘CCr 0 0:3 H,I -S> -i-Cr C CD~ — CCr — H, CD - ‘C V Cr CT Di CO CD Cr Zr CD CF 0 CT I — Cr Di CF — 0 — CD 3 0 H, CF Di :3 0 CD a V 3 0 Di :3 — Cr Cr C CD CF CT CD CD — 0Di CT 3 -5 H, 0 CF CT CD CD —S V CD 5 Cr V CD 0 CF — C STAGFLATION: THE IMPOSSIBLE HAS HAPPENED C rn V V rn = rl 01 (11 (11 — 0 V 5 — ~1 —4 -- — 0 (7) m r- (11 —4 Carter price level package of October 24. a • N) 5 CD CT 0 0 0 CF 0 Hi 0 Zr Di CO CD V Di CD C CD .a V 3 — 0 CD 5 CF CD 0 Di proposals for inflati on policy follo1,1ed by an evalua tion of the evolving CT CF ~ — — CF CT Z Di :3 CD Cr — V CD CD CF CT ‘C ~5 Di CD — CF a Cr CF -5 — Zr CD ~ — —a a — Cr ~ C Cr Cr — 0 :5 a CF CD (/1 C CT Cr CD .0 C 5 - CT Cr 0 Ca. CO 0. — C a Di 0 C CF V C CF 0 — ~ CO Di Hi — — Di Ca. CD Cr CF ~C $ — CF Cr Cr — Di ~1 CD CF CD ‘C 0 5 - .— CD C 5 — (5 CD V CF CT CD CO C — a Cr C CT CF CT Di 5 5 Di CF CT CD 0 0. C 0 CF — 0 V :3 0. Di CT Cr a Ca. CO 0 CT 0 V V — CF 0 CF CD V 0 CF 0 too potent , chopping jobs and production rather than subduing the price level. Money retains its majesty in financi ng output and funding jobs. CD 3 ‘C V -a Cr — CT CD CD CD CF Hi 0 CF 0 0 CT Di Cr — CF - ‘C 0 V 0 CF CD — CF Cr C CD i CD 5 3 0 5 — CF — 0 — Cr CF CT CD 0. 5 Di It has, too often, been simply CO 0 $ ‘C 0 CF 0CD Di _a 0 3 CD CF :5 CD >< CF -a a :3 0 V 0 Cr — CF — Di — Cr CT CD Cr CF Di CT CF 0 C — CD ~ Cr —~ CD 3 Di CD r CO CD $ Cr 0 Cr CF 5 H, — Cr CF Di CF CD Di ‘a .a ‘C .- — :3 Di Hi a Di -a- .a Cr Cr C CD Cr CD 0 CT — 0 Di _a CF 0 -5 CD $ ‘C — CO CT CF Cr CD 3 Subsequent discuss ion will strike on literal ly three planes , with first some general views to establi sh a positio n; next, to deal with some slightl y more technic al issues; and finally , a statem ent of my own Cr 0 CT Di Cr CF CT Di CF CF CD C 3 Cr CF -i — Di CF — 0 H, — CT Di Cr — CF - — CD Cr Cr C V V CD ‘C 0 9 H, 0 0 ‘C CD CF V 0 Di Cr Di CF CT CD ‘C CD CF 1 0 a 0 0 0. — ‘C CF CD CF CT Di 3 0 H, CD CO ‘C 0 CD Di a CF 0 H, — 0 Di 0 Hi CD CF CT CD V 0 Cr — CF — 0 :5 ‘C 3 0 Hi CO — a Di -s CD — Cr 3 — 0 C Cr 0 C Di a CT CD ~ 0 C .a — CF CD 0 Di C Cr CD CT CF CT — Cr 0 :3 0~ CD _a — I dwell on this because it would be a curious misreading of my 1 It has positio n to allege that I deny the potency of money suppli es. been the efficac y of money control as an inflati on instrum ent that has CT CD CD - CF CT Z CO 5 0 CD ‘C 0 $ ‘C Cr CF CD Di 0. — a — 0 — CF 3 V — — 0 Cr CD 0 CT Di 3 a CF 5 0 0 CF 0 C CF V C Di 5 CD CD CF CT H, 0 ~5 0 0. — CF — -1 0 0 V 5 — 0 Di Di Cr CF — Di CD Cr Cr CD — Cr ‘C V 0 ..a — 0 Cr CD 3 0 0 ..a. V CD ‘C —I — V I CF Di 5 CD 2 CT CD CF CT 0 S CF CD Di H, CD V 5 — 0 CD Cr CF Di CT CF CT CD 3 V CD 5 H, 0 5 Di :3 (5 3 Di 5 :5 C V CD 5 per annum can perform the stable price feat or whether a TIP-type incomes policy is essent ial as a prior conditi on for the real output C — C a CD CF CT CD 0 H, CD C Di ._a C Di CF — 0 :3 Di ‘C CT a CD 0 H, 0 _a ‘C V 0 a — 0 — 0 CF H, .a Di — Hi 0 i Cr V 1 0 V 0 Cr Di control mechanics implic it in steady money growth. Crc-f CF Cr0 (DO CF’C Di$ SCD O CD 0- CO U) Cr Cr CD Cr Cr — — :3 — CD Cr 0 0— Cr 0 1 CD V Di CF Di CF CT Cr 0 11 0 For perspe ctive, the formidable importance of inflati on is sketched so that discrep ancies in 3ssessi ng the issue can emerge sharply . CD 0- drawn the critici sm, never its potency. 00-3 Di CFDi 0CrDi DiDi CD3 H,Cr Ca 5 — CFZC CTCDH, CD .a -~Di CDCF CDCr O H,CD CF 7ZDi 0 CODiDi — Di0D$ CO- Di—H, C *a ‘C’C — 1cf. my Ca ital ism' Inflati on and Unem loyment Crisis (AddisonvJesley, 1978), and Keynes, Keynesians, and Moneta rists Univer sity of Pennsylvania, 1978) for further elabor ation. CDCD 5Cr Cr a — Cr Cr — 3 CD CD ‘C 3 0 a ‘C Cr CF CD Di CF CT CD 1 CD ~ CT — Cr ~a — CF Cr CD CD — Di Cr a C Cr ~ CD CD CF CT CD 0 CD Hi CD 5 CD ~ — CT CD —4 - CF Cr CD 0 V CD >< CD 0 0- $ ‘C CT 0 5 —a CO (~ 0 Cr CF CT CD 0 Hi Cr 0— Cr 0 C Cr Cr — 0 0 CF Cr I ~ 0 CT CD Di ‘C CD r Hayek-Robertson discuss ions of the 1930s, or by modern exponents. The differe nce between us, as I see it, is whether steady money emissions a a 5 Cr I 0 9 (/) — CD CT CF 0 — Cr CT CD ~5 CD I 0 H, CD C CT CF ~ 0 CO CD ‘C 0 a ‘C $ m CO Cr CF CD Di CF CT CD CF 0 CO — CT Cr C CT Cr 0 5 — — CF V Di 0 Cr CF $ CT CD CF H, 0 j. — 5 C 0 Hi ‘C CD 0 3 V CD 5 0 CD :5 CF 0 C CF CT CD — a ~ CD Di 0. 0 Cr CT for the most part, in subscr ibing to the steady money growth rule foreshadowed in the 100 per cent money of Irving Fisher, or the Simons- Inflation: The Number Number One Problem Concurring with the various polls, inflation remains our number one economic problem. It is “the "the one in many" economic many” that mars our economic short of our performance, suppressing actual accomplishments well short potential. potential. It impedes full employment; employment; it engenders income inequities and anguish, social unrest and political turbulence; it contributes contributes powerfully to the international dollar decline and raises import prices; it occasions stock market jitters, bearish bond markets, historic high interest rates, and unstable financial markets; it visibly upsets expengovernment and private budgets; and it deflects allocational and expenditure decisions from patterns (presumably more rational) ensuing under aa more stable price order. order. The stop-go of minor skirmishes and major failures in contating combating inflation has repercussions on on the housing and construction industry, with multiplier ramifications through the economy. Subdue inflation and our other national problems should fall into place. Continuing our past stumbles and fumbles leads to a cumulating agenda of unfulfilled objectives, whether envisioned as new ventures for government or as designs to eliminate areas of intervention and alter the scope of the private and public sector. The Great Intellectual Distraction Not least, the alarms over inflation and its acceleration consticonstitute a great intellectual distraction. are shoved into the background. Constantly discussed, new issues In the competition for the limited attention span devoted to public issues, aa Gresham’s Gresham's law is at work: work: the familiar diverts reflection from the more novel phenomena. 55 An age where economics has become mathematized, fascinated with 56 CF CT — Di CF CD 0- — O Cr Di Di .a CF CT Di CF CO — CD )< -a CD 5 V V ‘C .a .-.~ Di — CD Cr V CD 0 — Cr 0- Di Cr -a 0(0 Di a. H, 0 C 5 CD — —a Di H, 3 CD 0 Cr CF 0 Cr CF Cr CF Cr • CD -C CD H, 0 0 -a. CF — C )< CF Di V 0 Cr Ca CF CT CD Di CF CD 0- — — Di V Older 0CD 0 CD a • CD V V CT Di Cr CF CT C Cr CT Di ‘a CD C Di CT — 0 0 :3 0 CD — fl C CD Cr - — CF CD 0 CT 0 — N Di CF — a a CF Di CT Cr 0 Di CF CD a CF — Cr CT Cr 0 V CT CD 0. — h politically mature, and sophisticated economies endowed with all the — CF CT CD —~ Di CF CT ~ 00 ~ CD 0- CD Cr CD — 0 3 CD 0 0 0 Di CF CD 0. a CF — Cr Cr 0 V CT 0- Di a Di CF C i CD ‘C 3 0 Di — CF a CF C CD H, Hi a Di 0 CF CT CD 5 CF 0 a Di a Cr C CF 0 CD 0- CT Di V V CD CT Di Cr a Cr 0 — 5 CD 0 CF a 0. Di 3 havoc in all directions, has happened to us, and to other affluent, — or in bizarre comic operas where everything went wrong at once, creating CO — 0 ‘1 CD Di CF a 0 CD 0 Di CF CO ~ 5 0 CF ~ CD CO ~. CF CT ‘C CD C CD 5 ~ CT CD 5 CD CD 5 Di Cr V 0 ‘ 0 0 0 3 N Di -S 5 CD -~- CT a. 5 0 Z .a Cr 0 .a — 5 CD V C CT Di CT Di ~ Di — CT Di V V CD CF 0 CD 0- Cr What used to happen in banana republics, C 2: CT Di CF - CF 1 Di C 3 Di CD 00 C CT CF CT CD CD 5 H, H, C Cr CD Instead of a single disorder one at a time, 3 CD — CF Di Di CF CD 0 0 5 0CD 5 — Cr 0- CD .-a CO a Cr Di Hi 0 Cr CF CD Di 0- — - Cr CO — 0. — CF 0 a. $ CD 0 0 :3 0 CT Di a Cr 0 C CD Now, the see-saw has yielded to the buzz-saw: we have simultanI CF Di C $ — Cr CT Di C CD CD Z - - CT C N N I Cr Di ~ CF CT CD CF 0 a CD 0- -.a CD a ‘C Cr CT Di Di ~ I Cr CD CD Cr CF CT CD a ~ 0 ~ - CD 0- — -a Di C Either inflation or higher unemployment rates preJ I 5 CD V —3 Di CF CD Cr CF CD 3 ‘C 0 V 3 CD C ~ CO CT CD 5 CT 0 5 Di CF ~ 0 H, -a 5 — CF CT CD 5 a rn - CT Di 0 Zr Hi Di 0 .a. Cr Cr 5 CD 0 CD ~ CF CT CD Di 5 Zr CD a 3 Di CF CF CD 5 V 5 CD C CD 5 Cr CD CF CT CD a CD H, Cr —1 Di CF CD CF CD ‘C 9 0 CD 3 t C a Di :3 CO — Z upswing and unemployment rates fell; the reverse pattern marked the Cr C V In the older boom-bust cycles, prices and output rose during the 1 CF CT CD CO — 0C i 1 0 Cr CD CF V C CF C 0 Di :3 0- 0 CD Cr — V 5 a CD Cr 0 0 ‘C CT C Cr CF I CT 0 0 3 0. CD 5 0 CF CT CD :3 — of the language was a more total disorientation of the economy. - 0 3 ‘C CD 0 0 CF CT CD H, 0 0 — CF Di CF CD — 0 5 .a Cr 0- CF 0 CF Di 3 0 5 CD Di Cr ~ Di CO C Di CO CD Di -a CF CT CD 0 H, The price of this enrichment CF 0 CT 9 CD — 5 CD — Cr CF CT H, 0 0 CD — 1 V ~H CT CD • CF CD 5 3 :3 0 — Di CF .—a Hi tO IC 13 I—~ !t~~ CF CT CD CF 0 ‘C 0 CD 0 C CO CO — C a giving currency to the slumpflation term. H, N CD 0- — It is especially perplexing that in an CF Di CF CF CD CD — : 0 1 t CT ~ CD — Q Cr Cr V 9 The ''impossible,'' or ''inconceivable,'' has thus happened. — —4 CT CD Cr prescribed sophisticated stabilization techniques. 0 5 CT Di C 0 0 we suffer the double trauma. — - Di V CT CD CD Z CT Di C CD .a 0. 0 C CF Cr — Cr 0 3 0 V eous bad economic tidings. 3 Di CF CT CD 3 Di CF 0 ‘C CD I CF 1 0 C CT 00 C CT CF CT CD -a ‘C CF Cr CD economists would have been appalled at the juxtaposition of events. :3 5 CD V been more severe, as output fell amid a chaotic price level surge, a Cr C 5 CO CD CD C CD —‘ 0 CD a, V 5 0 .a. 0 CT Di 0 CF Di a. J 0- $ Di CD Hi 0 C CF V C CF Di Cr 5 CD Cr CD C CD 9 0 5 CD CD :3 CD CT CT CF The debacle in the United Kingdom has at times Cr 3 CD — CF Di CF Cr CT Di CO 00 9 7~ — CF CD 0- — C CF CT CD — a CD 0CD CT Di 0 —4 CT CD - 0 3 a CD Di ~ 0 — Di CF H, a Cr CF Di CO CD the stagflation ordeal. — 0 V — CF CD 3 0 CD 0 H, 5 CD CD Manifestly, the double-trouble attests to some failure of ideas, and a H, 0 0 CD recession fallback. CT CD 0 0 ~ CD CT Di Cr Cr 0 ~. 0 3 their reenforcement in policy. s Di S vailed. CD 0 0 CT CD ~5 CD E CF CT CD much inflation and too much unemployment, with the odd couple constituting — :3 CO — CF C CF — CF Cr 0 0 CD J 0 0 C V 0 00- CF CT CD CF CT ~ CF 0 ‘C 3 CD V C 5 CD 3 3 C 0 CT CF 0 0 Di :3 0- 0 — Di CF H, — 3 C 0 CT The last decade has witnessed the simultaneous distress of too CF 0 0 H, 0 Cr Cr CF 5 CD — Cr 0- Cr CF Di 3 CD 0 C C $ Cr — CF CT CD CD Cr Cr CD 0. CF ~ Cr CT Di 0CD 0 Di 0CD CF Cr Di CT CD The Stagflation Ordeal: The Impossible Has Happened CD 0- CD Di = Cr Di = CD CT Cr — 0 Cr 3 — CT CD —I -- .-a 0CD Di 5 0 :5 a 0 Di CF H, CF Di 01 CD -4 CT mate are conspicuously few. - ~ CD Hi ‘C Cr ..a C 0 0 C V — Cr 0 0 Di 5 CD Di CF CD $ .a a I CD ..a CF Di Cr :3 0 Di CF H, :5 .a. CF CT CD CD Cr CF 1 5 Di CF 0 Cr 0CD Di a. -a Di :3 CO a. 0 5 H, 0 CT CD 5 3 :3 C CF CT CD 5 0 CD Cr C 0 5 resources, the number of original ideas to arrest the inflation staleCr CD .a CD 0 CF C Di :3 CF CD a H, 0 0 0 C Cr Hi CD 0- 1 CF 0 CD 0 0 CF CT CD CD CF Cr V — 0CD CF Yet despite the concerted focus of intellectual CD -< - -a a. 0 — CD 0 0 :3 0 9 0 a. 0 0 CT 5 chronic economic ill. 01 Di CO CD a ~ CF CT CF CT CD 0- 0 C V a. 0 V 5 CD 0 CD -s Di 1 CD -S CD 0 C 0 3 Cr Cr Zr — .a Di 0 Cr Cr CD H, 0 -s V H, 0 Di 9 0 C :3 CF CD C C 0- undue amount of professional skills, moreover, are preoccupied with the econometrics and obsessed with the computer devouring piles of data, the main tangible result is aa sequel that previous generations generations of economists averted, namely, the stagflation malaise. Buried under the funcenriched technical avalanche, progress in ideas for the smooth functioning of the economy has been impaired. THE KEYNESIAN-MONETARIST DIALOGUE Passing reference must be made to the prescriptive versions of the dominant Keynesian and monetarist dialogue filtered over from professional to popular consciousness. Over the stagflation decade monetarists have generally alleged that central bank policy has been too lax, with the money spill spill culminculminating in inflation. They usually advocate annual money increases in the three to five per cent range. In more inadvertent renditions, aa steady money pace seems to be the virtue, rather than the two-pronged rule of steadiness at aa rate consonant with longer run production growth. The objective remains, to abort inflation on the premise that the steady percentage rule will restore a stable, full employment economy. Keynesians, with with minds riveted on past unemployment episodes and, until aa late day, less mindful of the inflation burden and inequities, have usually targeted their money supply recipes on alleviating job distress. Their money supply advocacy has more frequently, over the seized on annual money growth rates in the seven to ten dour decade, seized per cent zone. 57 58 - CF o ‘C V C chided for understating the social, political, and economic plight a 0- CO CT CF a V 0 — 3 S 0 O CD Pigou might be — CT CD CO CT CF $ CO 0 C V .a, - CD Cr Di CD through the "real-balance" effect the ensuing price deflation remedy ‘C CD 0. 9 5 CD 5 0 — Di CF H, 0CD CD —s — 0 V CO Cr Ca. 5 CF CT CD CD CF 0 CD H, H, CD CD :5 0 Di I CT Di .a Di 5 CD r CD CT CF an automatic route to full employment (Lapses from Full Employment); — a - .— CF 3 CD 0 a $ n ni C 0 3 -s H, Cr CD Cr Di r 3 CD S CF 0 ‘C V CD 9 Hi C CF ~ CF CD i 0 C 0 CF Di C CF 0 3 Di Di Di Cr Cr C CF (5 Di CO CD ~ Q 5 Hi CF CD a 0 Di CO 0 CO 5 .a 0 CO 0 C V CF CT Di CF Cr a. CT C CF (3 5 CF CF Di (5 ‘C — 0 V Cr .a dubious policy attributes that Pigou long ago noted for wage cuts as 0 C 0C CT 3 CD Cr Di CT CD CF H, 0 Cr CD Zr 5 CF Di Di V Cr CF CT C 5 0 a Di CF H, -~ a :5 Cr CF . Di CO Di C 5 CD (5 ‘C5 CF Di 5 CD The monetary cure against inflation thus partakes of the same 3 0 CT CD —I rates, the double-trouble of stagflation or slumpflation occurs. - Cr C 0 0 0 5 0 — Di CF H, C 3 V Cr 05 — Q Di CF .—‘ H, Cr CF Di CO H, 0 CD 0 C CT CF 5 CD I CT C 00 CD CF CT 5 Di CF CD Cr unemployment, insisting on higher pay despite jumping unemployment CF :3 3 CD 0 ‘C .- V 9 5 CD C 5 CO V a C 3 Ca- CF CD Cr V a. ‘C 0CD Di V CO CT CD 1 a CT 0 :3 CO — CF Cr . Cr S — CF CD ‘C 3 0 .— CD 3 V C — When labor grows more adamant despite CF CD V — 0CD Cr Di 3 S CF Di Di 0- $ 0 ~S CD CO 5 0 ~ Cr 0 CT Di —~ 2: CT CD - Cr Di 5 0- 3 CD 0- ~ Di CO CD Cr CF — S CO CF 5 Di CD 0 0- $ .a. a inflation, there is a precondition, namely, that labor must acquiesce a 0 CD Cr CD fl C CF Di 0 Cr 3 C i .a Di CT a CF CT Di CF CD ~ ‘C a :3 3Di a a 0 CF — CD o 0 :3 0- V 5 Di ~ Cr 5 CD CD CF CT ~a 0 Di CF H, t C Cr ~ CF Cr S CO Di Di a. S 0 ~ For it to win against CF CF ni 0 —3 CD - a 5 Di CT C 5 0CD Cr CF CT CD 0 —s H, ~ Di :3 CF CD 0- C S CF CT CD Cr CF Di V V supplants the unwanted for the undesirable. Cr 0- Di a. 0 1 — CO CF CT CD 5 CF CT Di 5 CO — CF C Di Cr CF Di CD 0- CD 3 a 5 CT CD CF CT 5 0 C CO CT a a. CF 5 -- 0CD 3 0— Cr 0 5 0 Di CF Hi S — CD CF CT — CO Di CF CD CF — 3 0 Di S CF — CF 5 (0 Cr Cr .a Cr — 0- CF 0 ‘C 3 CD a unemployment distress, it can mitigate the inflation disorder: it CD 3 V C Effectually, by inflicting 5 CO — 0 CF a -4, — ‘C CT ‘C CD (5 CF C Di H, Hi ni - .-a CD C CD CD -s — (5 V CF CT CD CF Di — 0 0 Cr C CF CT a Di CF fl CD Di Cr ascent and thus contain the price level. S — 3 might be more devastating than the original disease. CO CT CF doctrine -- it can indirectly slow up the average wage and salary Di 5 ‘C Di Cr 0- 5 ~ Di CO CD Di CF CT CD Di C CD 5 Di CO CD V C 0 Cr N [~ I—” I—s lCD In CF -a~ ~3 0- :3 0 Di CF ..h I I CD a 0 0 CF 5 0. By creating enough unemployment -- as under good Phillips curve 9 I 0 C 5 C CD — -a ..a — V Cr CT V CO 0 0 0- CD 5 C 5 0- Cr Di I CF :3 3 ‘C 0 V :3 CD C CT 5 0 C CO CD CO — 0 5 CD Di CF 01 ‘C destructive to the housing industry when it is severely restrictive. • CD C 0 CF .—.. Cr CF 5 CD CD ‘C CD C CD Cr ..a• Cr — CF ~ CT CD 5 5 ‘C Cr CF C S 0- — CO 0 C Cr — :3 CT CD CF CT CF 0 a. C CD CF 5 C 0 CF Cr CD 0J its hardest direct blo~1s on jobs and production, being particularly E :5 ‘C 3 Di o C . — Di 3 CF V CO — CT CD a :3 0 CF V -S 0 0C 0 0- Di Cr CT 0 Ca 0 Cr 0 CT CF — 5 CD 0 0- Cr CF CT Di 5 0CD Cr CF Cr CD 5 0 Cr 0 — 0 ‘C a V -5 ‘C Monetary policy scores CD CF Di 5 0 • — 0 :5 Di CF Hi -a 5 -~ Cr CF — CO Di ‘C Di CD H, H, — 0 Di 0 Cr CF — CD Di CF 0CD V 5 CD 0 0 CF to deprecate its efficacy against inflation. Di CF — 0 Di a V 0 Di Cr 0 0 CF CT CD (0 5 CF a Di Cr CF 5 0CD :5 C ~1 0 H, 0CD 0- — 0 CT in moderating its wage demands. Zr CT Di Cr Di 5 C CD 5 C ‘C 5 Di Hi a 3 H, CO — C Cr even while not derogating the potency of monetary policy, it is possible CD S 3 — Cr Di Cr CD ‘C CD 0 H, Cr 0- Di CT CD 0 5 Di CT .a Cr CT Di H, CD CT CF Hi 0 CD • Cr a. CD 3 CD 3 0 5 CF ‘C 3 CD :3 0 ..a C S CD 3 V Di Cr CF V .a 5 CD 0- CT CF CF Di V 9 — CF -a. 0 — 5 CO — 5 CO 0 Cr 5 a Di CD Cr CF 0 5 7c ID ‘C Keynesians clinging to implant the dire past unemployment memories. C~ ID 3 CO I CF 0 —‘ Di Cr > As a long-time critic of the fashionable brands of Keynesianism, CT-a Cr Cr — 0 V — Cr CF — 0 ‘C —a — 0 V ‘C Di -5 CF CD $ 0 H, 0 ‘C 0 S ID CF V 0 CT CD CO CF 5 0 CO Di CF -a. 3 0CD :3 0 CF CD a ~ CT CD C CD 5 problem, the monetarists to the Keynesian inflation neglect and the CD CT CD CF Di 5 0- CD 0 CF CO ..- :3 0 — Di CF H, S S a Di Cr .a CD CF CT H, 0 5 CF V Di CF 0 a. 0 5 CF Di CF CF CD .a CD 0- Di o ‘C 5 CD Cr CT Di 0 CT Di CD CD Cr Cr a CF CT CD ~ 0 5 CD - ..a C H, .