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 56, No.


The Case For and Against Indexation:
An Attempt at Perspective

I n TH E 1930 s, when widespread unemployment
was the economic malaise threatening the foundation
of a free society, Professor John M. Keynes, of King’s
College, prescribed fiscal activism as a cure. Now in
the 1970s, rampant inflation is seen by some to
threaten the viability of a free society. Professor Mil­
ton Friedman, of the University of Chicago, has pre­
scribed indexation as an effective expedient to pre­
serve a free society.1
Indexation proposals, however, have encountered
historically less-than-enthusiastic receptions in many
quarters, in spite of the advocacy by many eminent
economists. This article seeks to unveil some of the
less apparent aspects of indexation in order that one
may achieve a deeper understanding of the theoretical
and practical issues involved.

Indexation, or index-linking, refers to proposals to
link the number of dollars to be delivered on a con­
tract to changes in some specified price index. Under
indexation, money would continue to be used as a
medium of exchange and as a measure of value, but
not necessarily as a standard for deferred payments.
In the event that the purchasing power of the dollar
changed as indicated by an agreed-upon price index,
contracts would be honored in terms of a unit of con1Milton Friedman, “Using Escalators to Help Fight Inflation,”
Fortune duly 1974), pp. 94-97, 174-76.
Page 2

stant purchasing power over “goods and services in
general.”2 Thus, an index-linked contract to deliver
$100 a year from today would deliver $110 if prices
rose by 10 percent over the interval, that is, if the
purchasing power of the dollar declined by 9.09

The basic objective of indexation is the insulation of
contractually-created claims on output from the ef­
fects of changes in the purchasing power of money
over goods and services in general (inflation or defla­
tion). In a completely indexed world, all of the fol­
lowing would be indexed: all private and public wage
and loan contracts including deposits at thrift institu­
tions, insurance, and pension contracts; social security
and other transfer payments, including unemploy­
ment compensation; and, of course, government tax
receipts. With respect to taxes, indexation would ap­
ply mainly to income taxes by adjusting the level of
exemption, the tax brackets, and the base of asset
valuations. The progressive income tax rate itself
would remain invariant for a given social decision
regarding the relative size of the government sector.
Since profit shares are noncontractual items and are
2With changes in relative prices, the constant purchasing
power of money over “goods and services in general” neces­
sarily implies variable purchasing power over at least some
of the goods and services in the basket; that is, with rela­
tive price changes, the “index number problem” inevitably
creeps in. See Ragnar Frisch, “Annual Survey of Economic
Theory: The Problem of Index Numbers,” Econom etrica
(1 9 3 6 ), pp. 1-38.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

determined residually, they would not be indexed.3
However, to the extent that such contracts as those
for purchases of materials are indexed, it appears
likely that profit shares of some intermediate goods
producers would be indirectly protected through
Even money would be indexed under a com pletely
indexed economy.4 In a pure currency economy with­
out private money producers (banks), indexation of
currencies could be facilitated by dating them, such
as Sylvio Gessell’s stamp money proposal.5 With bankcreated money and legal reserve requirements, the
task would be more difficult and would require fre­
quent intervention by the central bank.

Experiences With Indexation
A review of foreign experience with regard to
indexation shows a wide variety of practices with re­
spect to the classes of contracts indexed, the extent
of the compensation allowed, and the choices of in­
dices to which the contracts are tied.6 The most com­
prehensive indexation was provided initially by Fin­
land and then by Israel, France, and most recently
by Brazil. In addition to employment contracts, vari­
ous loan, insurance, and pension contracts have been
tied to a number of price indices as well as to the
price of specific foreign exchange and commodities,
such as that of gold Napoleons in the case of France.
The People’s Republic of China first introduced the
indexation of bank deposits in 1949, followed by Fin­
land in 1955, and more recently by Brazil in 1965.
Experience with indexing loan contracts in the
United States and the United Kingdom has been
scanty. Irving Fisher prevailed on the Rand Kardex
Company in 1925 to issue bonds tied to the wholesale
price index, but these bonds were soon converted
into preferred stocks and ordinary bonds.7 The United
3Milton Friedman, Price Theory (Chicago: Aldine Publishing
Company, 1962), p. 99.
4William J. Baumol, “The Escalated Economy and the Stim­
ulating Effects of Inflation,” in Essays in Honour o f Marco
Fanno, vol. 2, ed. Tullio Bagiotti (Padova, Italy: Edizioni
Cedam, 1966), pp. 96-104.
5For a full discussion of Gesell’s proposal see John M. Keynes,
General Theory (New York: Harcourt, Brace and Company,
1935), pp. 357-58.
6David Finch, “Purchasing Power Guarantees for Deferred
Payments,” International Monetary Fund Staff Papers
(February 1956), pp. 1-22; Miroslav Kriz, “Inflation: The
Case for Indexing,” and Nigel Althaus, “The Case for the
U.K. Indexing Gilts,” Euromoney (June 1974), pp. 19-27;
and United Nations, Economic Commission for Latin Amer­
ica, “Index Clauses in Deferred Payments,” Econom ic Bul­
letin for Latin America (October 1957), pp. 73-89.
7Economic Commission for Latin America, “Index Clauses
in Deferred Payments,” p. 76.



