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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

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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.

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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

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ty in the economy.

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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.

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''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

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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

.

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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

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longer run growth of outp ut.

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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

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CT

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a

-S
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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

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recession threaten to determine the climate of the Presidential election
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duce a recession reaching into the year 1980 with initially small effect
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overwhelm and more than offset the action bearing on reserve require5

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the Carter team, then all the available evidence from history and the
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nature of the policy institution suggests that policy will be reversed

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to an inflationary course within three quarters under the increasing

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on inflation.

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themselves.

0)

to the level of short term interest rates.

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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

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of the various measures, they all share a common strand.

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the Fed draws on its Swap line at the Bundesbank.
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ply of foreign currencies in terms of dollars.

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the United States remains on the other hand unaffected under the stan-~.

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aggregates M1 and M2. The evolution of "overnight-repos" between banks
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however, not affected by these developments. But rational policy making
would require a thorough overhaul of the Fed's concepts and measurement
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domestic program announced on October 24 seem well correlated with the
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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
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the change in circumstances in the United States or abroad.

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monetary growth and the budget deficit in the United States.
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9

lying forces shaping the drift in the exchange markets.

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winter passes and no relevant signals of the necessary revisions in U.S.
—

we do not possess any firm knowledge in this matter.

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This development will raise the domestic political pressure in
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financial affairs emerge, the dollar market will reveal a new wave of
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further adjustments in our financial policies.

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ation rationally offset by the external measures.

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inflationary course imposed by the U.S. government on the world.

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West Germany, Japan and Switzerland, encouraging the return to the
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doubt.

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inflation and not by the "leadership of November l."
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dollar may ultimately be "saved" by a concurrent and general policy of

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change portfolio commitments without some credible signals bearing on
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dollar probably with some delays.

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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
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d
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a

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a
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0

a

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C

Tnken from: B.Sprinkel and R. Gene!ski, Winning With Money. (Dow Jones-frwin fnc., Spring, 1977)

I

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70

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75

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C=:J Peak to trough of business cycles

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fiscal year $48.8 billion.

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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

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appropriate Fed funds rate, there is little hope of success.
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surely expended a lot more valuable ammunition in the meantime!

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that price changes on particular items cause inflation.

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The returns are all negative.

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What About Recent Policy Initiatives?

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currency, monopoly power in labor and business, higher agricultural
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isn't true.
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too expansive, controls won't work!

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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

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STAGFLATION: THE IMPOSSIBLE HAS HAPPENED
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Subsequent discuss ion will strike on literal ly three planes , with
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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

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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

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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

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revealed; alternatives, if the policy failed to operate on schedule,
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stances under which they might abandon the pressure are seldom
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pursued long and relentlessly enough, will stop inflation.

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what was originally hailed as a predictive law into a less edifying

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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
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the price spiral.

-

(Curren tly, another tight money venture is in

62

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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

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Futility of Monetary Policy Under Outsized Pay Increases
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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

—-

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view.
e's infla tion source: the avail able evidence inval idate s this

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OTHER !NFLAT!Oll THEORIES
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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.

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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
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The produ ctivit y term A stand s prominently in the price level
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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

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over three years the mere augmentation will overshadow the $500 billion
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ordered without assessing military or social consequences.

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with a meat axe while government outlay cuts are evaded, or trimming
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story in excess real demand -- a view which I reject.

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Emphasis here on the ~/age-productivity nexus as the price level-

3

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would appear to be the best route to repressing government expenditures.
—J
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and thus civil service pay and the price of government procurement,

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amounts to $1.4 trillion.

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maker make remarks on where money fits in obligatory.
inevitably must be brief. 3

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federal 1979 outlay.

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3Further elaboration appears in my Capitalism's Crisis and Keynes,
Keynesians and Monetarists.

7Z

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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
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0

Deflationary
Growth
Steady State
Deflation
Depression

70

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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.

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72

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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

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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

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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
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110

cc

Dr. Webster is Assistant Professor of Economics at Washington
University, St. Louis, Missouri.

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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

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spending has led to a lowering of national income, to a lowering of tax
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argued that in a number of economic downturns the lack of investment
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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
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This has been the record in each and every case where direct controls

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