—a H, CT Di Nonetheless, each has called attention to part of the 7~ CD CF CT CD 0 CF Cr CF a Cr CD CF Di 3 0 S CD CT CF -. a CD 3 CT 0 V half full. 01 03 ensuing from fairly universal bankruptcy. CD the debate has been over whether the glass of water is half empty or 0 ‘C $ V CF CD H, a Cr CT Di ~ Di CF CD H, 0 Cr Cr Di CO CF CT CD Q CT CD CF CT CD 5 3 0 C CD CD CD CT Cr CT Di 0CD CT Di CF (0 CF CT CD Di H, 0 9 C 0 CT CF CD — Cr Cr V 3 a :3 Cr 05 0 Cr CD C V Cr Cr I C 5 0 Di CF CT CD CD 0 H, CF CD Di Cr CT 0 CO C CD Di -h C Dialogue has often been at cross-purooses, and misspent; much of My con vi ct ion thus remains, that over both the near future and conviction the long haul, monetary policy is destined to be inefficient inefficient in estabestablishing aa stable economy. II offer this as aa reluctant conclusion; II would prefer being mistaken, for my analysis suggests that new instituinstitu- tions must be organized to cope with the systemic contradiction. In error, the sole result would be that these skeptical views would be demolished by events and we could go on as before --— a a very small price to pay for the maintenance of an orderly and venerable economic system. The Incorqpj~~jed Incomplete Fed The Fed has been fighting inflation over most of its sixty-four sixty-four years. The dismal inflation history is aa result not of the lack of will on the part of the Fed officials, but of a lack of tools for a direct attack on the price problem without dumping us in the unemuneminflaployment ditch and, over the last decade, without discernible infla- tion surcease. The last two chairmen of the system system were dedicated and implacable inflation foes, yet both left office with prices over fifty per cent higher than at the start of their th eir incumbency. Even as they reminded us of their zeal and the Fed’s Fed's eternal vigilance, vigilance, they would intone the lugubrious price statistics. statistics As in the military communiques, they would always see light at the end of the tunnel crowning their valor, yet always the victory has been beyond reachreach. After sixty-four years of retreat, and cumulating distress, we would long ago have altered military strategy and probed whether the weaponry was ample for the task. cone l us ion My conclusi on has been that an unaided monetary policy cannot usher in aa sidewise price trend, at 59 60 o CD 0 Di V CD -s CF 0 5 - 0 — Cr C 0 V .a. 0- 3 Di 5 0CD H, 0 Di .a CD CT CF H, 0 CD Z 0 V CO The case might be made that the CF CT CD CT Di CF CF Di 0CD $ CT CD CO CT CF a 3 CD Cr 0 Di —4 CT CD - CD 0- C Cr CT CD CT Di ,a 3 Cr CF S CD C CD ‘C CT 5 :5 CO -“ ‘C — H, CD 0- CD Cr Cr _a Di CF 0 — ~ Di a -C CD CF 0 a CD 0- ‘1 to Di Di Cr CD 0- — .-a CT Di .a ‘C Di a CO — 0 or their wayward patterns of recent years, or the transformation of H, 0 — 0 S Di CF 3 5 a Cr Hi Di S CF CD CF CT 0 5 Cr 5 ‘C CD Di CF :3 ‘1 CD 0 CD H, 0 Cr 5 CF CF CD Di V 0- -s ~ Di Di ‘C ~ 5 CD CF CT 5 0 Cr -C CD C 0 aV Cr CT V H, 0 a. CD Cr Di 0 a. 0 5 S CF —a. CF CT CD 0 S CD CF 0 S 0 S CD CD 0- Cr a CD - There is no need to dwell on the intricacies of Phillips curves, CD CT -4 C a viability of the market system. - 9 Cr CF CD ‘C Cr 5 Zr CD CF Di CF CT CD Hi 0 ‘C CF a _a Di CT but it embeds some bad theory and dubious policy, dangerous to the CF CT CD CF 0 5 0 C Cr CO CD S 0Di o ‘C ..h 0 V C Cr a 0C CT .a 0- :3 Di 0 —5 ‘C CD CF CT CT Di 0- Cr 0 CT CD 0Cr 9 CD a CF C CF CT This is good Phillips curve doctrine CD S 00 0 CF ~ — C CD C -s 0 a. V Cr CT V 0- 0 CO 0 a Cr -4 CT .a Cr - CD :3 CF 0 ‘C 3 V 9 CD S -a -a CD Cr V :5 Di 0 (5 ‘C 0 ~ V More candid espousal of monetarist recipes acknowledge that the CF CT CD CF CT Di CF CD 0CO CD 0 S Zr fl Di Cr CD V — ID O ‘1 CF — Cr CD CF Di 5 3 o H, 0 Di Cr 0 C Cr V CD a .a. 0- Di o 0 ~5 CD S in case the battle goes awry. a ~ ‘C Di Cr CD 0 CO CD a CT Di CF CF CF CT CD CD 0 Di Cr ,a. In the military, there is at least a contingency plan Di S V -a ‘C — 5 CO CD S 0 0 5 CF (5 Di CD Di Cr CF a CF Di Cr — CD CF CT CD a ‘C CF Di — a a 3 CD CT CF — - CF CD 0- H, 0‘5 Di CF S 0 CD 5 Di a CD _a 0 CT CD 0C Cr 0 5 CF CD Di CD 5 V 0 0 CF CD 0- a. .a Di H, ‘C 0 a — V 0 CF CT Ct) — H, Cr a CD .a C Di CF CF CD 5 -,a Di ‘a - CD a _a C CD Di 5 revealed; alternatives, if the policy failed to operate on schedule, CD CT 3 0 a 0- Cr CD Di 5 CD C •5 CD Cr Cr CD V (0 CF CT 5 0 0- Di Di CT CO CT CF — 3 CD ‘C CF 0 CT — CT Z C 5 0CD 5 Cr Di S 0 CD stances under which they might abandon the pressure are seldom CF Cr Too, circumI C C 3 — 0 0 0 C Di CO C CD CF H, CD CF CD S H, 0 0 0 CF Cr 0 CF CD Ca C CT Cr CD Di _a CD Cr Cr CD 5 CF _a ‘5 CD ~ CT 0 0- Di )fl IS 0 0 How long, l~ I—~ r :3 - 0 . H, .a Di CF :3 a V Cr CF 0 .a ..a ~E 0 C CO CT :3 CD ‘C CD Cr Cr a CF :3 CD ..a CD :5 a Di CO :3 .a 0 Cr C CD 0- C V pursued long and relentlessly enough, will stop inflation. CF CT CD CF — Di CF CT Di CF ‘C 0 a 0 V CT C Cr — Di 5 to .a. ‘C Cr CF Di CF CT CD CD :3 C CD Zr Cr Di 0 Z 0 S 3 CF CD Cr Di Z CT Di CF what was originally hailed as a predictive law into a less edifying ~ and how relentlessly, are subjects too often left vague. :3 Di V V C Cr CF 0 0 0• S Di H, 0 ‘C aCr CD CF CD 3 0 CF CT CD 5 C S 0CD Cr CD CF 0 C 5 C CD 5 0 3 post-mortem on why events misbehaved. Di CF ‘5 CO C O Di 0C 0 O Di CF CT CD Cr ~ (0 CD O CF ~ Ca Zr Di ‘5 $ 5 a. V Cr _a 0 Cr CF I to policy can spell unemployment. Cr 0- 0 CF CT CD :3 Di Most dejecting is the advocacy of a policy that aims to replace 0CD 0 Cr CF S 9 CD C Cr V Phillips curve lacks even the staying power of the law of demand in .a CT are not drafted. CF CT CF :3 CD 9 CT CD 3 CD 9 Cr 0. consumer markets under the ceteris paribus proviso. 0 S O Monetarists nonetheless insist that their tight money medicine, :3 CD 00 CD ‘C $ CD :5 0 $ CF a CO CT CF 5 CF CT CD — CF CT Di CF Cr a Cr CF :3 .a Cr S 0 :3 CD CF CT CD -a CD Cr Cr CF a Cr S 0 :3 CD CF Di S Mischievous Phillips Curve Doctrine - CD :3 a- C 0 0 CF CD C ‘5 0 C Cr V V CT — -a Cr O CT a. CD C 0 C Cr .J• with enemies who prefer that it fail. H, Di -a- .a CF CT Di CF CF CD H, CD 5 ~ V CT Z a CD Cr 3 CD S CD CF CT J~ ~ ‘C CO 5 a. CF CF a S ~ C S 0 a Ca. Cr C O 0 CD CD 0- CF 0 ,a. CF CF Di Z ~ CT 0 3 ‘C 0 :3 0 o CD CD CD 5 H, ‘C Di CF — C CD i the relatively free economy who want it to succeed join unwittingly CD CD CF CT ket economy are available, in blocking mild reforms, the friends of H, 0 .a CD 5 0Cr H, CF CT CD Cr 3 5 CD Hi 0 5 0- a $ S CO 0 Zr a 0 CT -a — S a CD CT Di Di C Di a .-.a CD 5 Di 3 ‘C 0 0 CD 0 CF Zr CD Where alternatives compatible with the functioning of a mar$ Di 3 Di 0 H, S CO 0 CF a 0 3 a, H, C CF CT CD aCF CT Z CD CT V Di CF a 0 0 Cr CD Di CF a. C -5 Di _a CF CD CD CT CD 2: - 0 3 ‘C 0 ID 0 economy. H, one dismemberment with another disfiguration, or to supplant the 0 S CD social and political conflict with irreparable damage to the market J. CF 5 Zr CD $ Di CD CT CF CF 0 Di CO CD $ 0Di Di CT a CD 5 Di ‘5 CD V ‘5 a a, CF CT Z — 0 CF H, 0 S 0 Di (5 — CF V 0 0- Di Di _a a. Cr 0 0 CO ‘5 — :3 CF CD H, CD Cr 0- Di CF CD ‘C $ 0 V 3 C S CD — CF 0 0 Cr -s 0 V CT a. (5 CF Di Cr CF 0 Di Di — CF CT 0 C CF 0 CF :3 CF a CD Di Cr least not without a catastrophic cost in unemployment and festering inflation woes with the unemployment morass. To me it is simply immoral, let alone uneconomic, to recommend unemployment for other people, usually to menace menace the least adaptable members of our economy with the indignity of aa loss of jobs and income. II have said on occasion that advocates of these policies should resign, join the ranks of the unemployed, and become the great inflation fighters. If unemployment is good policy, they should be first to enlist enlist in the battle. Too, the policy is spurious. It is as if aa doctor advises a patient that he can cure him of aa coronary ailment by inducing kidney troubles (iatrogenic is the medical word, as Hyman Minsky, Professor of Economics at Washington University, has enlightened us). us would seek a new physician. Most of Medicine aims to eradicate all debilidebili- tating ailments, and not to substitute aa pernicious malaise for aa terminable affliction. In economics, however, we seem less concerned mYStic, with restoring total health, preferring some impenetrable, often mystic, talk of trade-offs. The Phillips curve, even when well-behaved, reports relations in labor markets as organized in the past. Not inconceivably, by adopting innovating policies compatible with with the market economy, or involving acceptable departures, money wage and salary movements may be moderated to much less inflationary sights without bending too much from the goal of jobs for all who are willing to work at prevailing real wages. 61 CF CT CD the price spiral. - (Curren tly, another tight money venture is in 62 CD 0I CT CF Di CF S 0 -a. Di CF CF ‘5 C Cr H, CF S Di 0 — H, — 5 ~ Hi 0 CD ‘1 C CF V 0 Cr Di CF V 0 0- Di CD 0CF 0 CD V $ 0 0 CD 0- Di S ‘a CD 0 5 Di $ -S Hi 0 CD 5 V CF Cr CT CD ~5 a C a 0 ~ CT CD CD 0- Di V V ‘5 CF ‘C Only the worst symptoms of joblessn ess are mitigate d. - CF CD 0- Di CO .a CF — $ CD Di Cr Cr CD s Cr Cr CD a 0 CT Ca. H, 0 Cr 3 CF 0 V ‘C 3 Cr CF Cr Q —s ~ CD CF CT ‘C 0 5 a 0 CF — CT -a CD CF V 0 CD Cr C Cr 3 CT — CD $ Di Zr 0 CF 0- CD $ Cr C CD5 V aCr Cr — CT CF 0- 0 CO 0 5 Z 0 .a CO 0 ‘i — C CD CF a CD (5 0 3 V CF 0 0 CF ~ I I CT CF Di CD CT CD ‘5 CF CF CD CT CF 0 CF V Di CF — CD — 0 0 3 0 0 S CD CF CT CD Money policy is eased, to CF 0 a CD 0- Cr Di CD — Cr ‘C .a — 0 0 V ‘C 0 S CD 5 - Cr CD CO Di CF CF CD 5 $ 0 ‘C V _a 3 CD _a CD 5 H, C CD CF CT 0 CF Di 5 0 CT 3 CO — ~ CD CD 5 5 0 5 H, —“ 5 Cr Di — :3 CD Cr ‘C CD 7C ‘C CT _a Cr 0 Di S 0 — Di ‘5 ,_a 3 CD fl Cr 0 Cr 0 C :3 0- CF 0 0- Di 5 0 Cr — 0- 5 Cr 5 C Cr CD Cr 0 ‘5 0 V CD Cr Cr — C -5 CD V CD 5 CD CT CF ~ CD CF After the repressi ve process runs Hi > - S V — Cr — _a Di CF CD fl CD Cr Cr — 0 Z3 5 Di 0 S CF — CD 0- V V ‘C 0 3 5 0 0 CD CD CT CF CT CF .a. ~ a Cr Cr CD Zr :3 0 Cr — 0 — 0 CO CD :3 ‘5 Di CF — CF 0 — S CD —~ 0 CD 0- 0 0 CD ,- Di ~ CD ~ CF CT Every time we show signs of robust economic 0 a 3 0 0 S CD 0 CF Cr 5 0 CT C H, 0 Cr CO :3 Cr — CT 0 ~ Cr CD ~ CD 3 — CF ‘C C-ri C CD 5 - CO — a 0CD 5 — CD E CT a Cr — Cr —4 CT 5 • 0- CD ~. 0 C 5 Cr — Cr CF Di CD .5 CF 3 CD CF 0 Di o CD CT C CO Di ,a a. r Di S 0- CD _a Cr c $ V CD CT CF CO — :3 CO CT CF (ii — • Cr Cr 0 o CD Di CT 0 Ca 5 0- Di 5 Di CF CD CT CF 0 Z CO CD CF CT H, a 0 S CF Di ‘5 0Di CF — CD Di CF CD CT CD ‘5 _a .a 0CD 0- 5 Di Sighting 0 V I CO CF 0 Cr 05 H, CD S CF $ S CD 5 C CO 0 CD C 0 0 S CD CF 0 C Di5 CO CD 0 0 0 C -5 CO Di CF CT CD 5 CD Z CD -J a CF Di 0 5 H, Di CD CT health we are coerced into iatrogen ic sicknes s, with the economy CO a z Hi — CO H, 0 3 CD 5 Di 0 — CF — Cr CD 3 CT C V CO S — Cr 0- We are compelled to adopt a posture of Di CD 2: ,.a Di S — CD V CD 5 Di ‘5 CD - Cr Cr a Cr CT 0 .5 H, 0- s 0 0- and delibera te retardat ion of the growth rate and job access. a 0— Cr .a 0 S 0 CF CT Di C CD CD ~Z ~a 0 — CD CD 0 :3 Di CF Cr CD CT CF a CD 0- 3 5 0 0 5 0CD ~ CD :3 CD a ..a a a 0 on for a time, we gather our courage to denounce government for stop-go tactics, and to sound some clarion calls (by Keynesians) for renewing CF Di 0 CF the Promised Land, a bugle call to retreat is sounded. — Cr C CD S CF C 5 CD ‘C S CD $ o CO CT CF CF Di 0 CF 3 CF CT CD S Cr Di Di CF CD $ 5 Di 0 CT .a CD C CD Cr 0 I’C Cr C Thus we are perenni ally trapped below our best performance, and CT ‘4 5 CD CF CT CD the march to the fuller employment gates. — CF C CD — 5 CD C I 0 CF CD $ Di Cr 0 0 CT — Cr 3 .a. 0 s 0CD C lCD Di ICF 15 CT lCD I-a- — CT C build the economic patient to better health -- not to complete vigor but, for his own good, this is presumed to make him suscept ible to CT C CF dropped into a recessio n tailspin . 5 Di S 0 CF CT CD ‘a ‘C — $ CF CD Cr 0- 0 Di CF CD Di CF r . Cr a 5 CD ~ Cr 0 ‘C CD :3 3 0 CF CT CD H, 0 CO CT CF CD S CO — CF ‘C 3 0 0 0 S CD CF CT CD Cr CF :3 a Di (0 Di a 0 5 ID — CF 0 Di C 0- 5 Cr Di Di a Di CT CD Di 0- 0 5 Di CF — H, — 0 H, CD 5 C CD C 0 — :3 _a CD Cr CD .0 C CT CD —4 - CO S — 0Di 5 CO CF CT CD Di CF Hi 0 C CD 5 CT r of the danger of inflatio n ahead and cautioned against the economy "overhe ating." The sequel involves a tighteni ng of the money screws, 0 Every time the economy approaches full employment, we are warned 3 0 CD 0- Di ~ Di 5 CD CD Z CF CD S ‘C $ V ..a CD $ Hi C .a 0 CT CD Cr Di 5 0 V V Di ‘C 0 CD 0 0 CF CT CD CD CF a 3 ‘C ‘ C-ri C CD - $ 0 — Cr 0- CF a. 0 1 Di CD 5 C 0 0 S CF CT CD _a. in the conventional wisdom. I 1 0 ‘C CF 0CD Cr CF CT a Cr - a. 0 :3 Systemic masochism earns the more euphemistic name of "fight‘C 01 • dedicate d underachievement at best, and signific ant frustrat ion at — 0CD delibera tely so condemned. ~a This is bewilde ring. CF CD 5 0 C Despite this "destroy -to-revi ve" tactic, we have not dislodged V a. CF CD Di CF Hi ,a 5 CF Cr 0CD 0- later illness. Di _a Cr V — 0 CD C CD Cr — ~ 0 —5 worst. a. ‘5 V . ing inflatio n." 5 CO CF CD 0- V CD CD Cr CF 5 0 CF Cr CD 5 a CD Di S Z S — ‘C — — CD 0. C 0 .a. ~S — 5 CF Cr 0- 0 C _a CF CT Di CF CF Di Cr ‘C S Di H, r C CD — 5 revi ve" fantasy that would stir incredu lity in wanderers not steeped CD C Monetary po 1icy, as practice d, enta i 1s a curious "des troy-to0 I I CF 0 ‘C Cr CF 0CD Cr C 0 .a. C ~5 0 Di — _a Cr CD 5 CF Di a 0- (5 CD — CF Di 5 V Di Cr ‘C 0 V 0 .a .a Di 5 ‘C CF 5 CD 5 a C Di Cr CF Di 3 CD m .a. C I 0 CD —4 0 I ‘C ~5 0 CF Cr C CD —4 CT CD The Destroy-To-Revive Fantasy process). We have, however, sponsored a sputtering economy, rather than a market system riding smoothly at peak efficiency. Monetary policy, despite good intentions, has mired us in an abject outcome compared to to an optimal and and presumably goal. compared an optimal presumably attainable attainable goal. THE ASSAULT ON THE LAWS OF ARITHMETIC Over the last decade especially, we have been engaged in aa mad assault on the laws of arithmetic. Average productivity over the longer term has been inching ahead by two to three per cent per annum; seventymoney income -- with money wages and salaries comprising the seventy-- five per cent bulk of the total --- has been leaping by eight, ten, twelve ... per cent or more. ... In the United Kingdom and Australia, to name but two countries, the more herculean feat was essayed in 1974 and 1975, 1975, with pay increases approaching a twenty—five twenty-five per cent annual pace. Consternation ensued when prices vaulted in concert. AA Basic Truism discrepancy AA price level surge is imperative whenever a sharp discrepancy occurs between beb1een average income and average productivity. Our inability to apprehend this homely truth is amazing for the results must follow: (l) PQ == Y, where PP = Q= (1) = average price, Q = aggregate real output, YY = = income p = = (Y/Q) = = (Y/N)/(Q/N) = N = = employment, P = (y/A), where N yy = per employee employee income, income, = per AA== average product product== Q/N. 63 64 CD a CD 0 CD CF 0 ‘C a 5 CD ö ~ 0 ‘5 H, Cr 3 CD CF Di 5 Di CF CD V ~ b - CD S 0 3 CD S Di V CT CD CO Z Di S CD ‘C 3 — 5 CO Cr CF 5 Cr C Cr S CD 0 Di CF C Cr — Di 5 CD Di -a 3 - S 0I Di $ a. CD Di 5 0- r CT I V C Cr CF Cr 0 "Cost-push" and "demandC r Cr CD Cr Di V C 5 0 CT CD ‘5 0 0 S Cr C 0 H, 0 CD 5 CF CD 5 V CD C Di CT 0 C CF H, 0 ‘5 CD S Cr — CT 0 Cr V CD —5 0- 5 CD 3 Di 0- s CD $ 5 Cr C 0 0 0 H, CO — 5 Cr V ‘5 — S $ Di CD CT CF S 0- Di 3 C Di I CD .0 0 CD _a. V CF CT CD H, 0 0CD Cr — ‘C V V C Cr CT (3 CF :5 0 0 0 Cr CF Cr -a 0 H, — CD 5 CF Cr CD 0- 5 CO S — H, CD — CT CD the chief ingredients of costs, on the supply side of the price equaCT CF This is a cultivated error: money wages and salaries are simultaneously S ‘C 0 C Cr a CD S CF Di C 3 Cr a. CD Di a. CD Cr Di 5 a Di Cr 0- Di ~ Di CO CD Cr :5 CD ‘C $ 0 -- CD 5 -5 0 5 a. C Di CF CD 0- .a . CF C 0 Di Cr CT — Cr —4 - — 0 S CF H, a Di 5 — 0 H, CD 0 5 ‘C CT CF — CT I V C Cr CD CO Di r Z Di Cr Di CT _a, Cr CF CT Di 5 Di (5 CF CD ‘5 — N CD 0 $ Di ‘C CD $ Some may characterize this as a "wage-push" theory of inflation. 0 UI > - 5 — Cr 0 C 5 S — ‘C 0 CF CD >< Di CF Cr 3 0 Di CT — S CO 3 0 a — • ,..a ~ ~- Cr CF Cr 5 (5 0 0 CT Di CF in unit labor costs (w/A), climbing almost exactly in unison. C — S — S Pis thus bound up with the flex X CD H, a CT CD CF CT CF a ~ V C 0- CT 0 C S Cr C CT CF — Cr V -— ‘5 CD a .a 5 CF CD 0 V CD ‘5 CD C CD _a ~ CF CF C CT 0 Cr CT 0 ~ Di Since about 1950, on the score of the k-factor P should a 0- C CT 0 Cr V Di 0 CF 0 5 H, I Zr CF CT CD Hi 0 CD 0 5 Cr 0 CF CT CD 5 0 a 0 —a (0 C.~ C CF Di CT CD 0 UI .a. 5 • CD 3 . 5 CF CD C 0 CF Hi — -S 0- 0- Z Di 5 00 Z 5 CO CT CF — Cr — S CO 0 ~ Cr CT ‘a 0 0 5 Cr CF Di S CF ‘C 5 Di CT _a 0 Di Cr — Cr Zr a 5 CD Di ‘C 0 I Year-to-year, k is reasonably constant, showing slight downward drift CF I .‘C CD Di H CD CD CD V 5 — 0 Di C CD ~ Di CO CD CD Di Zr PQ/wN). • •~—. .0 V II Zr 3 5 0 H, CD 5 Cr CT Di CO CD Di Z CT CD H, CF 0 0 0 Di ‘5 CD 0 — V —s CF CT CD average price markup 5 Zr C V Di $ V 1 — 0 Di (0 CD -~ Di C CD u Zr 5 CD V CI $ H, 5 0 a s — 0 CF CD fl C Di Y - kwN, then: ~ ~ •- CD S CT CF a Zr I -C — 5 I 3 ‘5 0 V 5 0 C CF 5 a Cr CF Di Cr CD — 5 Di Cr Di 0- Di Di (fi CD Cr ‘C S CD $ 0 CD CD CT — CT $ 0 —4 $ 0 s 0 CF Zr H CF 5 CD ‘C — V ‘— C-Q 5 r,, = 5 CD 0 CF 5 0- — 5 Di Cr ‘C Di V ..a ‘C CD Cr CD S $ 0 CD 5 V CT CD 0— Cr V Di ‘5 Di CF CO CT CD — S CT Di S CF CD -S CT CF Di H, — tion, and the mainspring of consumer demand, responsible for about 5 0 CF — To make average money wages and salaries stand out more promin- (or the reciprocal of the wage share, from k 3 5 0 0 CT CD CF 0 Money plays an indirect role S 0 5 Di 3 CD Cr CD CF CT $ H, 5 0 CO 5 Di CF — 3 Di S CD Zr CD CF Cr $ Di 5 5 CD $ ‘5 CT CF ‘CI eighty-five per cent of consumer purchases. V CF 0 C S ‘C Di CD CF CT CD -5 CD 5 Di N) —s 5 0 .a ‘-a a — S CD 3 CT C .a .a CD — CO kw/A, where k 0- — CF 0 0 in consumer markets emanating from the same money wage phenomena. Cr ~ = = • C CD .a CD — 0 CD 5 V CD CF CT a CF — CD Cr CF S CF — C Di .fl ‘C Neither in (1) nor (2) are there any separate terms for money, to CD ~ pull," rather than being disparate phenomena, are simultaneous strings C V P -S o $ 0 S CD .a S (2) V - I I link money quantities to the price level. Zr — 5 show about twelve per cent lower! Cr Cr CD Cr — S C 01 0 Cr Cr o C Cr CD ‘C Di CD CO CD — I - I over time. a - V 0 CD CF S 1 Ni 21 generally use Gross Business Product (GBP) for the income concept. o ently in the price equation, from PQ = Ci O 11 Cr CD Di Cr ‘5 CD — S 0 Di V 0- CD 0 C CF Cr .a N S 0CD 1 C — 0 0 V CD CF Di 5 S a 5 H, 0 CF CF — — .a Futility of Monetary Policy Under Outsized Pay Increases C - CO Di V CF CT CD H, — ..