Kingdom did not adopt indexation for loan contracts
until 1973. The number of people whose incomes are
partially protected by indexation in the United States
has increased dramatically in the past several years,
mainly through the wider use of escalator clauses in
labor contracts, the adoption of indexed social secu­
rity payments, and the food stamp program.

Failure to Gain General Support
Indexation has historically enjoyed the support of
many illustrious economists, such as Stanley Jevons,
Alfred Marshall, Irving Fisher and John M. Keynes.
Until the end of World War II, however, indexation
had failed to elicit the support of policymakers or
capture the interest of the general public.8 The funda­
mental reason appears to be that the economists who
advocated such proposals had not designed an ac­
ceptable means for their implementation. They tended
to emphasize the desirability of the proposal as if
. . we had a clean sheet of paper to write upon.”9
Too often they failed to consider explicitly how the
new arrangement would affect existing institutions and
outstanding commitments. Often missing was a com­
prehensive analysis of the likely distribution of the
total costs of transition. An important subsidiary ex­
planation for the failure of indexation to elicit popular
support appears to be the implicit public judgment
that the economics profession has not, as yet, provided
a generally acceptable index of price change.10

The fundamental case for indexation, in essence,
rests on the claim that it would approximate the re­
sults associated with a stable price level — even in
the absence of price level stability.11 The theoretical
''For a historical overview, see Finch, “Purchasing Power
Guarantees,” pp. 1-22.
''Woodrow Wilson’s first inaugural address in The Inaugural
Addresses o f the American Presidents, annotated by Davis
Newton Lott (New York: Holt, Binehart and Winston, 1961),
p. 201. This partial quote refers to the founding of the
Federal Beserve System and is displayed inside the en­
trance to the Federal Reserve Building in Washington,
D.C.: “We shall deal with our economic system as it is and
as it may be modified, not as it might be if we had a clean
sheet of paper to write upon; and step by step we shall
make it what it should be.”
10Benjamin Klein, “The Measurement and Social Costs of
Inflation: The Recent Inflation and Our New Monetary
Standard,” unpublished paper (Los Angeles: University of
California, Los Angeles, 1974).
n Irving Fisher, T he Purchasing Power o f Money, 2nd ed. rev.
(New York: Augustus M. Kelley, Bookseller, 1963), and
Stabilizing the Dollar, (New York: Macmillan, 1920); Al­
fred Marshall, “Bemedies for Fluctuations of General Prices,”
Memorials o f A lfred Marshall, ed. Arthur C. Pigou (New
York: Kelly and Millman, Inc., 1956), pp. 188-211.
Page 3

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

presumption in favor of price level stability is that a
fluctuating price level has undesirable effects on the
distribution of income and on the efficient utilization
of resources. In addition, the argument has recently
been advanced that indexation would help to achieve
price level stability.