-a —a 0 CF — Cr CT 0 C 5 0- ..a CD C CD _a CD n — price level is bound to fill the gap. ‘5 V CF 0 0 CD Cr -C Di CF CD — 5 V CD CF CT CF ‘C a — C — CF 0 C V 5 0 0- Di C CD 5 Di CO CD 5 CT Di CF H, Di Cr CF CD —5 Cr 5 C ~5 CD CD employee runs faster than average productivity, the private sector ‘C 0 CD $ V including wages, salaries, profits, rent, depreciation, etc. per Di CD CD V - 0 CD CF a 0 5 — CF a Di CD C V5 0CD 5 CF ‘5 CD V 5 0 H, — CF Cr Cr ‘a Di 5 — Cr Di a Cr CD CO Z CO S C 0— — 5 0 0 ~ 0 S N) — CD Di CO --s CD C Di Cr Di S CO 0 —a 0 Cr 00 CD Cr ii CD 0- CF CT CD CF ~ CT Di 0 Hi Cr Cr CD 0- Di CO 73 CD Regardless of what the Fed does, so long as average income 2 in affecting output and jobs, and thus (as under Phillips curve docdoctrine) through unemployment levels it can deflect the money wage trend. Tight money, presumably, will rein in the w(t) path over time and thereby work aa meliorating price level level impact, at least where Phillips curves are well-behaved so that labor militancy does not impair the relations. Tight money, however, by retarding investment, may defer plant modernization and thereby contain the A(t) course. Through this channel tighter money may be (mildly) inflationary. Instant Billionaires? The general theory must be correct. Othendse we could raise Otherwise average money wage and salary incomes not by two or three per cent per annum for aa steady price level, or the eight, ten, twelve per cent figures of recent years, or the egregious twenty-five per cent numbers of the United Kingdom and Australia, but by aa thousand or millionfold: why not make everyone an instant billionaire? ment of instant happiness? Why oppose the fulfillfulfill- After all, if money incomes have nothing to do with inflation, and money control by the Fed can inhibit the price price level excrescences excrescences regardless of wage increases, there should be no objection; there need never be any strikes by people unhappy over their money income lot if price levels are not upset by outsized general pay upheavals. In concurring that there is aa ‘right,’ "right," or optimal, pace of averaverage money wage gains, we are assenting to the ubiquity of incomes policy. Too, there is implicit aa recognition that money policy, unaided by aa supplemental conscious -- or fortuitous -- gearing of w’s w's -- and A's, A’s, cannot usher in aa flat P-trend. P—trend. 65 —- CD Cr 0- S the Many would fault big busin ess for exces sive price markups as view. e's infla tion source: the avail able evidence inval idate s this C ,a 0- Di CF 66 — 0 CD C Di a Di Cr CT CD — CD Di 5 Zr C V Cr CF CT — Cr Di CF CD Cr -- V —“ OTHER !NFLAT!Oll THEORIES In m 73 —4 5 C-’l 0 C —4 )r’ m r —4 ~ ~ ri 73 0 “4 - — C $ V CT Cr CF 0 CO a 0 Di —a 0 CT 5 0 CD CF 0- Di 5 Cr 0 5 Di CF — C — 5 5 0 CD Cr CT 5 H, -a ..a 0 0 H, CF ‘C — Zr CD CD 0 $ — CF CT Z ‘C 0 CD a, C Di CT 5 ‘5 CD 0 0 ‘ Cr CF CD 0 0 CT ‘C — C — CF 0C 0 CF 0 -5 V CT 0 CF I Cr 5 CD 0 Di S CF ‘5 — CT C CF CD Cr Di CO Di — S Cr ‘C C 0 CF — C — 0 0- V CD CT — Cr CF Cr — ‘5 ‘1 CD — CO 01 — - Di 0 CF Cr 0 0 — $ fi Di —a C CD 0- ‘C Di CD ~ ~ with removal contr ibute s a one-shot produ ctivit y boost er, conceivably likely delayed impacts. Big irres istib le produ ctivit y gains are more CD Large ly, however, their CF CT CD — ‘5 ~a CT 0 ~ CD C CD 5 -~ ‘C CO CD r Di ~ - Di 5 Cr —i 0 C — Di 5 CF V CF CD 0 0 CF CD 0. $ .a S Hi 0 i CF CF CD CD CT CT CD .a — will be bette r informed to cite parti cular s. .5 CD )< 0 CD Cr Cr — C CD ~5 H, 0 Cr Cr 5 CD -~- CT C Cr CO CT — CF CD C — 0CD S O CD CD Di CT j — Di C Di CF CT CD -- CD C ‘S 0 o Cr H, Di C Z 0 H, 0 5 ‘C — Di 5 to follow fresh innovations and techn ologi cal triumphs. 0 CD C CF CT CD ~3 Cr - Di CF — 0 5 Cr C CO 5 CD CD CF ‘C Cr Di Hi 0 I Cr C V CD , Di — Cr — 5 CO 5 Cr CF a 0 0 CD Cr Cr — -C CD CD Di S 0- -S a 0 I I 5 Cr .a CF CT CD Di CT ‘a 5 CO 0 Cr Cr Cr — “5 CD 0 V V CD V CF 0 CD Di Cr ‘C — Cr ‘C aI — CF C — o CF 0 0. C — CF It is easy to oppose sin -- or exces sive cost raisin g, or super Others fluous produ ctivit y-dep ressin g, healt h and safet y regul ation s. V 5 C 0 C Cr • ‘S Di CF CD CF CT 0 grov1th rate. Ci Ci decad 0CD 0 Di $ ~ CD Cr Cr CF CD V $ 5 a 0 5 H, C a CF 0 Di .a. CF CT CD 0- CF 0 S 0Cr C 0 CF — C — CF CF CD CD H, Cr CF 0 CF 0 5 C V V CD ‘5 5 0 CF 0 CD . 0 S 5 Cr 5 V CD CD Di CD ‘C — CT — -5 a S CO , CD — :3 — :5 ‘C 5 CF a CD a S 0— 5 ‘a CF CD 5 $ CD .0 C — V 5 CO Zr — Di I $ CD CD CF Cr 5 0 3 Hi Cr 3 Cr C — CF Di -a 0 Di fl CF Cr CD Z — Cr CD H, ._a Zr CD CD Cr ~ ‘C 0 V CD a 0 V a Di 5 ‘s CD CF CF CT C Cr 5 0 Di Cr CD .0 C CD 5 0 CD Hi 0 S Cr 0 0 5 CD CT 3 S C CD CF CT 5 C ,a CD Cr ~a ‘C ‘C 0 Di CF C 73 CD ~ - $ ~ I CF CD 5 Di H, CD CF 5 — CF ‘C Cr Di CD C .a 0 CD Cr 0- CO Cr 0 5 C CT CT — .a CF Di Cr 5 — 0 CF Cr CT Di $ — . Cr CF CD CD Di Cr 0 H, Di “5 <Ia Cr Cr CF CD CO C I CD ~ S 0 H, 5 CF $ CD CD 5 Di 0 CF 0- CD Hi 0 Cr CF CD CD C CT Di aa ~ — CF CT ~1 S Cr CD 0 S 0 0 Di CI 0 CO — 0 0 CD 7J CD 0 CD S CF • Cr Di — CT ‘C 0 5 Di ~ — CT CD Di CF $ ‘C $ Di CD 5 S — 1-4 Di CF — 0 5 0- 0 CF $ Di 5 V V CD 0— S CO 3 — ‘C CT ‘a C CD 0- CD 0 CT Cr Cr Di ~ CF — ‘C 0 5 CD $ —4 — CO CT CF - CD S CF o V CD ‘S 0 Z CF Z 0 CD CT Cr CT Di 0CD Di 0 Cr CD (5 — Cr 0- CD Cr CF Di CF — $ CD Cr ,a ~fl ‘-4 0 Cr CD 3 - Cr — 0CD CT — CO CT CF CT CD 0 CF CO :3 CD Di 5 — CF CD S ~ 0 V CD CF CT 5 CD CD CF CT — ~ -a C 5 s Di ‘5 CD V 0 CD 5 CF V CD 5 5 CD CD side. three per cent per annum, with three per cent leanin g to the high The 197Os estim ates disclo se a shade below two per cent. ‘a ~ -.Ni Di S 0- --a a~~’- H, 0 Cr $ CF CD — 5 - 0 5 CD Cr 0- 0 0 Hi 5 CF $ CD 5 0 CD 0 Di S H, — 0~— — $ Di CT Di 0- C CD 05 C ‘C ~ CD S H, CD CF Cr Di Di S 0- -a C CF — 0 5 CF CD (5 Cr CF 5 a. Di 5 0. CF — 0 S Cr may Tight money, it was observed, by impeding plant modernization rns, with have had a (mild) inflat ionar y bias. Recent ecolo gical conce regupollu tion and safet y drum-beats, have foste red enactment of new and (2), lation s and stric ter enforcement of old ones. In terms of (l) it insof aras a steel mill has to insta ll scrubbing devic es, say, reinin g A. defle cts capit al sums from steel- makin g equipment, indir ectly m to Likewise, in hirin g personnel to clean up the air or to confor to depress safet y rules , the number of employees per ton of steel tends y the A-term. Regulatory consequences can thus retard produ ctivit CT CD 5 0 5 CF ~ 0 Di CF 0- CD 5 Cr C Di $ CD Di Cr Z CF CT ~5 0 Z CO CF ‘C — C — CF 0 5 0 0C V a ‘C — 0 Di 0 CF S — Cr - a CD CD C CD V ‘5 — 0 CD CF CT — 5 S CF ‘C — 5 CD $ -~ V Cr CF Di 5 0- Cr J~ $ ~5 CF CD CF ‘C — C — CF V 5 0 0C 0 —4 CT CD The produ ctivit y term A stand s prominently in the price level two or equat ion. Histo ricall y, produ ctivit y growth was measured at C Di CF .a 0 S Cr 0 5 CF — Di C 73 CD CF 0 0 Cr Di 5 0- 0 0C 0 CF — C — CF Produ ctivit y and Costly Regulations Others federal deficit. deficit. Others indict indict the the federal Yet the last last fifty fifty budget Yet the budget years years have seen only nine years of surplus, often of piddling size and yet, until the last decade the price level performed reasonably well. In 1933, with a deficit fifty-five per cent, the price level deficit of about fifty-five actually fell. Deficits are hardly the indomitable inflation-maker inflation-maker despite the popular rhetoric. More detailed analysis would reveal the deficit theory, when undraped, as aa crypto-money theory of inflation amenable to aa monetary remedy. Government Debt and Expenditure Government debt, comprising the residual cumulation of deficits, also gets its share of inflation calumny. debt has plunged far faster. Fact: since 1945 private Fact: Until recent years, the big public debt lurch occurred between 1930 and 1945, 1945, in aa period when the price level behaved “orderly,” "orderly," again by modern standards. Relative to GNP the federal debt has declined sharply over the last generation. Bombed by Proposition 13, though never really out of season, current onus is directed to government expenditure, especially the federal government though its aggregates are outpaced at the state and local level in recent years. The projected $500 billions federal outlays for fiscal 1979 would, in 1963 prices, be about $240 billions. Government outlays under even unaltered programs cost more as aa consequence of inflation: when defense hardware prices go up, when civil servant pay climbs to match private sector sector trends, budget outoutlays inevitably advance. lays inevitably advance. Relative to GNP, GNP, federal absorption of of outoutRelative to federal absorption put has not been making greater inroads on the recent aggregates. 67 68 cc U’ 0 Di IDi NC a 0 C o .a U’ U’ C C, I —‘ Di C Di .a Di .aC, 5 ~C Di r CF Di U’ U’ Di >< C :3 ‘C CF -a. C -‘. CF C, C a C 5 Di to Di I a Di CF r :3 C Di Di 3 ~ < P1 0 —i -< ~ 0 ~ ri —1 > ~ m 0 (1) —4 0 rn o > C’) ri s SOME ASPECTS OF MONETARY THEORY 0 CO 0 U’ Di CF C -a- a Di 0 a Di CF 3 Di Di to C C to U’ -a. Di U’ -s Di C ~1 C CF Di C CF C -~ U’ CF Di C Di r CF CDi CF C -s Di Di -~ r CF Di 0 9 Di —s C C, C a CF Di 3 5 r Di C C to C Hi Di C, — -a Di CF a :3 Di ‘C ti Di Di -aC, C % U’ Di -a. ..‘ c -~. C, U’ C -. C 3 -h —a C, ‘C -~ Di . Di U’ a :3 Di Di to Di Di r CF C Hi CF 3 Di :3 a CF Containment of the wage and salary climb, Di 0 C • U’ Di 5 ‘C Di Di C -a- H-~ a Di 1 :3 C Di 7ç~ Di CF —a At an eight per cent annual escalation, the feat Di CF Di Hi Di CF .. :3 C .a Di CF —a Di C, Di U’ —a C Di ~ Di CF :3 Di C, i Di ~ CF .a to Di Di CF > • Di ‘C —a CF C C to —J —a tO —J Di Di a —f Di 0 C —‘- .a C -a. C 0 (3, CF r Di ~ C r Di a Di —5 U’ C C —‘ —J —a. ~ C -a. CF Di CF 3 Di to C Di 1 Di 3 Di Di ~ CF U’ Di Di 5 ‘C Di Di r CF 1 Di over three years the mere augmentation will overshadow the $500 billion C C At compound rates of 10 percent, in just a CF U’ C La. :3 • Di :3 CF C, -s Di 0 a —a Hi C U’ Di CF Di a s C C C 3 C C, CF > • C -a -a. —a- 5 CF -~ • —a b~ CF C U’ CF C 3 C Di C 0 C .a. CF Di U’ :3 Di 3 ~C C, C Di C ‘C Di —a -C Di 3 C CF Di CF ‘C a Di ~ Di U’ ..J~ C U’ -~ Di CF — :3 Di U’ CF Di .a I Hi .a 0 U’ — to U’ U’ Di —a Di r CF to C -a- CF Di CF Di C, fl C C, -~ Hi C CF :3 Di r C, Di 0 Di CF r CF Di -s C U’ CF -~ —‘ -a. —4 C To illustrate the penchant for concentrating on the less signifiO~ U’ C r Di CF Di -a—~ r ~ CF :3 cant while the substantial slips away, total employee compensation now Di C, - C -- CF —-a Di Hi — Hi C U’ Di -a. Di C ~ r CF ~5 ‘C Di Di CF C 3 -~ C -~ U’ C tions for monetary theories of inflation. -‘. CF I Di C, — -a C 3 .a a CF ~ U’ a CF -“ — C, ~Ii Di a to Di —5 —5 Di —a a Di Di Hi a -a C C CF • 3 Di CF Di — C C, Di ‘C -~ CF C C CF CF r C C without outlay containment would feed larger deficits, with implica—li ~ Tax slashes U’ Di U’ Di —J U’ Di )< —4 U’ - Di C, fl Di C .0 Di U’ C C, —a 0-a C, a. C U’ 5 C ‘C CF Di ‘ -a 3 to -a- Di U’ U’ Di U’ U’ C C CF CF r ~ -‘- a Di 1 Di a C ordered without assessing military or social consequences. Di -aU’ Discussion .aU’ 0 • ‘C to Di CF C -a -a- C C -~ CF U’ -a. Hi ‘C :3 Di C 2 Di 5 r Di Z 3 C 7C U’ U’ -a. Di U’ r -a Di r CF -J. —~ ~ Di a to 0 -~- 3 3 — CF 5 j C • Di Di a C Di Di Di i U’ C, C CF ‘C —a C CF C Di :3 CF 2 Di 5 C C to Di -I. —J r ~ Di >< Di Di CF Di 3 Di ~ — ~ with a meat axe while government outlay cuts are evaded, or trimming CF More difficult to fathom is the conviction that taxes be chopped C -a Di a C r C, Di C U’ x Di Di CF r Di CF CF C -~ CF aC, C :3 C C, Di r CF U’ —“ 3 r C Di CF -1 C CF -a CF C ~a. C, Hi Hi ~ a Di ~ C C • C CF C C i U’ C Di Di U’ -a- C CF Di -~ —+, -J- ‘C Di —a CF outlay in inflation season or out. C CF 0 Di 3 j Di C to C —‘ C CF Di H-, U’ ~ Di C U’ Di -a C C a -~ C C Di -a C ti -s ~C Di C C CF Di r CF .. -s C Di ~ Di C r Di 3 C U’ 1 presume, however, that our people would oppose wasteful government Di ~a CF a a C ~ C 3 One would Di 0 - C, Di Di C-a. ~5 r- C, -a. ~ r ~ Di —a- C Di I I a Di Di 3 a —a Di Di Di U’ U’ C, )< Di ..a. ‘C 5 C U’ CF story in excess real demand -- a view which I reject. U’ o -j U’ - 3 — U’ Di -~ Di C) 3 ‘C U’ Di -s w 3 Di Di Emphasis here on the ~/age-productivity nexus as the price level- 3 rr, would appear to be the best route to repressing government expenditures. —J C. and thus civil service pay and the price of government procurement, a Di will take under five years. Di -a Di • -~ Di -~ -~ C CDi C U’ CF -~ 3 Di 7r Di 3 CF Di C —a ‘C -‘. C C C amounts to $1.4 trillion. 0~’ • CFC Di Di r maker make remarks on where money fits in obligatory. inevitably must be brief. 3 Di federal 1979 outlay. Di .a.CF U’-a- Di CFC a -o ~ C -o All this, however, presumes that stagflation is a Di U’ .a CF — C Di —~ Di to —F, U’ CF CF Di r CF Di U’ 3 C U’ ~1 Di -C .~ Di C ~ Di C -. U’ .a. r CF ..a > - —a ‘C CF Di Di C a. CF ~ C proportionately. DiC SDi C~a Di U’~ CF Di~ Di c Di11 U’ Di ~< Di CO 3Further elaboration appears in my Capitalism's Crisis and Keynes, Keynesians and Monetarists. 7Z U’ Di — U’ I a C C Di C to CF C Di U’ ~ ‘C —a CF C C CF :3 Di 3 1 Di C < to Di ~5 Di U’ Hi C U’ ‘C —i .-a Di -~ C, t3 Di Di ‘- a Di .J cluded, especially insofaras government outlay has not gone up disC a C, = "causes" inflation, then other forms of expenditure must also be ini 0 -“ Di C U’ C —a Di CF U’ C 3 Di a a• CF C —s a Di >C Di Hi C U’ 3 Hi C 1 ~ Di r C CF Di r CF ‘. C -a. CF Di — -h -~ r U’ Di U’ Di C C, > Hi -s Di C CF a 0 C Di Di CF Di 3 1 C Di C to -a- C U’ Di ‘C U’ CF C U’ ‘C -~ Di ~ Di C U’ Di Di -~ C CF .a. r to C C CF Although it braves heresy to say so, if government expenditure Modern quantity theory doctrines link money supplies primarily to money incomes, finding the connection of money supplies to prices and to output variations more perplexing. equation of exchange of MV (3) m(IIM/M) m(AM/M) = = = = In the symbols of the old income PQ, implied is: (IIP/P) ++ (~Q/Q), (IIQ/Q), (tP/P) (11Y/Y)/(11M/M) where m m == [l [1 + + (IIV/V)/(IIM/M)] (AV/V)/(LsM/M)] == (M/Y)/(aM/M) Murkiness -- or indeterminateness -- enshrouds whether money supply -— -- changes affect primarily the P’s P's or the Q's, Q’s, the latter welcomed and policy. the former ordinarily rejected in economic policy. In adumbrating the steady money rule of, say, three per cent annual money increments, there is an implicit proviso that the money swell swell will sustain the (11Q/Q) increment rather than spill over to generate a AP /IP splurge. (AQ/Q) From the wage-cost markup equation (WCM) (WCM) of PP MV (4) = = PA = = = = kw/A, or from kwN, it follows: fo 11 ows: m(IIM/M) m(M1/M) = = (llk/k) (llw/w) ++ (IIN/N) (Ak/k) + + (Aw/w) (AN/N) jumps are If we neglect kkin in (4), as with Ilk= tk = 0, and if money wage jumps excessive, and taking 11.1. in (= con~= the money income elasticity at values con- jectured in monetarist studies) nearly constant, then a failure of money supplies to balance money wage hikes will have impacts on employment, ML AN. In (4) the potency of money policy for WCM theorizing emerges, with Fed's slingshot, instead of PP being brought Q Q and NN being hit by the Fed’s directly to hand. From the WCM: (5) (AP/P) (IIP/P) = = (Ak/k) (llk/k) ++ (Aw/w) (llw/w) - (AA/A) (IIA/A) - By-passing k, PP reflects aa tug of war between wwand and A. 69 From (5), ;tj CD 0 Deflationary Growth Steady State Deflation Depression 70 Recession 0 S Cr Cr CD C 0 - Stagflation Slump fl ati on 0 S Di CF C $ ~ H, In 0 Di CF — ~ To make separate provision for H, 0 C — Cr — 0 S o ‘I V Cr CD V Di 5 Di CF CD Di Zr CD 3 O —4 - >< — Di CF 9 0 Others may elect different names for the CF CT CD H, 0 5 Cr CD 3 Di CD ‘1 CD S CF Hi 0— H, CF 0 CD $ Di ‘C CD C CF CT CD 5 Cr • ‘C . .a o V ‘C CT) CF Di 5 0 $ 0 Whether column l, 2, or 3 is our lot _a 0 CF 0 C ‘5 — Cr U) 0 5 a N) ‘a S $ C 0 0 5 CF CT CD CT CD S CD )< C Cr - CF ‘C a. .a 0 CF C CD I V 5 0 0- (0 Di CD CF CT a Di ‘5 CO C ~ ~ 5 CF Cr 5 C) E — 5 CD V CD 5 0Cr -a 0- U) 0 5 ND a 5 0 — 5 Cr 0- Di 0 $ ‘C CD 0 0 5 CF CT CD -S CD Whether the economy lands in row l, 2, or 3 depends, in WCM arguments, ~ CT CD CF CT Table l indicates the variety of potential economic situations. - 0 5 Cr .a. Cr — CF C Di CF — 0 3 0 CD 0 0 S ._a CD S CF — Di CF V 0 0 H, ‘C C Di 5 — CD CF CF CT CD Di CF CD Cr 0 — 0- 5 a ~ CD —4 Di CT (6P/P) ;< (6w/w) - (6A/A). - —S > ‘-‘-. N I ~ — ‘--.. N —‘- Ally ‘-—‘ ~ V C> -o I! — 5 ‘-— N 5 - $ 0 S CD V CD S 0Cr 0- C CD a a 0 CF Cr CF 5 0 0 0 5 reasonable constancy in m, whether money policy is expansive, neutral, CD S CD C CF ‘1 Di ‘a Cr — C Di V CD — Cr 0 ‘C ~a. V 0 CD ‘C 0 5 $ CT CD CF CT CD 5 ~ ‘a 3 S a ‘C S 0 Di 0 0 S Cr CF CD 5 CD Di Cr 0 S Di CT CF CT CF CT CD 0 S C~) :3 0 C CF 0 CF Cr S Cr a- CD CF Di CF CT C Cr ‘C 0 V 0 CD CF Di :3 0 S Monetary policy thus retains its clout in WCM theory. CD Cr Cr — 0 5 “5 C CD V ‘C .-a In CF Di CO Hi + CFCF CD-~0 5 Di DiDi In (.fl CFCF :3 CF CT CD .-a H, 0 CT a ~ CT Cr CF Di 5 O CD Cr 3 O C 0 S = aDi Di0CF’C — 0In SCF Di CF CD H,CD 0 CD Cr I + .a 5 CD Cr CF Cr rests on monetary policy. C In CDCF Q Growthflation Di CF p 0 S Di J. CFDi CTCF 9 CD unemployment, a twenty-seven cell, or three dimensional table, testing V circumstances which fill the matrix. 0 — on the wage-productivity nexus. C ‘5CD ~ x H, Di ‘5 C S or constrictive depends on m(6M/M) —4 CC) 0-S 50 Stationary State ~ CF CT H, C) ‘S 0 Growth at Constant Prices Cr~ CFCF DiCT S CFDi CF -O + 0 CC OH, ~a + C our facility for devising names, would have to be erected. 0 C —1 The Potency of Monetary Policy 0 a. 0 -O C -S CD CF Di :3 0 S 0 Hi -C CF CD S 0 a •0 CT CD CD - CD Cr V V C Cr ‘C CD :3 0 3 0 H, CF Di S CF .-a ~5 CD Cr C Di N C C Di S 0- CD 5 CF Cr 9 elements and (60/Q) a resultant of money supplies. CD - S C) CF CT CD CD 0- C 5 CD Cr 0 V “— V N CF CT z— U) CF 0 V Di 5 CF CD 0- Cr a. Cr S Di CF CD S CD Cr .a 5 $ CD 0CD CF determinateness is imparted to (3) with (6P/P) resolved by the WCM With TABLE l The 6P and 6Q Matrix Pursuant to 6M Action INCOME GEARING: THE TIP PROPOSALS INCOME All economic systems that pay out money incomes, whether aa capicapitalist or aa collectivist model, must adopt some method of gearing money incomes to output flows. The market economy has hitherto relied on an indirect tie, namely, the control over money supplies in the thought that the MV aggregate, equal to Y, money income, can thereby be managed. My remarks have assayed the imperfections in the system, or the effect Aw has flounced disproportionately; in YY == kwN, on the NN variable when 6w when unemployment politically AM va variatoo, v1hen unemp 1oyment has grown pol i ti ca lly intolerable, intolerable, the 6M ri ations ti ons have invariably had to be relaxed. My thoughts then have gone to ways to gear average money incomes more closely to productivity developments, and in aa manner compatible v,ith with the enterprise economy. With P(t) reasonably flat over time, Q’s and N’s monetary policy should then be able to stabilize the Q's N's in should be able to purpurthe acceptable incomes policy, monetary policy should sue, more or less, the steady money rule. rule. In this sense sense monetary and incomes policies can be mutually reenforcing. Opposition to Price and Wage Controls Those of us who have peferred market-oriented market-oriented incomes policy have been concerned with what we contend are modest institutional reforms to marprotect, to improve, to salvage, to restore, and to perpetuate the mar- ket system; the aim is to embed measures to enable it to realize its maximum potential. It is the market system that the policies intend to preserve, rather than to devise grandoise, impractical, and futile plans to supplant it. But the system admits of improvement, notoriously in respect of jobs and inflation. 71 conduct. — 0C 0 CF :3 Incomes policy can build on this characteristic. 72 - Cr .a. Di 0 CF CD -S 0 CT Di Cr - Cr CD V -S CD S CF CD -S CD :3 CF Cr CF ~3 0CD CF CD 0. Di S Cr CD C .a — S 0 CD :3 CF S CO CD “5 CD 0 a 0 CD Di Private decision making under the corporate income tax CF Di CD $ 0 0 — 0 5 Di CF CD V 5 0 0 CD CT CF ~5 0CD S C 5 CO .a• Di Zr $ Cr — O S .J 0CD O C Di CF CD a V CO CT CF • a CT I Di J Hi .a CD CF CT Di CF CD .a. 0 CT C 0 CF ‘C Di 5 ‘C Z Di 5 — 0 CF C C 0 CD CD ..a Di 0 0 CD V CF Di CT Di S — 5 CF CD 5 CD 0- .-a Di $ system altered in an acceptable evolutionary way to obviate the inflaCr CF CD Cr ‘C and fiscal policy, harmoniously meshed with incomes policy in a market CD CF 1 Zr Di $ Di — ‘C 0 a 0 ~ V Cr $ CD 0 — 5 0 CT a. CF Z 0- CD 9 CD Cr CT ‘C 0 C Cr .a 0 S 9 CT Di 1 ‘C J — 0 V 0 ~ Cr 0 Di J H, 0- 5 Di decision making under traditional (or modified techniques) of monetary ‘C 3 0 S CD CF Di 5 Hi 0 -.-- Cr C CD .0 .a CT S CD 0 CF 0- CD a. Hi a. 0- 0 9 5 0 0 :3 Di .~ . 5 Di 0.~ CF CF C S 0CD 5 S CO ‘a Di Zr $ 0 S a 0 — Cr 0CD of strawberries must not be elevated as the prototype in lieu of private CF CD Di C a. -S V H, 0 C CD — .a S a• CD V ‘C 0 CF CF V 5 0 CD CT CF Di Cr CF CD 0- CD C Di ..a CD CT CD CF a S C Cr CF 3 CD Cr a 5 5 CD Di ~ CT Cr CF 0 Hi CD Di CF ..a V Di H, 0 CF H, CF CT CD CD CT CF ~5 CD 0 C CO .a. Di S S — N CF ‘C 5 C C CD CD (0 Di — :3 CF C Di V Hi 0 Di CO CD — The image of Captain Queeg tyrannizing over the theft of a plate $ —4 CT CD CF 0 S CF CT Cr • 9 Hi CD ~ Di Hi 0 CF CT — S CO ‘C Di 5 ‘C Di - tically anything for a few months. O 5 Di 0 I V a. S Cr CF Di O Di 5 ‘C $ o CD 0 0 S CF CT CD CF CT Di CF ‘C ..a Di — S 9 CD Cr .a V $ — a 0 CT CT Z I I Cr Cr CD C CD 5 a CD 0 CF effectiveness -- which implies mainly that the economy can stand pracHi Hi CD the Nixon 90 day price and wage freeze in 1971 operated with tolerable a CD CD 5 Di CT 0 CF CF CT .a ~ CD 0- CF Di 0 V CD 5 ~0 -4 ~ — 5 CD N H, 1 CD CD ~ Di CO CD Di 5 0- a 0 CD V 5 ‘C 0Di C (0 0 S — 5 CF CT CD are being legislatively contemplated prior to enactment; for example $ a CD Di $ V )< CD H, 0 5 5 CF CD 9 CD S Di 0 CF CF 0 V 5 — 0 5 Di CF CD 0- V CF CD :3 0 0 ‘C a C CD a. Di CF .a CD CO — Cr (0 CT CD Di 5 CD - 5 CD 0- .‘a .-~ 0 C CF CT CD CF 0 Cr CD CD Di Cr C $ CD . ~ CT C 0CD 5 CF CD 5 .a. CT 5 — CD H, Di H, 0 ~5 ‘C a 0 S >( CF CD S 0- CD 0- would extend only for a brief interlude while measures to be outlined .J ~ 0 C 0 My own support for controls 0 0 S CF ~5 0 ..~ Cr Hi 0 5 CF Cr C V V 0 S 0 ‘C S .a Cr - 5 CF 5 0 0 Di CO CD Di S 0- CD 0 a V 5 ‘C Di CF 0 -S 9 Di S a. 0 ~ of mandatory price and wage controls. J CF CT 5 o 0- _a CT C — O Di S — V 0 $ CD Cr :3 V a $ $ 0 0 Di a 0 CF tion blight. o 0 :3 is a commonplace, erecting incentives and deterrents to enterprise Cr ..‘a - CD Cr V 0 C Cr Di :3 Di Di Cr CD CF CD 0- ~5 V -S — S CF CD ‘C 0 CF CD 3 5 CD CT CD O Di 5 CD CT CD 0 CD 0- :3 Di 0C Di (0 Nothing advanced here can be remotely interpreted as an espousal 0 CF CT — 5 5 citizens. Cr - :3 CD N CF — a 0 retinue of court attendants and jailers; and they outrage vexed 0 CD 0- DC C CD C CF ‘5 Di (0 CD ‘C a CF CT CD Di S 0- ‘a- Cr -5 CD .a .—a Di Di 5 0- Di CF CF CD 5 0Di S CF Cr C -S CF 0 0 H, 5 CD CF — S C CD forum for legal histrionics to clog court calendars; they support a ~ Di Cr C V V 0 ~1 CF ‘C CF CT CD ‘a - Cr s 0 Di a CD 5 0Di CF C 0 0 0 CO 0 CF 0 CT — Cr CF ‘5 .~ 0 S — 0 Cr Di -~ CO CD H, 0 5 3 Hi 0 5 C in consensual transactions, they thereby erode freedom; they erect a Di CD 5 CD 0 CF CT CD ‘C CF ~.. $ CD 00 CD H, 5 CD 5 0 0CD CT ‘C CD CF CT CD 1 ‘C CF CT CD CF 1 Di S Cr Di 0 CF .0 5 Cr 5 Cr CD 5 Cr C Di 0 0 - arrr!Y of snoopers and enforcers; they breed a new type of crime engaged a- CD S CO Di CO CD 0- - 0 -S 0 Hi ‘C V CD E CF S CD Di CD 0- CD ~5 CT ‘C CF CT CD -a - CD S Hi 0 5 0 CD 5 Cr Di :3 0- Cr S 0 0 V CD -S Cr 0 Hi $ ‘C Di for business to abide; they are apt to be politicized; they induct an Di .a S 0C 0 CF ‘C CF CT CD CD 0- N CF — 0 .a V 0 CT CD CF 0 Di V CF CD 5 Di ‘C CF CT CD 0CD - ‘a - Di CT CF 0 CD Cr Cr :3 CT C Cr 5 Hi 0 CF CT they are bureaucratic, dilatory, harassing, costly to administer and a Di S 0- Cr CF CD S sa $ Di 0- CF 0 ‘C 0 0 Cr CF ‘a Di Cr Cr aS CO 5 CT Di 5 ‘C CF Di 0— ‘a CT C 5 CD Di C 0 ~5 Di CF — 0 Di -S CD CD ‘C a- :3 Cr ‘C Cr CF CD CD CF -S Zr $ Di CF CT CD 0 CF Di $ Di CF CT CD Di Di -S CD Cr a 0 CF -S Controls are anathema to the market system: :3 a C V 0 ..— 0 — CD Cr • 5 C CD :3 CF .a 0 5 — Cr CF CF CD interventionist policies. —4 ND 0 0 controls are neither contemplated nor advocated; the quest is for nonS 0 Hi 0 5 Cr a .0 C CD Cr CF CT CD CF ‘. 0- Di 0C 0 0 Di CF CD -~ 0 5 CD 0- CF Di - V $ CF CD :3 0 0 CF CT CD a. :3 CD Di -S CD Cr ..a 0 CF 0 0 S CD 0 .J. V S Di :3 0- CD ~ Di CO ‘C a Di S 0Di CF $ $ Di CF CF CD 1 a CD CF CT :3 0 :3 0 0 :3 Hi C Cr — 0 Di S ‘C 0a. Cr V CD -4 0 To dispel any confusion on the matter, mandatory wage and price The Wallich-Weintraub TIP The Wallich-Weintraub TIP (for tax-based incomes policy) is reasonably familiar. is intended to subject firms to an Briefly, it is average money extra corporate penalty income tax if they violate an ~ 4 wage and salary norm of, say, five per cent per annum. The TIP annum. object, however, is not to collect taxes taxes but to deter inflationary money income conduct. Firms could surpass the norm, but at aa price; price; like all good legislation that takes account of special cases, theretherefore, there is an escape valve valve for those who cannot conform or who prefer to overshoot the target. The analogy is to aa posted speed limit which can be transgressed, subject to aa penalty. Obviously, aa very steep penalty scale scale builds an almost absolute prohibition, while a modest rate structure entails aa less formidable obstacle. On the progressivity of the penalty schedule, differences of judgment can abound. abound - As the object is not to collect taxes, the normal corporate inin- come tax rates could be reduced so that that the estimated treasury tax— taxtake is held constant, or reduced. Inasmuch as monetary and fiscal could work more closely toward full employment under less policy could inflationary pay conduct, on balance it should be possible to lower the corporate tax rates. TIP could not be fairly fair1y indicted with eroding internal corporate venture capital. 4For aa recent statement see my "Proposal “Proposal for an Anti-Inflation Package,” Challenge (Sept. 1978). 1978). Package," 73 TIP could be confined to about the largest one thousand firms, covering about fifty-five fifty—five per cent of GBP, or the largest two thousand firms responsible, according to available estimates, for about eightyeighty— seven per cent of business output. Legislation could specify firms employing over five hundred, or five thousand employees, etc., or reporting a sales volume of over $5,000,000, or $50,000,000, or whatever numbers judgment condones as reasonable and feasible. As about one half dozen extra lines on aa corporate income tax form are entailed (involving known information on the wage and salary bill and number number of employees), presumably one auditor should be able to to examine examine ten ten forms per week or about five hundred per annum. For two thousand firms the administrative personnel directly involved would be nominal, and aa trifling cost considering the full employment prize at stake, involving $50 to $150 billions in lost output in recent years. The tradeoff of administrative outlay as against economy gains is overwhelmingly favorable. favorab 1e. TIP Supp 1ements Supplements Labor bargaining would not be precluded under TIP though settlesettlement terms are bound to be more restrained on the principle that firms would not go far to trespass the norms, and unions could not expect to win huge gains. Blue Collar labor could secure more than, say, five per cent if other employees obtained less than the stipulated average. Bargaining would be centered in aa dispute over relative pay scales, rather than all pay moving along synchronously, after minor or longer practically time lags, so that in the end all run faster and all occupy practically the same position in the pay pack. 74 To strengthen TIP, at least in its early implementation, for firms that agree to pay, for instances, at least one percentage point over the stipulated norm, several corollary features can be devised. The following are illustrative; others will be able to provide better ideas. For example, some firms may face bankruptcy if their offer offer is rejected and unions strike. These firms may be candidates for temportempor- ary loan guarantees to cover payment of fixed costs; the provisions would have to be hedged to prevent collusion, obviously. Likewise, some NLRB penalties may be levied on unions for rejecting the norm—plus norm-plus contract. Labor and business specialists may be able to prescribe more workable provisions to forestall gross violations of the TIP objective. Prospective supplementary stiffening of TIP reflects the versatility of the approach. Widening the TIP Settlement Band The conclusion that the the TIP TIP norm, say, of of five five per per cent, cent, would would The conclusion that norm, say, become the minimum settlement figure, need not follow. For example, firms could be allowed aa two percent reduction in the "normal" “normal” income tax for settlement, say, at from three to five per cent over the preprepay levels. vious year's year’s average pay Some have suggested even widening the band, leading to aa perverse conclusion that firms which cut average pay 1,ould would win a sharp tax break. Obviously, any provision of this sort would arouse labors labor's ire “slave” labor. for fostering "slave" The intention is to block price ascent, not to foster a price level decline! decline~ So, some stop on on the lower end of the pay band would be critical, to provide for firms that could not match the average five per cent pay norm, but would still s ti 11 qualify for 75 tax benefits with aa settlement in the three to five per cent range. (All numbers are purely illustrative though they represent reasonable magnitudes.) TIP-CAP The illustrative five prefive per cent annual pay increase, on the presumption that productivity trends of three per cent per annum are resumed, would mean an annual price trend in the two per cent range. By recent standards this would be noninflationary noninflationary indeed. AA flat price level would entail about aa three per cent norm and, if future productivity improvements improvements because because of energy costs are more more productivity of higher higher energy costs are nearly zero, aa more stringent incomes policy will be imperative. In the retrogressive economy, average money incomes would have to fall to realize a steady price level. Economy-wide productivity is the proper guide for establishing the pay norm, rather than firm or plant productivity. In my early writings on TIP, the basic calculation for the penalty tax was aa 5 simple pay average. average.5 In my collaboration with Federal Reserve Governor Henry Wallich, aa weighted pay average was recommended to recornended in order to avert some possible fudging by firms that raised executive pay excesexcessively and then hired many superfluous low paid employees to reduce the average for TIP calculations. My colleague, Dr. Lawrence Seidman, who has written extensively extensively on the subject, has persuaded me that any wage-padding could only be 5The essays are reprinted in Keynes, Keynesians, and Monetarists. 76 76 advantageous on aa short term look at the matter: after the first year, the firms would be saddled with aa too-costly work force for no possible tax benefit or, in making layoffs, they would encounter the same penalty prospects. Weighting clearly introduces extra complexities and invites endend“right’ weights. less controversy on the "right" To To immunize some pay grants above the norm, and to evade the weighting aspects while encouraging productivity improvements, firms might be permitted to compute a simple simple productivity average for TIP reporting, and then to correct the value- added figure per employee by any of aa variety of price level indexes to eliminate distorting price changes. If the corrected average producproduc- tivity ((CAP) CAP) surpassed the economy-wide productivity growth, employees could share in the special gains. For example, if the firm's producfirm’s produc- tivity calculation was nine per cent or six per cent above the economywide figure, the average pay increase could be equal equal to the norm of five per cent, plus one-third of the six per cent productivity bounty, lifting the wage and salary norm in that firm to seven per cent without penalty. 6 penalty. beneficiary of superior producproducLabor could thus be an immediate beneficiary tivity performance, with aa direct stake in improvements. By and large, however, superior productivity improvements should translate into relative price drops. Firm or plant productivity figures cannot be fully allotted to the firm’s firm's employees as aa bonus without erecting aa discriminatory pay scale through the economy, and blocking output 6For detailed elaboration, see Capitalism’s Capitalism's Crisis. 77 advances by maintaining costs and prices in sectors of even spectacular productivity triumphs. TIP can thus be fortified in TIP-CAP, with the extra productivity attachment going some way toward dismantling outmoded feather-bedding restrictions.restrictions CAIP: Government Construction and Procurement TIP or TIP-CAP, because of the tax aspects, would have to clear where it is certain to be misconstrued as tax committees corrnittees of Congress where a tax measure, and subjected to misdirected misdirected debate. Faster Faster progress on other lines. in income gearing or incomes policy might be made on Under the Davis-Bacon Act the government mandates that on governgovernment construction, or government government assisted construction, prevailing wages must be paid, usually interpreted generously as the highest in the vicinity. Effectively, Davis-Bacon nails a.a high floor on governgovern- ment-related construction, and inserts a high pay underpinning for the industry. Without general cognizance under Davis-Bacon, and WalshWalsh— Healey which covers minimum wages, the government is effectively imposing an incomes policy; the idea of incomes policy, therefore, is legislative annals. nothing new in our legislative As matters stand, labor often lobbies with business for construcconstruction contracts which mean jobs, and at good pay. voted come strikes for still higher pay. After the sums are It should be possible to limit pay grants, over the life of the contract to an annual increase managerial pay. of five per cent, as well as to cover executive and managerial Pay aggrandizement at government expense and raids on the treasury might be aborted thereby. Penalties could take the form of disallowing disallowing 78 magnanimous pay settlements as costs in computing income tax profits; disallowance of cost contract negotiations; or closing disallowance of cost overruns overruns in in contract negotiations; or closing off off bids by offending contractors on other government jobs for aa period of years. The idea could be extended extended to military procurement and to governgovernment purchases generally. Inasmuch as the veritable Who’s Who's Who in American enterprise engage in sales to government, CAIP (Contractual Award Incomes Policy) could blanket from twenty-five per cent or so of the business business sector, sector, and and could could do something to to suppress suppress the the wayward the pay explosion. The Okun Variants of TIP Arthur Okun, Okun, in a more more recent recent variant variant of of the original TIP TIP proposproposArthur 7 al, has tried to hide the ''stick'' “stick” and dangle a ''carrot." carrot.7 While his proposal has has not not been been spelled in in detail, detail, he he endeavored to build build foreforeprinciple of "voluntarism." most on a principle ‘voluntarism. Union employees who agreed to aa pay increase of about seven annum would qualify qualify for a tax credit of of about $225 $225 per per per cent per per annum annum, amounting to about two per cent of a $12,000 income and enlargenlarging their pay increase to about nine per cent. by Firms that abided by the norm norm would al so realize realize aa two two percentage point or corporate tax tax the would also percentage point or so so corporate reward. except It is possible to be dubious of the "voluntarism" “voluntarism” feature, except as aa tactical debating wedge. Too, the exclusion of nonunionized 77cf. to Slow Slow Inflation," Issue “Innovative Policies Policies to Inflation,” Special Special Issue Cf. "Innovative Brookings Papers on Economic Activity, Number 2, 1978. 