Distributive and Allocative Effects of an
Unstable Price Level
Inflations have real consequences when they are
imperfectly anticipated. Even when perfectly antici­
pated, inflations affect allocative decisions.
Incom e Distribution — From the point of view of
equity in the distribution of wealth, a stable price
level is superior since the redistributional effects of a
less than fully anticipated inflation do not occur. The
distributional implications of imperfectly anticipated
inflation depend crucially on the existence of binding
contracts fixed in nominal monetary units (monetary
contracts, hereafter). For a given stock of existing
monetary contracts, be they loan or employment, the
magnitude of distributional effects depends positively
on the gap between the actual and the anticipated
rate of inflation at the time of contract formation. If
all the transactor units were neither net monetary
debtors nor creditors, there would be no distributional
effects.12 In the event of an under-anticipated infla­
tion, net monetary debtors gain and net monetary
creditors lose; the conclusion is reversed in the event
of an over-anticipated inflation. The opposite distribu­
tional effects occur during a deflation.
The effects of imperfectly anticipated inflation on
the distribution of income generally have been con­
sidered undesirable. As Irving Fisher, who pioneered
the seminal distinction between anticipated and un­
anticipated inflation, put it, “. . . the real evils of
changing price levels do not lie in these changes per
se, but in the fact they usually take us unaware. It has
been shown that to be forewarned is to be forearmed,
and that a foreknown change in price levels might be
so taken into account in the rate of interest as to
neutralize its evils.”13



efficiency by freeing other resources from the task of
information gathering.14
When the price level changes rapidly and is antici­
pated to any extent, the holding of money becomes
more costly and its services less efficient. Other re­
sources are then drawn into the performance of money
services, leaving less resources available for the pro­
duction of goods and services. This inflation-induced
reallocation of resources would shrink the effective, as
distinct from the notional, production possibility fron­
tier, thereby reducing the amount of goods and serv­
ices available for present and future consumption.15

Indexation Helps Achieve Price Level
Traditionally, the advocacy of indexation was based
on distributive equity and, to a lesser degree, on allo­
cative efficiency grounds.16 Recently, a third dimen­
sion, based on a diagnosis of the underlying cause of
modern inflation, has been added. The modem day
proponents of indexation, represented by Professor
Friedman, have thrown in a sweetener. They claim
that indexation would tend to restore price level sta­
bility in an existing inflationary situation. Their posi­
tion can be interpreted to be based on their implicit
diagnosis that inflation is a “political phenomenon.”17
Their argument would run as follows. Inflation oc­
curs as a result of an increase in a nation’s money stock
in excess of the ability of the economy to produce
goods and services. Usually the initial force leading to
inflation is increased demand for government expendi­
tures to aid various sectors of the economy or segments
of the population. Those demanding greater govern­
ment services may not even be aware of the inflation­
ary consequences of their actions. It is only necessary
that in striving to better their relative and absolute
14Given imperfect foresight, a variable monetary yardstick
(implied by a fluctuating price level) increases the uncer­
tainty associated with any monetary contract and, assuming
aversion to purchasing power risk, increases the cost of
reaching agreement.

R esource Allocation — In a money economy the
commodity called money performs the services of col­
lecting information and facilitating exchange between
all participants in transactions. In an anticipated stable
price environment, money is believed to promote

15Robert Clower, “The Keynesian Counterrevolution: A The­
oretical Appraisal,” in T he Theory o f Interest Rates, ed.
Frank H. Hahn and Frank P. R. Brechling (London: Mac­
millan and Co. Ltd., 1965), pp. 103-25. Clower’s distinction
between notional and effective demand has been adapted
10Finch, “Purchasing Power Guarantees,” pp. 1-22, and W.
Stanley Jevons, Money and the M echanism o f Exchange
(New York: Twentieth Century Press), p. 91.

12Reuben A. Kessel and Armen A. Alchian, “Effects of In­
flation,” Journal o f Political Econom y (December 1962),
pp. 521-37.
13Fisher, Purchasing Power, p. 321.

17Joan Robinson, “Quantity Theories Old and New,” Journal
o f Money, Credit and Banking (November 1970), p. 512.
The term “political phenomenon’ was coined by Robinson
in the article. The juxtaposition of the term, with the result­
ing implications for indexation, is that of the author’s.

Digitized for Page 4



positions they induce an accommodating increase in
the nominal money stock which is faster than would
be consistent with price level stability.
In this interpretation of their view, although the
villain fostering the inflation is the public demanding
more from government, the basic cause is much
deeper. It is imbedded in our system of “advocacy
politics.”18 Those who are ultimately responsible for
inflation are those who succeed in inducing the gov­
ernment to try to command a greater share of society’s
resources than is explicitly provided for in tax laws.