79 employees from a tax benefit would be an inequality. A A fairer method would inscribe a three per cent tax credit for all those with employee compensation (or all taxpayers?) of, say, under $12,000, and two per cent for those above this figure, with aa $200 minimum and $300 maximum credit. This feature adopted from Okun could impart real income protection especially as labor to labor, and make aa TIP program more attractive, especially leaders have shown little willingness to analyze the proposal while plunging headlong into advacacy of mandatory price and wage controls. Nonetheless, the Okun "voluntarism" “voluntarism” will not do. Militant labor leaders could aim for fifteen per cent gains gains while others accepted seven per cent, with the former deriding the latter as “weak” "weak" sisters: why accept aa $200 tax credit when maybe this much extra can be grabbed off per month by an exercise of muscle and power? Likewise, aa two percentage point corporate tax cut appears too limited to induce firms to to stand against extravagant pay demands. By accepting the Okun tax cut for subscribing to the pay norm (or settling slightly below), below), and and invoking invoking aa penalty penalty for transgressing transgressing the the norm, the the slightly effective tax stimuli and deterrent can be be widened to make pay excesses more costly. Government Employees Empl oyees and Anti-Trust Anti -Trust Government employees could be held to an annual five per cent pay increase. For conformable state state and local pay behavior, federal norms. grants could be made contingent upon compatible pay norms. To prevent government pay scales from trailing private sector trends, government 80 pay scales could be corrected every two or three years to ensure reasonreasonable correspondence. To counter labor protests that prices are not touched, and to avoid debate over the issue, the FTC might be required to report quartquarterly on trends in profit margins of firms covered by TIP. Where marmar- vJOuld be on hand. hand. gins rise unduly, data for reasonable review would AccordAccord- ing to the evidence, however, we can be confident that price margins will not be inflationary so long as wages and salaries are reasonably aligned to productivity. THE CARTER INFLATION MEASURES The Carter measures of recent days to subdue inflation provoke comment. coment. On October 24, after after twenty—two twenty-two months of incumbency, and and thus about eighteen eighteen months late, the President announced aa program prowhich, in principle, was based on the theory that motivates TIP proposals. exchange markets and Meeting negative reaction in foreign exchange Wall Street Street impelled the President on November 11 to impose aa fairly persuasion. drastic set of measures typically described as monetary persuasion. Let's consider the latter first. Let’s There was the almost unpreceunprece- percentage-point tick in the rediscount rate, effectuated dented full full percentage—point by the Federal Reserve. There was also, aa two percentage percentage point jump in reserve requirements against certificates of deposit of $100,000 or more. A A foreign exchange stabilization fund of $30 billion was organized to discourage the frenzied wave of speculative attacks against the dollar, whose prolonged sinking spell brought soaring import import prices. A steeper pace of gold sales 11as was put on the agenda. A 81 dramatically Shock impacts were uniformly and drama ti ca lly unfavorable. dollar rose instantly in Tokyo, Frankfurt, and Basel. The stock market, The stock in splendid euphoria, rebounded by thirty-five points in the Dow Dow Jones for the largest single day flourish ever. Assessments are that the tighter money curbs curbs will, over time, rein in the economy and yield aa harvest of recessionary tendencies, especially in the housing industry, with multiplier ramifications through the economy. Prediction of aa lagged downturn are thus rife. It may be, however, that as the rest of the President’s President's program falls into place, monetary policy can be eased and that aa serious fall-back fall—back can be evaded. Time, the great hindsight prophet, will reveal the answers. answers The President’s President's non-monetary program, disregarding the inevitable born-again homilies opposing government waste to take the edge off political adversaries, contained three main features: l) 1) First, aa summons to labor to hold pay demands on new concontracts to seven per cent per annum. 2) In reciprocity, the President pledged to ask Congress to “rebates” insofar as price rises exceeded seven provide tax "rebates" seven per cent. insurance" to make the seven per cent This embeds the Okun "real “real income insurance” norm more palatable to labor. Calculations by the press and economists tended to magnify the possible tax loss though, if the program is successful and prices rise by less than seven per cent, "rebates" “rebates” will be nil. The President’s President's description of the rebates was vague. They probably will take the form of tax credits, with rebates only for those 82 who have withholding taxes. who have overpaid overpaid withholding taxes. As noted above, above, it to me me As noted it seems seems to that this protection should be universal, and not confined to unions volunteering to abide by the program. Too, it can be interpreted interpreted as aa gesture to advocates of indexing of income tax rates. To many, the seven per cent norm is too high. For 1980, 1980, a six per cent number is in the wings -designed more to shave the inflation -rate than to stop inflation. The pace reflects aa concession to opinion that inflation must wind down “gradually,” "gradually," to avoid damage to expectaexpectations from a sharp price deescalation deescalation. The United Kingdom has dumped its inflation rate from twenty-five per cent to under ten per cent in short order, with benefit rather than deterioration. Under the gradual time-table, nobody will get hurt, according to exponents, except those who have been basely ravaged already. 3) Business firms are to hold their annual price increases to five five and three-quarter per cent per annum, or one-half per cent below the pace of the previous year. Sanctions on firms that fail to comply wi 11 consist of denying government procurement to them, or removing will import protection, or subsidies, or other forms of penalty as yet unspecified. News releases indicate that the price policies of four hundred of the largest firms are to be monitored. The denial of procurement is aa “stock” "stock" lifted from aa countrycountry— cous in of TIP that Chancellor Chancellor of the Exchequer, Dennis Healey in the cousin enactment. United Kingdom, is readying for parliamentary enactment. vlhile never" While applauding the President for aa "better “better late than never” commitment to subdue inflation, the present program is too bureaucratic 83 83 my tastes; monitoring prices and costs costs smacks of price controls. for my Too, it is likely to engender bureaucratic hassles when for example, the Department of Defense wants essential component purchases and encounters opposition from the price overseers. The air will be filled make." with "yes, ‘yes, they did; no, they didn't; didn’t; and what difference does it make.’ Snarling is likely to create new headline excitement, but not much sursurcease from the eternal and infernal immersion in minor aspects of the inflation torment. Prospects? Future Pros pects? Contemplating the wage contracts already in the pipeline for 1979, 1979, the President’s President's men expect a price eruption of six to six and one half per cent, aa miniscule improvement after three Carter years. The 1978 figure should come in at above eight per cent so we are snail's progress. supposed to cheer the snail’s already The AFL-CIO George Meany has al ready voiced displeasure at the package, expressing skepticism of its "fairness" “fairness” to labor. He has, instead, pronounced his support for mandatory price and wage controls. Some business spokesmen express fears over the price ceilings as aa prelude to controls. While opposition has not crystallized, enthusienthusi- asm for the measures appears underwhelming. Still, the President has taken aa first step on on aa necessary journey to bring about aa mete of rationality into the wage-price shuffles that have plagued us in generating inflation and evoking the tighter money stagflation response. This II find encouraging. Considering the lack closer kin of TIP, in lieu of alternatives, we may have to come to some closer of the bureaucratic structure that seems to be in motion. motion. 84 84 While such events are seldom predictable, predictable, the rocky climb may yet be diverted to mandatory controls, postponing aa more rational TIP to the longer future. 85 INFLATION: IMPERFECT MARKETS AND GOVERNMENT POLICIES Robert R. Nathan Everybody agrees that inflation is a costly economic disease an economic menace. -- It is like aa cancer metastasizing through the econoniy economy adversely affecting investment, productivity, our international competitive capabilities, resource allocation, in fact undermining alalmost every aspect of the American economy. overcoming more than aa So far, we have made little progress in overcoming decade of serious inflation. It will not come easily and quickly, but we do not have to trade off other high and important priority goals in the fight against inflation. In the war against inflation, we basically have four alternatives: One alternative is aa deep and enduring recession. To achieve aa measurable drop in the consumer price index or in the GNP deflator via this alternative, it will be necessary to resign ourselves to aa substansubstantial increase in unemployment over a significant period of years. The chance of significantly reducing the rate of inflation by by aa mild recesrecession of moderate duration is remote. As a matter of fact, aa short and shallow recession might aggravate inflation rather than contribute to its reduction because of lower investment and poor productivity. Mr. tir Nathan is Chairman ChairmarfThT of Robert R. Nathan Associates, Inc., Washington, D.C. 87 The cost of aa deep recession for years would would run into the the hundreds hundreds cost of deep recession for several several years run into of billions of dollars. This does not mean that we can ignore or risk overheating the economy. AA second alternative, which II also find disturbing, is aa decision to live with inflation. It is an alternative that encompasses aa relaxarelaxa- tion of concern over inflation along with attempts to index everything. That notion was the fad not too long ago. There are many businessmen businessmen who only aa few years ago said that if four or five per cent inflation persisted over aa long period of time, time, the economy would fall apart, that we could not live with it. per cent inflation isn’t isn't so bad!” bad!'' to make it better. Now they say, "Well, seven or eight “Well, seven It will get worse if we do not seek Seeking ways to live with inflation is an unforunfor- tunate self-defeating alternative for this country. The third alternative goes to the other extreme, namely, mandatory controls. As Chairman of the Planning Committee of the War Production Board, II worked closely with the Office of Price Administration, and was impressed with the effectiveness of aa mixture of firmness and flexibilflexibility. manControls worked quite well, but peacetime is not wartime and man- datory controls would be much more difficult to apply now, especially over an extended period of time. The Phase II freeze in 1971 1971 and Phase II worked fairly well, even though most of those administering Nixon's Nixon’s controls did not really believe in what they were doing. and IV were largely phony in principle and practice. Phases Ill III In any case, concon- trols are generally undesirable and over any given period of time raise very grave problems. alterThey should not be regarded as aa priority alter- native, though they may be preferable preferable to runaway inflation. 88 The fourth alternative, which I strongly support, is is to attack ininflation on a number of fronts. many forces. tions. The continuing inflation derives from My vote goes with the Carter program ---- with some excepexcep- II strongly support Alfred Kahn because he offers possibilities of achieving reasonably positive results. highly motivated and highly realistic. Kahn is highly intelligent, Given support and reasonable fruitful. time, his efforts can be fruitful. What disturbed me most about the responses to the Carter anti- inflation program of October 24 24 was the tendency of the media and finanfinanciers and some academics to celebrate aa Mass for the program even before the ink was dry on the press release. It is unfortunate that this propro- gram was written off by cynics cynics before there was any any possibility of obobserving or measuring improvement. breath that we Those who say in one breath must be patient because it it is going to take monetary policy or fiscal restraints aa year or two or three to slow the pace of inflation are the same ones who are unwilling to wait even aa few months to observe the success or failure of the Carter program. The monetarists who say they are for moderation in applying monetary restraints are anything but moderate with respect to supporting or even tolerating other anti-inflaanti-inflation policies and measures. Of all the Carter programs announced on October 24 and November 1, l, there are only two parts to which I take exception. exception. and the other is an omission. rise in interest rates. One is aa commission The former has to do with the degree of I have grave doubts whether the one per cent increase in the rediscount rate is going to permit us to avoid aa recession next year. The recession prospects for 1979 probably moved 89 up from about 25 or 30 per cent prior to this interest rate move to, perhaps, 50 to 60 per cent thereafter. Having said that, II would happily accept a limited recession in exchange for several percentage points decline in the inflation rate. But there are serious doubts that aa mild recession is going going to have aa sizeable effect on the rate of inflati-0n. inflation. The serious omission in Carter's Carter’s program was the absence of any policies or programs on energy. If we could reduce our oil imports from $45 billion dollars or even keep them from rising over the next few years, whether we did it by by setting oil import quotas or by by bebecoming serious about relying more on coal coal,, or expanding nuclear energy areas this would and intensifying R&D in other areas, would strengthen the dollar more than anything else. Actually, it will be remarkable if we can avoid big increases in the value of oil imports. I am concerned about the time when we run out of gold to be sold and when we run out of foreign exchange swaps. As long as the dollar is deteriorating, due in considerable degree to huge oil imports, and the trade trade deficits are not offset by rapidly enlarging industrial md ustrial exports, the dollar will lose value and this will exacerbate exacerbate the difficulties of containing in— inflation. Makeshift adjustments will wil 1 work only if other more basic corrective programs are undertaken, especially especially with respect to energy. Let me comment further on the monetary picture. As we move against inflation, some degree of monetary restraint is essential and desirable. Where II part company with the monetarists, however, is in my conviction that the complexity and the long persistence of inflation require attacks on aa wide range of fronts. go 90 Cynicism of many be regulation, investmonetarists concerning other programs, whether it be investis indeed disdisment, productivity, trade policy, or tax alternatives, is tressing. If you have aa complex issue, it seldom lends itself to aa simplistic approach. simplistic approach. Support for the the Carter Carter anti-inflation program does does Support for anti—inflation program not mean that monetary restraint should be ignored. But, monetary policy should not be proposition as is so so often policy should not be an an all-or-nothing all-or-nothing proposition as is often urged urged by monetarists. On the subject of monetary restraint, there there are grave doubts, looking back back at at the the real growth in the United last year looking real growth in the United States States over over the the last year and aa half, whether excess demand has actually prevailed and our real growth has been excessive and aa major factor in the worsening inflation rate in throughout 1978. rate in late late 1977 1977 and and throughout lg78. recent demand-pull inflation. supply bottlenecks. There is is little little evidence There evidence of of There Bre are only isolated indications of are needed Reasonable fiscal and monetary policies are to prevent excess demand when that to arise; arise; but but exclusive exclusive to prevent excess demand when that threatens threatens to makes little reliance on smothering the economy by the blanket approach makes sense when the economy is not overheated. If we have aa recession next year, the most serious consequence will not be just unemployment. With all of our unemployment compensacompensa- tion and and welfare arrangements and other transfer transfer payments, the the impact impact on on tion the unemployed will be fairly manageable. What is most disturbing disturbing is the effect this will have on levels of investment. We need higher levels of investment, we need to improve productivity, we need more costs low. modernization, we need more innovation and we need to keep costs Yet aa recession due to rising interest rates and monetary restraints will almost certainly bring aa decline in the ratio of new industrial 91 GNPand commercial investment to GNP. That would lead to aa tragic cost in terms of our international competitive competitive position and our productivity. One consequence of of a recession next year will be an increase in the federal deficit. AA recession will cause aa drop in revenues relative would be. to what they otherwise would of As aa matter of fact, aa large part of the budget deficits we have had in recent years reflects a shortfall in revenues. With aa recession, there is not much doubt that the deficit will go go up, no matter how tough, mean, and nasty Carter might be in dealing with the appropriation requests of his agencies. Let me reiterate my previous suggestion that the Carter antiinflation program ought to be given aa fair chance. Most of the criticriti- cism to date has been focused on the guidelines, as though they are the whole of the program. II carefully read the President's President’s Message and found many proposals in addition to guidelines. about budget restraints. He talked seriously If he does exercise budget restraints and public expenditures without eliminates some degree of waste and reduces public sacrificing essential needs, these will surely provide positive weapons, in the war against inflation. The President spoke very strongly about regulations. He indicated the need not just to eliminate regulations with respect to airlines and trucking, but to pursue environmental and health objectives objectives through economically sound and flexible means, rather than arbitrary standards. He spoke about the need to weigh the costs against the benefits in environmental and health programs. This emphasis on improved regulation should not be tossed aside flippantly as just rhetoric. 92 Those who attribute some of the inflation to regulation are the very ones who are most skeptical about regulatory curtailment and reform serving as weapweap- ons against inflation. The President also talked about agriculture. about price supports. We have to be tough I would much rather see income supports for family farmers than price supports. Looking back on what has happened 1978, it is shocking to remember the tractors to agricultural prices in 1978, rolling on Washington one year ago in the demand for higher farm prices. In 1978, farm farm prices have been aa major inflationary factor. The President talked about trade policies. He did not elaborate in detail, but up to now the President’s President's policies on protectionism have been, on the whole, constructive. II part company with my business and labor friends on protectionist tendencies which are very strong. The President’s program of importing more beef makes aa great deal of sense. President's Too many industries iITTllediately immediately raise prices on their products when competitive import prices rise due to the devaluation of the dollar. Reasonably liberal trade policies are needed to prevent administered prices from going through the roof. The President said he was against any more income tax reductions. I thought what he was trying to say in a subtle manner was "from “from here on, let's let’s take a hard look at tax reductions and see that different inflationary impacts of different tax cuts are taken into account.” account." every tax reduction has the same effect on inflation. 1978 did not make too much sense in many respects. Not The tax cuts of The cut in the capicapi- tal gains tax is much less likely to stimulate new investment than would accelerated depreciation or an extension of of the investment tax credit credit to 93 structures as well as machinery and equipment. Carter did not develop his tax thoughts fully but the implication was very strong that tax the changes designed to increase investment incentives and for having the most impact in lessening the rise in prices should receive priority consideration. The President went on to discuss competition and productivity. He is committed to developing policies and programs that will improve efficiency and productivity as another step to curtail the rate of ininflation. The price and wage guidelines were stressed by the President, but they certainly are not the whole of his program by any means. Carter Carter is also very much concerned about regulation, trade policy, policy, taxation, investment, agriculture, productivity and other factors influencing inflation. I have worked closely with labor over the years. II know many of our labor leaders and II do not think all the views of labor are corcorrectly reflected in George Meany’s Meany's statements. son. Meany is aa strong perper- He exercises great influence in the American labor movement, but he does not reflect the views of all his union heads or members. There are a considerable number of labor leaders in the United States who are not antagonistic nor unreceptive to efforts to lower the rates of wage increases as long as success can be achieved in lowering the rates of price increases. Many business leaders have publicly committed their companies to support the guidelines guidelines. Even more controversial than the President’s President's program to combat inflation is the issue of the degree of price competition and the 94 94 effectiveness of the market place in our economy. II believe that the market performs a great many very valuable functions, provided it is working reasonably well. If it is not functioning well, then it is essential to concentrate concentrate on activities that will help improve its operoperation rather than go the route of more regulations-and more controls and developing other substitutes or alternatives to the market place. Yet, adoption of many of these alternatives can be conclube traced to conclu- sions, often but not always warranted, that the market is failing to perform as expected. Economists are frequently to blame because they refuse to study the market critically and just assume it works effeceffectively. They ignore the adverse consequences of monopoly or oligopoly or collusion, which not only undermine market forces as much or more governmen t intervention but actually lead to such intervention. than government enterprise and pracpracMany in the business community preach free enterprise tice monopoly. That is a pretty harsh statement but, unfortunately, it applies in many man y cases. Many businessmen want competition where they buy goods and services but they seek to exercise market market power where where the selling takes place. There is now far too much interest in this councoun- try in mergers and much too little interest in new investment. Many business peopl peoplee want government regulation when they think re~u1ations regulations are going to protect them, but they are against regulations that might help others. I encounter such attitudes all the time because aa 1large arge portion of my work and that of my associates is in the regulatory field. Many business executives like to increase prices but very seldom seldom do they engage in price cutting. 95 In many instances we see larger price price increases when demand is less vigorous than when demand is strong. There are cost factors as well as the demand factors, but price competition seems to have weakened. There is aa little anecdote that II find amusing. About twenty years ago, when Estes Kefauver was Chairman of the Senate Subcommittee on Monopoly, he had some steel executives testifying before him. He said to one steel executive, “When "When U.S. Steel raised its price 5.738 per cent, why did you raise your price 5.738 per cent?” cent?" ''To be competitive.” competitive.'' answered, “To The fellow Laughter practically practically broke up thesesthe ses- sion. We do have very strong tendencies in the direction of administered pricing and rigid costs. Part of our inflation has elements of pricing practices that need to be better understood and corrected. We need to take aa hard look at the competitive situation in the market place —-- the rigidities on the downside of prices and obstacles and stickiness and rigidities costs. We need another TNEC. TNEC. In the mid-l930s, mid-1930s, Senator Joseph O’Mahoney O'Mahoney of Wyoming introduced aa resolution in the Senate Senate calling calling for a Temporary National Economic Committee. Chairman. It was established and O'Mahoney O’Mahoney become This Committee worked for about three years and was one of the least politically-motivated committees ever established in WashingWashing- ton. The TNEC undertook a variety of studies of competition and prices in commodities and product markets and costs. jobs ever done on studying the market place. It was one of the best The work was done at aa time when there were no computers and when the data base was nowhere near as large large as it is now. 96 We need to understand more fully and more clearly what is happenhappening in our business practices and structures. It is not easy to exex- plain what is happening or has happened in in 1978. Even in the competicompeti- tive agricultural sector, there is real confusion as to how demand/supdemand/supply situations are manifesting themselves in the pricing area. With the tremendous crops we have had, why have such inflationary price phenomena arisen? We have not had the shocks that we had in 1973-74 1973—74 with OPEC, OPEC, although we will get aa shock from higher oil prices pretty pretty soon. We have not had the bad agricultural crop failures abroad that we had in 1973-74. We have not had the two sudden devaluations, alal- though we have had steady devaluation. We are suffering an intensifiintensification of inflation, which cannot be attributed to the same kind of external shocks we had in 1973-74 and which are confusing. confusing. know more if we are going to prescribe better solutions. We need to We urgently need another TNEC. The inflation problem is not a partisan issue. Carter would be a strange politician if he were not thinking about what inflation is going to do to him politically. If he does not achieve more success in reducing inflation by 1980, and if the value of the dollar continues to deteriorate and if productivity does not rise more rapidly and if our level of investment continues to lag, the electorate will demand changes that may not be rational and orderly. Easy promises and polipoli- tical opportunism opportunism can be seriously disruptive at aa time when the people are properly demanding an end to inflation and all its horrible impacts. I do not believe that success will be forthcoming by relying only on monetary and fiscal restraints. Some such restraints are needed as 97 part of aa total program, but we must look to many other areas of policy. Leaders in academic circles and in financial circles should provide constructive leadership. It is going to take some time to show results. Alfred Kahn has my vote and I urge aa little patience for his efforts. The true issue concerning inflation is whether we are really serious in stability. seeking to move toward price stability. are serious we will supsupIf we are-serious port efforts on a broad front and not just seek a trade off between inflation and recession or depression. 98 RECONCILING MONETARY POLICY AND THE INSTITUTIONAL STRUCTURE Murray L. Weidenbaum Wei denbaum Most of the critics of the monetarist approach to fighting inflainflation are on the left, advocating various various extensions of government government power power tion are on the left, advocating extensions of decisions. over private wage and price decisions. My own inclination being to tilt e:,d of the policy specspecto the right, this critique is aimed from that e:id trum. Hopefully, it will be taken as aa constructive proposal. Lest I be misunderstood, II am well aware of the power of monetary or policy to influence the level of nominal, that is monetary, income or output and I am aa strong advocate of its use. As aa sometime participant in the policy making process, however, I am also well aware of the very powerful constraints that operate to inhibit monetary policy decision makers. The key constraint, both conceptual and political, II will call -- which II define as the portion of the change in nominal the Z 7 factor -Z, of course, is the portion of the output that is price; one minus 7, change in nominal output that is is "real." “real.” (Why Z? 7? it is the Because it last letter of the alphabet and perhaps aa last recourse.) My concern is based on the painful knowledge that, in the early stages of a program of monetary restraint, the 7Z factor tends to be high. That is, the major initial impact of of.aa slower growth in the Weidenbaum is Director of the Center for the Study of American Dr. Weidenbaum Ci~ff~7~for Business at Washington University in St. Louis. 99 inflamoney supply tends to be lower real output rather than reduced infla- tion. That relationship should not surprise us. We have learned in specific areas of the ec economy to price and onomy that short run responses to income changes are small smaller er than long run adjustments. For example, it is now generally agreed that the price elasticity of the demand for energy is much lower in the short run than in the long run. To be sure, continuation contin uation of a policy of monetary restraint -- such as aa stable growth of the money supply supply over aa sustained period of time -— will result in aa change in expectations and in business and facconsumer decision making and thus in aa subsequent decline in the 7Z factor. However, it is in the short run that political forces enter, and for fairly sensible reasons. When the short term effects of monetary restraint lead to aa rise in unemployment, aa shift in national prioripriori- ties usually follows, from curbing inflation to reducing joblessness. In general, those political pressures effectively prevent the monetary authorities from continuing the posture of restraint which, if it had been maintained long enough, could have altered expectations, reduced the Z 7 factor, and yielded the results generally desired by society. Indeed, expectations generally are based on the workings of this cycle in political economy. Incomes policies, of course, attempt to provide an answer to this dilemma. We need to recognize the basic reason that incomes policies -—— both voluntary and compulsory, both here and abroad -- have been resorted —- to. It is hardly because we as aa nation like to interfere with private 100 100 decision making or that the citizenry is enamored with the success of government intervention. Rather it is that citizens and policy makers makers have not been satisfied with the apparent results of indirect measures such as monetary and fiscal policy and will support at times a more activist policy stance. But aa more satisfying approach than incomes policy experiments, however, may be to change the size of Z, 7, especially in the short run. As has been amply demonstrated in the recent literature, there is aa myriad of government legislation, legislation, rules, and expenditures which which interfere with competition, raise prices, or restrict the supply of factors and products. These range from government determination of "prevailing" “prevailing” wages to restrictions on the use of transportation facilities to supsupports of product prices to limitations on imports. But the concern II raise here is not the conventional one of economic freedom and effieffi- ciency (which II personally share), but the large welfare costs of these government activities, viewed in terms of the unemployment that results from their interference with the workings of macroeconomic policy. The changes that II have in mind are in terms of moving toward aa more competitive market economy in which labor and product markets would be more price-elastic than is presently the case. There are several routes that can be followed simultaneously in pursuing this objective —- conventional antitrust policy, regulatory reform, and a reduction in the whole range of government subsidies. reIn the antitrust area, one specific approach comes to mind -- re—- ducing the various statutory “immunities” "immunities" from antitrust prosecution. We could do well to lift the exemptions from the competitive norm now 101 extended to many product markets, markets, such as interstate trucking, trucking, milk milk extended marketing, maritime activities, etc. Moreover, it may be time to think about the unthinkable -- reducing the broad immunity extended to most -- labor union activities, which covers so many aspects of product as well as labor markets. In the area of government regulation, we only need to refer to the expanding literature on the excessive costs costs of many regulatory actiactivities and the ways to reduce their negative impacts. It is important, moreover, to view these governmentally-imposed governmentally—imposed impediments impediments in aa dynamic sense. In a static world, the one-shot elimination of costly government regulation would have only aa one—period one-period effect on the inflation rate. But in the real world of government policy making, we are faced with the phenomenon of aa rapidly expanding network of regulatory requi requirements. rements - Viewed in that light, a regulatory reform reform effort effort which which is steadily bringing down the costs that would otherwise be imposed on the private sector would yield rising returns over an an extended period of time. The current concern with reducing or at least slowing down the size of government could well focus on the various subsidies embedded embedded in procurement, credit, and expenditure programs -- subsidies which -— shelter numerous groups from market forces and make more difficult and expensive the access to those products and markets by the rest of the population. The supply of factors and products has been restricted by such government subsidies as production and import quotas and generous government stockpiles of minerals and metals. The opportunities for reducing the Z 7 factor are as exciting as they are numerous. 102 Of course, these microeconomic structural structural and institutional changes must be seen as supplements to appropriate monetary and fiscal policy. Indeed, these changes would enhance the effectiveness of these traditional macroeconomic tools. Overcoming the natural reluctance to cite one's one’s own earlier work, I recall the conclusions of an article in a 1972 issue of the Review of Economics and Statistics in which II wrote that, over the coming decade, this nation may be increasingly resorting to greater controls over wage and price decisions in imperfect factor and product markets, unless we take strong actions to reduce those market imperfections. " ... the - .the “. choice may well be between fostering aa greater degree of competition in private markets or relying more heavily on government government conirols con~rols over priprivate decision making." making.” Wistfully and reluctantly, II repeat my earlier conclusion as a forecast for the next decade. 