Historically, indexation has been proposed at times
of on-going and relatively high rates of price change.
The case generally advanced against such a proposal
has been based primarily on the fact that we do not
start with a “clean sheet of paper to write upon.”
Since at any moment there exist outstanding con­
tracts which are not indexed, it is argued that indexa­
tion would tend to cause problems for those indi­
viduals and institutions involved in such contracts.
An additional standard argument against the index­
ing proposal has been that the adoption of such a
proposal would tend to weaken support for anti-infla­
tion policies. More recently, some have contended
that indexation would tend to affect adversely the
terms of international trade for an open economy.
The following statements were made by the Coun­
cil of Economic Advisers and others in 1952 in opposi­
tion to the proposed issuance of a purchasing power
bond by the Treasury. These statements are represent­
ative of the arguments used against indexation in
W ould w eaken support for anti-inflation actions
The issuance of a purchasing power bond would
imply a defeatist attitude toward the problem of in­
flation. Widespread ownership of purchasing power
bonds would add another group to those who think
themselves sheltered from the effects of inflation, and
would weaken public support of a stabilization



tractive feature to one type of security offered to
the public in competition with other Government
bonds and such other forms of assets or contracts as
currency, demand, time and savings accounts, shares
in savings and loan associations, and life insurance
policies. It is very likely that great pressure would
develop to extend the purchasing power clause also
to other investments, public and private. The greater
the number of persons who considered themselves
shielded from inflation, the greater would be the
possibility of its occurrence.
W ould harm som e individuals and institutions
The demerits of the proposal are clear and com­
pelling. First the issuance of a Government bond,
the value of which was guaranteed in terms of pur­
chasing power, would place other forms of fixedinterest investment at a decided disadvantage and
would jeopardize the continued existence of such
other forms of investment. There would be raised,
therefore, the serious problem of fairness to savers
who already had their savings programs in effect.
Moreover, it appears inevitable that the adoption of
a constant purchasing power Government bond would
lead to a disastrous collapse in the value of out­
standing investment media.
W ould b e difficult to choose appropriate index
The determination of the index measuring the price
at which the bonds would be repaid would present
technical difficulties and — no matter how decided —
would result in popular dissatisfaction.
W ould w eaken terms o f international trade
A new dimension in terms of an open economy
context has been injected recently. Based on the prem­
ise that indexation would accelerate inflation, Profes­
sor Murray L. Weidenbaum objects to indexation on
the ground that:
We do not live in a closed economy. We already
have seen that accelerating inflation at home means
devaluation of our currency abroad. That brings de­
terioration in the terms of trade and declines in our
real standard of living.20


The proposal for purchasing power bonds applies
the principle only to a limited amount of bonds.
The Government would thus add an admittedly at­

Both sides of the debate appear to agree that (1)
an inflationless alternative is ideal, and that (2 ) in­
dexation would prevent the emergence of inflationinduced distributional effects (making “living with in­
flation” easier).

18George P. Shultz, “Reflections on Political Economy,” Jour­
nal o f Finance (May 1974), pp. 323-30.

As mentioned earlier, the proponents tend to ignore
the transitional costs involved in adopting indexation,

19U.S. Congress, Joint Committee on the Economic Report,
Monetary Policy and the Management o f the Public Debt,
Part 2, 82nd. Cong., 2nd. sess., 1952, pp. 888-89, 1097, 1109.

-"Murray L. Weidenbaum, “The Case Against ‘Indexing’,”
Dun’s (July 1974), p. 11.

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F E D E R A L R E S E R V E B A N K O F ST . L O U I S

while the opponents tend to emphasize the likely ef­
fects on the viability of certain existing institutions.
With regard to the inflationary implications of adopt­
ing indexation, the proponents and the opponents are
diametrically opposed.
To help assess the pros and cons of indexation, let
us first speculate on the properties of an idealized,
completely indexed economy. Such speculation would
help to illuminate the possible difficulties accompany­
ing any period of transition to necessarily less-thancomplete indexation.21