103 103 THE GOVERNMENT'S GOVERNMENT’S STAKE IN ECONOMIC INSTABILITY Paul Craig Roberts I would like to take the opportunity of having the last word to add some perspectives to those that have been discussed today. It may be that what what we see as problems in economic stability actually reprerepre- sents maximizing behavior on the part of the government. From the perspective of social welfare maximization, we see see the government doing all the wrong things. But what looks looks like failures from from this perspective may not look like failures to the government itself. It may see successes because, if you think about it, economic instability expands the role of government. for the expansion of government government programs. Inflation produces revenues According to the Joint ComCom- mittee on Taxation, for every one per cent.rise in the price level, the government's government’s revenues go up by 1.6 per cent. So inflation is welcomed more. by people in government who want to spend more. Private sector unemunem- ployment expands constituencies for public service jobs and for public policyworks, and so, what we see as problems may be seen by government policymakers as successes. assumption. economist's behavioral There is aa dichotomy in the economist’s That is the great failure in the public finance and public choice literature. People in the private sector are assumed to maximize Dr. Roberts, former Economic Counsel to Senator Orrin Hatch, is AssoAssociate Editor of the Wall Street Journal. 105 their self-interest, self-interest, while while people people in in the government government sector are assumed assumed to maximize the public’s public's interest. interest- The self-interest self—interest of government is left out. We must take into account that the government benefits from econecon- omic instability -- not aa lot of instability, for if it gets out of -— hand, those who have power will be displaced by by somebody else -- but aa -— certain amount of instability is beneficial to to the government. As far as II can tell, the power of Congress depends on handing out things and doing favors. instability, it gives Congress more opporWhen there is instability, oppor- tunities to do these things. "Mr. Chairman, Everybody is on his knees, “Mr. exemption to this,” this," or "I've got to have this we have got to have an ekemption “I’ve got special allocation," "Please do this, that, and the the other for us.” us." allocation,” and “Please Doing favors is aa source of power and, as II have already mentioned, inflation produces revenues that the government might not be able to to get in other ways, while recession expands the market market for government unemployment programs. programs- The constituencies cultivated cultivated by government grow with economic instability. Now, why have we had this dichotomy in our behavioral assumption? don't know. II don’t said about it? don't more people notice it, or why hasn’t hasn't more been Why don’t Maybe Keynesian economic policy veils it because it propro- vides the type of rationale, the type of interpretation, interpretation, which does veil it. it. We get in frames of of mind mind where we we believe that full full employment We is caused by demand and inflation is caused by autonomously rising prices. pri ces - 106 .5 107 CF -s 3 CD a 0 C CD In C r CF CF a. a CD CD 3 CD In CF In CD 3 CD CF .a. CF CD a .a In In CD CD CD C) a .a. CD 3 a. CF .-a CD 0 ~1 a a C) CD I CD 0 C) CD C In .. :3 ~ CD ~5 CD CD ..a -1, :3 .a. a cc C) CD C In In .a. a .-~. a In CD a >< CD CF C -a Q C CF a CF CD C ~. CF CD .-~ CD :3 0 In .a. a CD 0 1 • C CF C CF -c 0 -4, Q CD CD CF -5 CD CF CD CF to sell is consistent with the situation in which the money supply grows a In -~ 0 Z cc 0 In C ‘C CD 3 0 a CD a CF a C) .4. -a a. a .4. 0 CF CD In a. CF C ~ CD 3CF CF .-J. ~ CF a In CF CD .~. In :3 0 C) -In —a The decline in the responsiveness of supply to opportunities 3 In CD ~. CF .a. a C CF 0 a 0 0 0 CF ‘-C a -a In C -4, 0 CD In In CD C In a -5 CD In -a 0 a -a CD CF a a. CD .a. 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CD a CD a CF -4, 0 0 ...h CF CD N .~J CF CD 0 3 CD CF a CD CF CF a CD :3 -a CD C CD a CD a 0 B CD :3 a a CD -h a CF pi CF =~ a a CF CD 5 CD In a C In a In a. CD 3 CD ~c CD CD -a CF 0 a CD CF -s In In CF CD -~ CF CD :3 ~ 0 -~ cC 3 0 r CD CF CD CD —aIn 0 Monetarists have tried to help Keynesians understand that infla- investment, their their effect effect is is to to reallocate resources from investment investment or or investment, future production to·current to-current consumption, thereby raising the level of prices. In today’s today's environment, small upward shifts in the price level level are occurring continuously, and it may be difficult statistically to to segsegon inflation rates. regate these from the effect of money creation on There are other things which are affecting the responsiveness of supply -- for example, federal rules and laws that reduce the value of the-value —- capital assets by reducing the property rights of the owners. This has an impact impact on on rates of return return and has an impact on the amount amount of investinvestment, no matter what else is going on in terms of monetary and fiscal policy. which may well be raising costs There are other things going on which and causing output to fall relative to demand. AA good example was Weidenbaum when he spoke about the slowdown effect pointed out by Dr. Weidenbaum regulations. on research due to the high cost of regulationsRather than cite any more examples, I'd I’d just like to say that maybe we should face the possibility that the government is not parparticularly interested in private sector capital formation because pripri·vate vate sector jobs are competitive with public sector jobs. If the labor labor If opporforce is growing relative to the growth of private sector job opportunities, you have an expanding market for public service employment. If productivity is not increasing, the opportunities for real wage increases are not very great, and this increases the constituency for income redistribution. In other words, if you can’t can't get ahead one way, that reduces the opportunity cost to the politicians who are offering you another way to get l~,ead. r',ead. 108 Economists have not done their homework on the question 109 a .a. 0 In - CD a 0 0 a In a a CD CF CD a- CF CF In CD In C cc cc 0 CF • In 3 ~5 -4, -a. ‘C (7 In r — a cc CF CD a cc -a 0. -~- In CF CD a 0 -~, In CF In a C) ‘C CF — C a CF v 0S 0 0 CF aCD CD C) 3 It seems to me aCD a CF 3 In CD CD In CF — - a CD ~ .5 a --4-, CD 0 C 0 CF CF a CD ~ 0 a- Z 5 ~ aa CD .a 0 -a CD a CD CD .5 CD aCD -5 CF a a. 0 CF — N CD a CD cc 5 0 ~C a In any organization there are people who CD a — - In 0 a 0 -aa cc In CD ‘C a -o CF CD a aCD C 0 C ~ CF aCD ‘C CF (7 C ‘a CD — CF -~- a C CF .5 a 0 a t CF -4, a. a 5 0 0 CF 0- 0 ~ a CD In CD CD cc ~ CD .5 aa. cc a- CF CD -S 0 (7 CD .-J 5 CD — a- 0 CF a CD ~ o CD .a ~ CD CT a ~ 0 C .~ In CD 0 3 CD a CD cc -a -H a a CD — -h - In CD — CF -a. a C CF .5 0 a -a c CF 4, — 0 c —5 0 CF a a CD In 0 0 .5 0 CF ‘C CF — .a -a. a -a. CD )< a 4, CD -a- CD 5 cc CD 3 CD a C) CF In C ~5 CD a CD .5 reduce managerial flexibility to respond to profit opportunities. CF In CD £3 C CD a- CF a a CD a CD CD (7 CD In a- a aCD a CD CF % CD C a a CD ~ a a C CD CD ..a a 0 CD t) a a CD CF CD In CD -5 0 CF CD .5 understand TIP, managers would be allowed to hire labor at higher wages a 0. C that it would raise costs and reduce investment, because it appears to 0 CF In .5 CD 0 CD 0 CD CF a. CD In C) CD C CT CD a CF a CD 3 CF In CD C a -a. CD C C) -s CD 0. a a CD In CF C) 0 In CD In -- CD —5 a C ..a ~ 0 CF —i. CF a CD CF -a In -‘. a a -a- CF CD CD CF —S -o CF CD -5 a My interpretation is .a. ~-C 5 • a 0 -~- CF 4, a CD a .a CD C C) a -5 CD a C) CD a —1 ~ 0 a- 5 CD In C CF 0 a CD 3 — it should be different in this case. • CD C) CD In — In a- CF a -a. CF a CD CD -4, -h — a CD (7 a —‘ 0 C a- In CF .a. a -~-4, different from what advocates expect, and there is no real reason why a- ~c Z a CD In 0 -S CD — CD CD -5 a 0 — In CD CD a- CF CD a a C) CF CD a )< CD In CF CD CD C) C 0 a CD CF CD a- Z 3 0 -i 4~ CF a CD CD -h In CD In CD a -a- 0. :3 CD In CD .4. — C) a a -4 0 CD 0 3 C) CF C o CD a- CF ‘C CD .a .5 CD a Generally the outcome of _policies and ideas is CD ~ • ‘C C) CD _a -‘. — CF .—‘ 0 0 CD — C CF .5 CD C) CF CD CF So I think that TIP will be very ‘-C CD .5 C (7 CD — ,~a ‘3 —I CF CD a- CF ~ a-“ a CF un 0 • In a 0 — a C 0 CF 0 C a CD CF In CF - a 0 a 0 a- ~ In .5 CD 0 ‘C 3 0 CD 0 CF a CF CD -s a 3 CD C cc a CD a- CF 3 0 a a , -~ CF CD .a -4, a -a. 0 -4~ CD a CD 3 CD a CF In CF —a. —4, a- In CF — CD C) CD C In because it shifts the blame for inflation from the government to employCD (7 the pressure on Congress and the Executive branch to reduce the deficit, >C CF — C) — -1, a CD CD a- CF CD C) CD a C .5 a CF C) a a- 5 CD CD (7 CF — C C C) CD m CD a- CF a a CD -5 CD In In a cc 0 0 a a CD In In C CD 0 a CD CF 5 It thus reduces In CD C) C CD a —s C In a- CF CF — • CF a CD 5 a 3 CD 0 C cc CD a- CF 3 0 -4, — CF In CD 3 0 C CD - a CD a In CD 1 0 ~C .a 3 -a CD CF CD C CD a -s -~- private employers and removes it from the government. 0 5 In In CD In C C) C) CD -s a CF ~In 3 CD -s CD .5 0. a C 0 ‘-c ~ CF a CD -4~ 0 >< CD CF CF ‘C —a CD a CD in order to respond to profit opportunities, but they would have to pay a a -s a —‘- I am not sure how TIP can reduce inflation. 0 CD ~ 3 0 a- -s CF aCD B CD a -s a CT CD 3 ‘C CD ~ CD -4, CD ç- a C a Z a Ci. t CD CD a CF In a CF -a -a -H CD a- CF CF CD c government is that it shifts the burden of restraining union power to a- 0 CF CD ~s a -c 0 ~ — 0 a C -- a -aa cc CD CF In CD -4 a a CD a —5 C (7 CD CF The greatest attraction TIP has to the ~5 CD a- CF o CF In ~ a- 13 — —H a a — CF CD C) CF CF 5 CD In CF CF CD CD CD cc CD a- — - In In CF CD CF CD C) 0 -C CD a In CF — CD In CF cc a- — CD CD 3 In a. -4~ a- In CF -~ CF CD a- CF .a. In CF 3 CD a ~ .5 CD cc 0 C carrot version of TIP, I began to wonder if Congress sees TIP in the 4, CD a- CF a — —4 — a In CD CD In CD In In a cc .5 0 0 — -s CD a a Z 0 0 CF a CD cc a (7 CD *a — -H 0 -h a In a. 0 CD .5 C CF 0 CD ~5 C) CD a- CF a -‘- a CF CD In CD CF CD a -a. In CD Z a In CD C —5 CF -‘- -o CD a a CD CD x CF r CD C) a C -5 CD 0 CF In CF a ~ CD 0 a- Mikva, who wants to reduce ''tax expenditures,'' was interested in the Z S .a C C CD 0 When I heard that Congressman CD 3 In In CD a cc -s 0 0 CF CD a- CF .5 a CD CD a- a CD a- ~ • C In -a ‘-< 0 5 -~. CD In —~ — CD r CD CF a CF CD CD C a- CD a— a r CF think we have to take TIP seriously. CD a o a CF 0 a -~ In ‘-C -4, ~ a -a. 0 CF C) -a. 5 CD a CD CD a- CF CF aCD c-F CF want to stand pat and people who want to move forward. CD a ~ a penalty tax for doing so. CD CD C a- CF CD (7 .a. a .a. CF In — a The main direction of my remarks, then, has been to suggest that 3 CD — a CD —4 a- that the TIP penalty would reduce the opportunity costs of standing pat aCD CF attractive politically. In CF — In o a 0 3 Ph C) C) a 0 3 0 C) CD s CD a CF and that there would be fewer new undertakings by firms. a a CD ers who don't stand up to unions. cr3 - ~ CD ~. C -4, O CF whether economic instability is a problem or a success depends on one's aCD same light as its advocates. C point of view. a -h a - —4 — o -4 0 In CF C) -a CD In CD CD 0 3 In a a In 3 CD CD 4 CD 5 — CT a- CF CD ~ — a C .~ C) C) a a a I will conclude with brief remarks on some aspects of TIP. I If I of whose interests are served by public policy. And they have neglected rates of that the responsiveness of output is a function of after-tax after—tax rates return. return - 110 cc Dr. Webster is Assistant Professor of Economics at Washington University, St. Louis, Missouri. .5 It, 13 111 a CD In .a a ~ .a. CF -a. CF CD a- CF .~. a cc In CD ‘C -a 0 a 0 -S a cc CD 3 — CF CD t a — ‘ — CF CD ~ a C) a a In CD CF CD CD 5 CF In CD CD a CF — 4, 0 CD C) 0 — a- C) In a CD ~1 CD CF a- — W a a CD . In CD C) a CD C £3 CD In C) a a -s ‘C CD a a — CF CD —‘ a -4, — of accelerating money growth while ignoring or disbelieving the inevita ‘ CF C — CD a -a. CD a- CF a cc C — CD — CT CD In -a- a 0 cc cc a 0 -s -aa — CD .a aa. E a- CF cc .5 0 ~ 3 a a CD ‘C cc — CF CD CD - CD CD C) C) ently irresistable political temptation to enjoy the short run benefits In CF .~. -h CD a CD (7 a .5 C CF 0 -5 a- In CD a- CF ‘C 0 a (a. CD a CF a a —“ CF CD 3 ~ CF CF CD a — C) CD CF — 0 0 CD .a CT CD CF In — In CD 5 .5 .a CF —~ ‘C CD a made the job of limiting monetary growth more difficult; 2) the appar—5 I a a CD -s CD CD a- CF —-a- N3 a. CF C) C 4, — —t, — CD a -5 0 ~ CF a3 0 .5 cc ‘C CD CD CF a cc 3 a a a. CF — 3 — -4, a Ca. 0 CT aCD CF 3 CD a CD —4 a- 1) the large and growing federal deficits which ~ a— C) a- In CF C) .a -a. -h CD a 5 CD ..a CD a CD .4, a cc — ~ -~ 0 CD a a cc CD cc CD 5 .a CD a- CF — .a -- CD -s CD E -4, CD C) CF 0 5 In CD In CD of growth of the money supply above the rate of growth of real output. CD - CF a C CF c C ..~ CD CD -s 4, 0 a- CF 0 ~ .5 cc 4, 0 CF CD -5 CD CD a- CF CD ~ 0 C CD ‘C .-a 0 a In C ‘C 3 a a CD a- CF -4, 0 a- ~ CF 0 0 -4, cc -4, But, according to Dr. Sprinkel, three factors kept the rate CF CD -s CD CD a- CF CF a CD 7c- In 0 -s CF .4, CD C) 5 CD CD a- CF *a -a CD -~- a — (7, -0 - C 5 a CF C) C) a a — a cc CD C CF C) • a CD .a .a 0 ~ 0 to move towards this policy, and so price stability should have a CD CD C a- a C aa In ‘C CF .a. ._a - (7 CD In CF CD — C) a ~s In 0 a a CD ‘a ‘C C) 0 ..~ — a In -a- a- CF In .5 0 Z pi CF CD 0 C 0 3 CF In 1975 the Open Market Committee of the Federal Reserve decided * a- ~ CF a 5 cc —1, a C a CD a C) — CD a CD •1 In CD CD ~ -l CD .~ CD a ~1~’ CD CD a- CF -1 a CD CD CF CF o a 3 3 -a- CD CD CF CF CD ~5 a -5 C 0 a cc ..~ CD a- CF In CD CF CD 2~- l 5 CD C a CD a a- CD CF (31 ~-J C-C -a — a 1 CD CD 3 CD In ~s CD a- CF CF CD CD ~i In CD C) a — a C ._a a0 In ‘C a 0 a In C ‘C CD a 0 3 CD a- CF a CD a ~ CD CF ‘a C a CF 0 C h 0 a- ~ CF a .5 cc 4, 0 CF CD CD ~5 CD CD CD a- CF In a CD CD C) >< CD ‘C a ~ In C t • a CD ‘C 3 0 CD a- CF —4, a a- CF 5 0 cc -4-, 0 ~5 0 C) C) C — .—a a ~ a 0 -‘- CF CD a -h —a — of growth of the money supply exceeds the real rate of growth of output, Hence, the money supply should increase at the a C C) a He concludes C) 0 CD • In CD CF -s cc CD CF a- CF 0 Z a3 0 a CD ‘C cc —5 CF — Z CF CD In CF .a In 0 -a- CD aZ CD -5 — C) a- ~ In able inflationary consequences; and 3) the Fed's choice of interest rate CD h 0 CD CF CD CD -s CD a- If the rate CF -h — • In CD ~•5 — C) a a a CD ‘C CD a 0 a 3 CD CD ~ CT CD CF a -a- a In a- 0 -a. CF CD CD -s CD —‘ CT CD CF — C) a CD 0 l ‘C C CD In states the obvious when he indicates that, in the long run, there is a — In CD aCD .5 CF -a C 5 a cc 0 CD a- CF a -a- —5 He CD = In CD In• In C a CF CD CF —5 3 a -a- -h a CD ‘a CF 3 a- C a CD In CD In a. CD -5 .5 CD CD In CD 7;- a -5 C —5 aCD CF In CF CD CD a a -aC) — CD a a- CD a- Z In C — 0 C a- 0 CD a- CF In CF CD CD CF Dr. Sprinkel's paper raises a number of important issues. CF 4, 5 a 3 a CD C C) a CD .5 In .4. -s -c cc .5 a ~ CF a- CD CD CF 0 3 -4, a CF CD 1 targets which were inconsistent with money growth targets. CD CF a- CD a very predictable relationship between money and prices. 0 CF cc -a. a-~ CD! In! • -S CF CD -s 0 CD CD a- CF cc — :3 N — C) by criticizing the Carter anti-inflation program, saying that it will C) 5 — CF — CD cc CF same rate as the long run rate of growth. CFj C)! In! CD! 2 0~ a a Ph C) 0 -h a - In • In 0 -5 1CD In In5 00 C H a In CD CD a- CF -i, — a ‘C 0 a a CD -4 —i. r (7 C-c inflation will occur. SCF C CD cc a- — a- ‘C -5 < CD ~-c —a -5 CD a CF work if and only if the rate of monetary growth is reduced from its l a Z These factors were: a C-” In In CF CD 0In C In currently very high levels. .5 C) C followed. C-n— CF In -a CFCF ~C CD -a. In -lCD In (7 CD ~ -a C a-S a_5 Charles Webster _5 CF CD In a CD In CD CD 0 "INFLATION -- CAUSES, CURES AND PLACEBOS" C) C C,, 0 Ph -a C It’ C ‘a-n Ph 0 C ‘a (I-’ Ph C 0 --4 — C C m C -~ I-In Ph S S 0 C COMMENTS ON: I, of of course, agree that that in long run run prices prices and money move I, course, agree in the the long and money move monetogether; however, this does not imply that there is no room for monetary and and fiscal policy. tary Keeping the money supply growing at at aa constant rate requires offsetting exogenous exogenous shocks to to the money money supply. supply. Keeping it growing at the same rate as real output, on the other hand, requires offsetting monetary shocks -- shocks to the real economy and changes in -- the real rea 1 rate of growth of the economy. Hence, even aa growth rule rere- qui res the manipulation of monetary tools, and the use of some sort of quires indicators of the growth rate of output and the money supply. But if subpolicy tools can be manipulated for the above-mentioned reasons, subcan't the tools be used when the ject to substantial uncertainty, why can’t economy needs aa bit of stimulation to get back on a full employment path. path- It is easy to think think of times times when policy actions have been quite successful (tr,c r.redit-tightening times of 1966 and 1970) as well as (tnt r.redit_tightening times when more monetary activism would have been quite successful (the great depression). In terms of fiscal policy, it is easy to build models that show that fiscal policy should play an active role in stabilization policy even when the model is characterized by parameter uncertainty, and total crowding out (however crowding out is defined). Dr. Sprinkel sees as aa primary cause of the current inflation the Dr job of limiting large and growing federal deficits which have made the job the growth of the money supply more difficult. While few would disagree implications he draws from this with this, agreement with some of the implications would be substantially less than unanimous. I know of no Keynesian economists who consider deficits a “boon "boon to mankind." mankind.” 112 Rather, they see to the low rate of investment, we should look for explanations other 113 CD C a ‘C CF — .< -a. CF C) C a -1 0 4, a a- C a a - CF ‘a .4, — C) — CD a CF a 3 CD a .5 CD C cc a CD cc CD CD a- CF 0 CF CF a CD 2 .CF In CD C a -a. 0 -~ ..a CD C) CD a- CF ~s a 3 -4, a CD .5 Thus, the lines of causation a — 0 CF C In CD CD C) -4, 0 In a CD -“ CD a- CF C In -a —4 a- - CF — C) — h a CD a CD CD In CD -5 C) a — a CD 0 CF CD a a ‘a CD In C C CD a spending has led to a lowering of national income, to a lowering of tax a CD CF —in a a cc — ~i CD a CD 0 CF .a CD 3 C) 0 a — ._a a CD 0 J. CF CD a .4, 0 a cc — .5 CD a ~ ..a CD CF a CD ..a In aCD a cc ..a. a CD a a In CD argued that in a number of economic downturns the lack of investment CF a CD 3 CF In CD a C — -4, 0 C) CD ..a CD a- CF In a C ‘5 CF a 0 ~ a C) 0 a 0 3 — C) CD -4, o 5 CD CT a C 3 a CD — CF aCD CF cc C CD a a In addition it can be CD (7 a CD C) CF -a- a 0 .a CF -“ a a CD — a • CF a CD 3 CF In CD a C — CD a a In a cc In CD C — a— cc aCD -s 0 CF a CD Di .. .a ~ —a• CD a C) 0 3 — —s CD a— cc a- ‘a CF a 3 CD a ‘C .-~ CD 3 -a ....a C -4, aCD a CF In In CD ..a —4, 0 In CD 3 CF — a -a- a CF C) CD In fact, in times of less than full employment, higher income -h a — • .4 CD CF CD 4 a CD In C -~ CF CF CD 3 CD CF CD a- CF 5 0 -h o a a ~ — CF a In C 3 a 0 C) .5 0 ‘a CF 3 CD a CF In CD -C a — a -s CF C) CD In CF CD for private sector investment, or consumption, or for that matter used 5 .a. c CD 0 .5 full employment, the resources used by the deficit would in fact be used CD a CD C In CD a- C) CF -~, CD a -a- a a 0 C S CF — C) — -h CD a CD a- CF ‘C (7 a CD C In In CD C) In 0 C 1 .5 CD a- CF ‘a CF 3 CD a ..a 0 ‘C 3 0 CD -4C What is not so obvious, however, is whether, when the economy is not at aa CF CD CF a a ~. In ‘C C) 0 a a 3 CD CD a- CF CD ~ - CD a- CD CF a- Z — In -s ‘a CD C ~ CD aa ‘a In a C -a. C a- 0 In a 0 CF a In a. CD CF a- ~Z of full employment, be consumed or invested by the private sector. CD • 0 5 CF C) CD In CF CD CD -l — C a CD a- CF ‘C (7 a CF CD In -C a — 0 .5 a CD 3 In C a a C) CD CT CF a CD 2 — 0 ‘C 3 -a CD -4, C -4, 0 .a. is obvious that government spending uses resources that could, in times CD 3 CD In — CF a .a. ‘a a ....a C a C) CF aCD CF In CD 5 C) In 0 C .5 CD In In C a cc — a a CD 0 In CF a 3 CD a 5 CD 0 -C cc CF CD a- CF C In C ..a. 0 CT 0 In CT CF — In CF — - CF a CD 3 CF In CD C a — 5 0 4, a C In CD CT CD CD 5 ~ CD a- 0 a C .-‘ ~ 0 CD CF a- CF In a cc In CD C — a a cc a- In 0 5 CT CD ‘C by absorbing savings that would otherwise be used for investment. S CD a- CF 0 In a CD CF — 0 CD -a .a >C CD ~5 CF 0 -l cc 0 CF CD .5 CD 0 CD a- 0 CD CD ‘C ~ CD -S a- CF 0 CD a- can run from the lack of investment to the large government deficit, C C) CD a will lead to higher savings and investment. 0 7~ a 0 a CF CD — >< a CD 0 CF CD CD ~5 CF 3 0 -a ‘C In .a. CF revenues, and to an increased deficit. a C —a ao In CD a CF 3 CD a CF In CD C a — 0 -4, CF CD CD CD If we are to explain the low rate of growth of productivity due ~ — —4, a not simply the other way around. 0 at all. .5 0 CD a- CF 0 a- CF 0 cc —s ‘C CF — C ..a• CF C C) a 0 .5 a 4, 0 ~ CD C) .a CD a- CF —S -4 0 CD CT In — a o 0 In CD — In In CF — C) -I, — CD a CF 0 C CT CD In CD 7; CD 3 CD 7; a ~ — a C/n CF a a — a CD ..~ -a- In 5 CD C 5 a CF a a CD CD a -s C) 0 a a ~ CD In it’ A second controversial point Sprinkel makes about deficits is CT CD aCD C ‘C CF aCD CF that they have been responsible for the lack of productivity growth CD a- CF CD In satisfy any given goal -- in particular monetary stabilization. a - 0 a — CF CD N CD (7 — ...~ — CF In CD ~5 ‘C CD CF a CF 0 a a .a. a a 0 ~ — C) ‘C c — In C) CD -4, ‘a CF ~ a 3 0 C .5 CF In a — ‘C C) .a. .a -a a CD .-a a cc In — CD CD CF a- CF a cc In — a. •5 13 .5 C In surprising that a single policy instrument, fiscal policy, did not Q~ -s — C) C a CF a a CD 1 — .a a cc 0 CD CD C .a. cc ‘C CD ‘C .4, — In CF economic purposes that impinge upon the federal budget, it is hardly ‘C — 0. aCD — In CF — a CD CF a cc (7 C CD 5 CD a -4-, CD CD a- CF a a a C CD 3 a — a cc — CF aCD CF In CD In a a .5 C 0 C) C) 0 a 0 3 CD a a CD .—a CD — C) CF ..h -a a a -4, 0 CD C >CCF — 3 CD a- CF a Given the mixture of political and CD — C C) - CF - —h — C) CD a CF 3 CD a 0 ‘C 3 a CD .a C -4, In C In -s CD C versus full employment deficit. Ca) CF objectives and the low level of aggregate income -- witness the actual C CD CF C) CD CD a- CF In In CD a CF ~ — Ii CD 3 C) 0 a — CF CD CD CD cc .5 , CD cc cc 0 CD C CD ~ 0 CD a- CF a a CD In CD .4. C CF C) 0 ~CT CD 5 CD C) — CF — .a 0 -i a 3 -a -4, a CF CD .J In C CD CD CD C a- CD a CF CD In a — CF C a- ‘a — C) ‘C 0 a a In — CD CD ‘C a CD 4 0 CF 5 result of Keynesian policy, but instead have resulted from political In C ..a CD The large deficits of the last two years have hardly been the CD a- CF a CD CD a ‘C a- a- CD 5 CD CD C a- In CD .5 CD ‘C CF Z 0 CF In CD CD a- CF 4, 0 In CF — a CD -i, — C) CD ~5 cc CD CD -H a- tools that can either be used or abused. - 0- CD C In CT CD 0 .5 a CD C In (7 CD aCD ~5 CF — CD CD a C) CF CD CF a- In CF 0 0 h — C) ‘C 0 -a CD — CF a CF CD -a 0 CD In CF C) — CD -4, — a 5 0 C In a In C .5 a CD — — 3 a CF In a a CD — C) ‘C —a 0 -a In C) CD a. fiscal policy and its implied surplus or deficit as potential policy It than the large government deficits. other much more II believe there are other plausible explanations for the low rate of investment. The most obvious explanation is the substantial under-utilization of resources when the economy is at less than full employment enployment and the lack of confidence in the economy’s economy's ability to use all its resources in the future. This seems to me to call for stabilization policy, policy, not argue against it. Finally, Dr. Sprinkel believes that slower money money growth to reduce the rate of inflation is worth the adverse effects of slower growth in output. a;,ees with this view or not will very much depend Whether one a;.ees upon the price in terms of output of reducing the inflation rate. In aa recent paper, surveying the results from aa number of different macro- that, on average, the models yield econometric models, Arthur Okun found that, aa one per cent per year reduction of the inflation rate for about ten per cent loss in the annual GNP. This seems seems to be a very high price to percentage point. pay for reducing the rate of inflation aa single percentage There needs to be an elucidation and tabulation of the real costs of inflation before we jump into aa strong anti-inflation policy, policy. What are the costs? The small anti-inflation yield of contractionary policy explains why the Carter Administration has turned to its current policy. UnwillUnwillharsh monetary and fiscal measures, the PresiPresiing to pay the price of harsh dent has opted for a program with less adverse impact but also aa low probability of success. 114 i t COMMENTS ON: "TIP “TIP FOR INFLATION: WHY AND HOW” HOW" Denis S. Karnosky Dr. Weintraub has presented aa proposal which emphasizes his conconcern about the seriousness of the current inflation and the continuin~ continuir10 failure of the national authorities to correct the situation. II agree with his emphasis on inflation as an economic problem, and his analysis of resulting res ult i ng economic inefficiencies. i neffi c i enc i es. However, II am uneasy about some of the analysis which supports his proposal and some of the effects which he foresees as aa consequence of adopting his variation of a national incomes policy. As II understand his position, Dr. Weintraub's Weintraub’s recommendation for a tax-based incomes policy is based on two contentions. First, that alalFirst, ternative monetary and fiscal actions either either will not work or are very inefficient --- in the sense that they would cause unacceptable losses in output and employment. going to use something Second, that if we are going other than the traditional monetary and fiscal actions to fight the ininflation, we should adopt aa program which does not interfere with the tern. market sys system. Considering these premises in turn, turn, there are four aspects of the satisfactorily. proposal which are not handled satisfactorily First, the manner in which the traditional analysis of inflation, as aa monetary phenomenon, Dr. Dr Denis S. S Karnosky is Vice President-Research of the Federal Bank Louis. Reserve Reserve Bank of of St. St Louis 115 is dismissed is disconcerting. For example, aa contention contention is made in the paper that inflation cannot be successfully combated by monetary actions because both current and prior chairmen of the Board of Governors of the Federal Reserve System have been "dedicated “dedicated and implacable inflation foes" and yet the inflation has gotten worse. foes” The clear implication here is that the Federal Reserve has actively pursued an anti—inflationanti-inflationary monetary program and failed. When II started in the Bank twelve years ago, one of the first things II learned from Homer Jones (former chairman) was that there is aa distinction between monetary policy and monetary actions. disI think that Dr. Weintraub fails to make this dis- tinction, misinterpreting the rhetoric of monetary policy, which has been definitely anti-inflationary, and the deeds of monetary actions, which have notnot. In those rare instances, such as 1969-70, when the Federal Reserve has undertaken restrictive actions, the restriction was very short-lived. The Fed then backed away just as the anti-inflationanti-inflation- ary effect began to take hold. The economy was run through unnecessary recessions and periods of slow growth, and the monetary stimulus to inflation was then reapplied. The available evidence on on leads and lags shows that the expected result from such aa start/stop program is shows stagflation. The monetary interpretation of inflation cannot be dismissed as irrelevant on the observation that the Federal Reserve has not reduced the inflation rate. The Federal Reserve has not taken any action to reduce the inflation rate. From a monetarist monetarist point of view, the key element is not considered by Dr. Weintraub -- a steady fifteen year —- 116 acceleration in money growth. Perhaps, before we go on to an alternaalterna- tive proposal, proposal, such such as the monetary by the the pretive as TIP, TIP, the monetary actions actions suggested suggested by prevailing (but (but certainly not universal) universal) theory monetary vailing certainly not theory of of inflation inflation as as aa monetary phenomenon should be tried. However, the TIP proposal is also offered as necessary even if we agree that excessive money growth is the culprit in the inflation proprocess. The contention is that monetary restraint is too expensive to employ, in terms of lost output and employment, and aa program such as TIP can get to the problem, without this cost. Again, the available evidence seems to argue against this position. A inflation as aa monemoneA policy prescription derived from trea~ing trea~inginflation tary phenomenon does not necessarily mean that a steady non-inflationary rate of money growth should be achieved immediately. ing with aa clean slate. We are not startstart- We have aa decade of persistently inflationary experience and a large amount of economic behavior which is based on the presumption of continuing inflation. Borrowing Dr. Weintraub's Weintraub’s analogy, it is aa matter of aa doctor advising you that treatment of your ailment is going to incur costs, one of which might be kidney failure. Is it reasonable then to seek other doctors until you find one that assures asonable you that you can be cured at no cost to your kidneys? Are the policy recommendations of this last doctor correct? Not necessarily, but it certainly sounds better better. The other three areas of concern are with the proposal itself itself. The TIP proposal is based on Dr Weintraub’s well-known and long-stand- The TIP proposal is based on Dr. Weintraub's well-known and long-stand- ing the price price setting setting mechanism mechanism in the mark— marking analysis analysis of of the in the the economy economy -- the —- up determination. up approach approach to to price price determination 11 7 117 L It is is safe safe to to say that there are It say that there are few people who would disagree with the contention that there is aa funcfunctional relationship between unit-labor costs costs and prices. would not. II certainly II do have difficulty, however, making the transition from that empirical relationship to recommendations for an incomes policy. For example, it is true that over time the mark up of prices over unitunitlabor costs tends to be stable, with aa slight trend. tell us about policy? What does that unit-labor Does that tell us that if we control unit—labor costs directly, inflation will be controlled directly? Not at all. We are talking about a structural relationship within the economy which relates two endogenous variables to each other, with unit-labor unit-labor costs costs on the right, ''explaining'' left. “explaining” prices on the left. Unit-labor costs (in terms of rates of change) consist of the rate of change of money wages minus the rate of change of average product of labor. variables. endogenous variables. These These too are What causes wages to change? What causes propro- ductivity to change? It is not enough to say that productivity grows at some “normal” "normal" rate over time and that wages will rise by whatever the market power of the labor union determines beyond the increase in productivity, simply because these variables have moved in line in the past. Considering Considering relationships between endogenous variables, especially when they are prices, requires careful attention to the general system and the other factors affecting each. The relationship cannot be considered considered in isoiso- lation, without reference to how it fits into and is affected by the rest of the system. Establishment of an an artificial relative price between goods and labor, without considering considering the other forces working on both prices, can only lead to aa serious distortion in the system. 118 118 - CD CD C) In CD C a In CF CD CD CD .5 119 - CD CD C) a In CD ~ a- • CF CD — 5 CD I C) CD C CD - C Bureaucra03 C) CD a- CF ‘a ‘C — —1 — a a 0 ~ CD -h a a a — CF CD CD a CF 3 CD .~ 3 a — a CD a- CF a -h CD 3 In 0 CF In C -a- CF CD a cc V — In looking at just some of the 0 0 a — • a CD a — >< CD a- CF — a In CD CD In CD C) 5 a — CD CF a- CF CD CD 5 a C) In In C CD 5 CD CF — C) — a CD CD a ‘C a (7 CD — a CD 3 CD C) C) 0 CD (7 ‘C C) Lastly, it has become standard that every proposal for an incomes In CD a C) 0 3 — a CD -4-, 0 5 a 0 In CD 5 ‘C -a -s 0 a CD C CD CF aCD CF CD a a CD a CF In CD 3 0 In It is difficult for me to dis— In I 0 a CF CD 3 —s 0 4, CF C C) — -~ —i-, — a — In CF — - In CD CD C) CD a In - CF ~5 a 3 CD a CD 0 C cc CD a- CF CF CD CD —a C — a a0 Z — CD CD In aa CF a 0 In CD ‘ — CF a CD CD a. CD In 3 a 0 — 0 CF In CD CF 3 CD -5 CD a- CF -in 3 a In .~. C) aCD a CD 3 CD C) 5 .a. a CD C — CF CD~ C) — a cc 0 ~5 -~ 3 -a .a ‘C In — — In CF -s a 3 CD a CD C cc 0 CD a- CF ‘a a a CD a CD CF In CD cc CD — CD C CD CD In 0 3 0 —~ 3 -4, CF CD CD C 0 CD E a CD ~5 the relative price mechanism of the markets to impose penalties on those a- CF who deviate from some average standard, the government is simply forcing a- By imposing tax penalties (and subsidies) on individual units In CF — a C .-a C CD a C — a a — — a 0 — In CD .a. a In — C a- In CD a a In CD — CF .a CD a CD a )< CD CF a cc 0 In a. 3 -a — ‘C 03 • — 0 aCD aCD C wage, price, and output determination, the government is mandating CD a a cc — CF CD 3 CD a a — In CF CD ~s a 3 CD C cc 0 CD a- CF ‘a 0 a — CF CD a a. 3 -s CD CF CD a CF -a C 0 C CF a a CD ‘a .5 — C) a ‘a CD C CD cc 0 -4, In 3 CF CD a — 0 CD C — aa- CD CD CF 7C -5 CD 0 a 3 In CD — CF .a — a cc a CD a CD In — — By imposing penalities on market behavior in terms of 3 a a 03 ‘C • CD .-‘ a- C 0 CF 0 -4, CF 0 umpire very casually said, "Son, if that bat comes down, you' re in a r CD a — CD -s - 0 C ‘C ‘a a 0 C a In CD C) 0 3 CF CT CD CF aCD CF -~ — ‘a C/) a a ‘a a In CD — a ‘C C CD C) CD In ‘C CD C CD — C 3 a a CD a- CF ‘a ‘C a a Reportedly, the CD a a 5 CF ~ CD - — -5 CD CD a- CF a. a CF aCD — In a- a cc — a cc — ~ CT ‘C In a — 0 CF 0 3 CD — In a- CD a In In 5 CD baseball player years ago who took umbrage at an umpire's call and exI CD >< a 0- CD .a C) CD In - CD CD a C 3 a — -s CD CF CD 3 a—~ CD cc CD CD a- CF -4, a CF CD a- CF CD 7;~ — 3 C C) a- — In 0 a CF — C CD CF The situation is much like that of the In — a- —H C ‘C C) -a- Q a ~5 ‘C 3 a a CD CF a CD CD CD CT 0 CD CF 3 0 CF a 0 7C~ CF C a0 0 CD cc In 5 CD CD ‘C -s ‘C CD a CD . CD a- CD CD In a- In 3 CD CD TIP seems In —i — a • a — 0 CF a. a C) CF In a. a CF aCD CF a cc — ~- a 3 CD — CF ‘C a C) C -a. a — -in -h -4, 0 .a CD CD a CF CD CD cc 5 CD CD CD C a- a — C) ‘C a 0 a In CD C) 0 3 a — ‘C = •5 r 3 CD a a CD CF 0 aCD CF — C a CF CD CD — C) In In CD ‘C ~ C) CD — ‘C CF In CD — a C) — C) — CD -4 CD n efficiencies typically associated with a "mandatory" incomes policy. .5 CF CD — In CD a 3 — a ~ a0 41 a In -~. In aCD CD a- CF 0 a ‘C a CF CD -S .a C C 0 a a CD ‘C .5 0 CF CD C) CD (7 a CD CD CF C CD aa- C — In 3 CD a a • In CD .~. CF CD a a CD a a cc — CF tinguish between mandatory and voluntary on the basis of who administers a- CD In — CF ‘a ‘C —‘ CF In CD r the penalties. CD a- CF have a great deal of difficulty in making that distinction. CD CD C CD — a — —4, a — In CD aCD C) 0 3 ‘C CD CC) -s CD C) CD 5 0 CD C CD a- C) CD a a a CD CF C In 3 C) ‘C CD -j C C) CD policy be accompanied by an explicit reassurance that increases in the — 0 -a pressed his emotions by flinging his bat in the air. CD a- CF -4, — 0 CF a- C CD CF CD In cc cc In C CD a- CF 0 -41 In -i. CD CD CF a CD ~ s CD aC —5 bureaucracy must and can be avoided. a a- CD CF a cc CD In — CD C) .5 a — general details of the suggested implementation of a TIP policy, the CD cc CD a who violate the government's decrees. a a CD )C CD ‘C CD a- CF I In CD CD In cc C In 0 — ~t< a a CD -4, 0 5 CF — CD a CF CD lot of trouble." C) o a — CF -a~ a CD CD ~5 potential for increasing the bureaucracy becomes infinite. 0 a behavior. CD C cc CD C .5 cies are like noxious gases -- they expand to fill the available space. In CD C) — to me to be a mandatory policy. cc A new regulation creates new space. a CD 0 continue their inflationary path. — 5 a — CD a- CF a CD C 0 — 0 CF In CD a CD CD 3 In a CD CD a 4, -h CD —s — In CD 0 In a 0 5 a a —4 — CD a- CF a ‘C a a- CD CF ‘C a CD — 0 CD CF —~ -h a .~5 a. CD a- CF a- a CD —4 Thirdly, the TIP proposal is offered as a means to avoid the in- — a C CF a C) have been applied and where fundamental factors, such as money growth, ‘a ‘C cc .5 0 C CF a- CD 3 0 a CD In C) a- In C In CD C) CF 0 -5 Hn 3 a CF CD CD CD -h C a a CD CD a- C a a CD a CD — -Q a CD a CD aCD CD aCD C CD S In .a a .5 CF C) 0 a CF C) CD — a CD CD C a- CD In C) CD ‘C .5 CD C CD a a C) a- CD CD a C) a ~5 a CD 5 CF aCD CD CD a a- In aCD In -a- a- -H This has been the record in each and every case where direct controls I
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