Some Properties of a Completely Indexed
R elative Price C h an g es— It might appear that in a
completely indexed economy, the relative prices of
various goods and services would remain constant.
Indexation, however, does not immunize a producer
from the risk of changes in relative prices incident to
changes in preferences, technology, or weather. A set
of relative (output) prices would still guide the allo­
cation of resources. Indexation is designed to insure
only the equality between the realized and the con­
tracted claims on output for the hired factors of
Governm ent’s Claims On Resources — The share of
resources commanded by and flowing through the
government would ideally not deviate much from the
level that the public “voluntarily” transfers through
its pledges of current and future tax payments. The
government would be deprived of the power to col­
lect inflationary taxes from the populace. The income
tax system, with indexed exemptions, asset revalua­
tions, and indexed tax brackets, would lose a con­
siderable amount of “built-in” stabilization potency
widely thought to be associated with a progressive
tax structure.22 However, should the government at­
tempt, through continued creation of money, to com­
mand more real resources than those tendered in
explicit tax payments and private-sector lending, in­
flation would persist and the price level could ap­
proach infinity.
Existence o f Inflation — An intriguing question aris­
ing in this context is the consequence of moving into
21A real-world exchange
indexed and still remain
Economy,” pp. 96-104,
Inflation (New York:



a regime of indexation from the initial position of
inflationary disequilibrium. Without indexation, a
given rate of inflation may eventually be eliminated
by the inflation-induced changes in income and
wealth distribution. A completely indexed economy
would be devoid of this mechanism, and hence would
bring into the open the underlying conflict of interest
existing among the competing claimants.
A bsence of Money Illu sion — Various forms of
“money illusion” would be completely absent from the
system. Money illusion would be absent in wage
negotiations. The absence of money illusion in wage
perceptions would tend to “worsen” the terms of the
short-run trade-off between inflation and unemploy­
ment in the sense that no amount of inflation would
buy less unemployment; that is, the short- and longrun Phillips curves coincide, being vertical at the
natural unemployment rate.23 This factor would tend
to reduce opposition to an anti-inflation policy. In
addition, the behavior of interest rates on loans as
well as negotiated wages would tend to stabilize since
they would not embody anticipations of inflation.
Inform ational Efficiency o f M arkets— More exten­
sive use of the markets would be encouraged under
indexation for inter-temporal exchange and transfor­
mation of resources. To the extent that the costs of
collecting and processing the information regarding
productive opportunities are lowered through mar­
ket exchange, real output would be increased for a
given structure of preferences and a given state of
Risk-free A sset— Indexation provides assets which
are free of purchasing power risks. A short-term
monetary asset in this regime, such as Treasury bills,
would be free of purchasing power risk in addition
to default and relative price risk associated with
changes in interest rates. The availability of such an
asset would rescue much of the theoretical results of
the modern capital pricing and portfolio choice theo­
ries which are predicated on the existence of a riskless

Potential Impact of Indexation on Inflation
Although indexation, by itself, would not prevent
price level changes, the advocates appear to believe

economy cannot have its money
viable. See Baumol, “The Escalated
and Amotz Morag, On Taxes and
Random House, Inc., 1965), pp.

23For a discussion of short- and long-run Phillips curves, see
Roger Spencer, “The Relation Between Prices and Employ­
ment: Two Views,” this R eview (March 1969), pp. 15-21.

- - “The Deceptive Lure of Indexation,” Business W eek, 25
May 1974, pp. 147-52.

- ‘Marshall Sarnat, “Purchasing Power Risk, Portfolio Analysis,
and the Case for Index-Linked Bonds,” Journal o f Money,
Credit and Banking (August 1973), pp. 836-45.

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F E D E R A L R E S E R V E B A N K O F ST . L O U I S

indexation would reduce inflation by reducing the
pressure for inflationary policies and by making antiinflationary policies more palatable. The opponents of
the proposal argue that indexation is likely to exacer­
bate inflation since by removing its sting, the con­
stituency for anti-inflationary policies would be weak­
ened. They recommend more resolute anti-inflation
policies, but seldom provide an analysis of the under­
lying force driving inflation.
What is critically missing in the argument that in­
dexation would lead to accelerating inflation is the
analysis of why inflation occurs. In the absence of any
analysis as to the incentives and the mechanics of in­
flation, a case based on the fears of accelerating infla­
tion (which is conceded to be “functionless” in terms
of distributive benefits) is not very persuasive.
As noted earlier, the proponents provide such an
analysis of inflation in terms of advocacy politics and
the share of resources commanded by the government.
From this perspective of the diagnosis of inflation, it
is the government-deficit-induced increase in the
nominal money stock which underwrites persistent
inflation. The issue fundamental to the inflationary
implication of indexation, then, may be posed as: is
indexation more likely to lead to the abatement of
pressures for policies which lead to inflation?
The advocates of indexation answer the query af­
firmatively. They cite the reduced incentives to pro­
mote inflationary policies under indexation as well as
the asserted reduction in the costs of anti-inflation
policies to bolster their case. Their case would be more
persuasive if one could accept their implicit premise
that taking the “honey” out of inflation would reduce
the pressures for policies which are likely to lead to
deficits, excessive monetary growth, and the entailed
inflation. As was touched upon earlier in discussing the
inflationary implication of moving into complete in­
dexation from the initial condition of inflationary dis­
equilibrium, their implicit premise is not based on a
firm foundation.

Why Attempt to Reduce Inflation Under
Complete Indexation?
The modern proponents of indexation seldom make
explicit what additional benefits they perceive for the
asserted abatement of inflation if its distributional
effects are neutralized under indexation. Passing ref­
erences to the nuisance of bookkeeping changes are
made. However, the possible gain in allocative effi­
ciency associated with the inflationless solution alluded
to earlier is seldom made. If, as the proponents argue,



indexation neutralizes the distributive effects of infla­
tion, isn’t the presumed anti-inflation benefit of index­
ing simply superflous without some amplification of
the effects on resource allocation and balance-ofpayments developments?
In evaluating the balance-of-payments effects, one
must take into consideration the prevailing foreign
exchange rate system and whether or not indexation
will lead to more or less inflation. Under a freelyfluctuating exchange rate system, the case for indexa­
tion would not be affected by its balance-of-payments
effects, regardless of its effects on inflation; exchange
rates would simply change to reflect changing rates
of inflation. Under a fixed exchange rate system,
however, the case for indexation would be greatly
attenuated if it results in accelerated inflation, as some
opponents contend. This is so since the likely con­
sequences would include increased restrictions on
product and capital flows to cope with the emerging
balance-of-payments difficulties.

A Recent Experience With Indexation
and Inflation
Some of the proponents of indexation have cited
the example of Brazil as a case in which adoption
of indexation has both reduced inflation and in­
creased growth of output. Interpretations differ as to
the role that indexation played in the Brazilian “mir­
acle.” Friedman suggests that indexation contributed
both to accelerated growth and decelerated inflation.
Both Walter W. Heller and Ronald A. Krieger tend
to emphasize the incidental contribution of indexation
to growth. They assert that the main spring of growth
was the enforced redistribution of income to capital
from labor which could have occurred only in a regi­
mented command economy. They leave unexplained
the deceleration of inflation.
Our reading of the Brazilian experience suggests
that both occurrences are the predictable effects of
conscious policy choices made by the government
with the tacit approval of the populace. The govern­
ment of Brazil replaced inflationary taxation as the
dominant form of a savings-investment technology in
1964 with financing through capital markets and di­
rect taxation.25 The motive for this action was the
realization that the yield of inflationary finance had
atrophied alarmingly as people increasingly made ad­
justments by such devices as capital flight abroad and
25David M. Trubek, “Law, Planning and the Development of
the Brazilian Capital Market,” The Bulletin (New York:
New York University, April 1971), pp. 20-21.
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F E D E R A L . R E S E R V E B A N K O F ST . L O U I S

barter transactions. The consequent massive reforms
in tax laws, tax administration, and in the capital
market regulations proved effective.26
Ingenious tax incentives, such as granting tax cred­
its for the purchase of shares in the so-called 157
Funds (specially created mutual investment funds),
which are then used to purchase new and secondary
equity issues, stimulated the development of equity
markets and promoted savings.27 The government, in
effect, used the tax system to elicit savings, but relied
on the newly developed capital market and the price
system to allocate the savings thus created.
But the single force which contributed most to the
decelerated inflation was the government’s conscious
and deliberate policy of reducing deficits. The aban­
donm ent of inflation as a savings-investment technol­
ogy must be credited for checking inflation, not the
indexation per se. The adoption of indexation, coinci­
dent with the move toward less inflationary policies,
served primarily to eliminate the inflation-induced
income distribution. Its contribution to the decelera­
tion of inflation was accommodative rather than
Economic growth in Brazil can be explained at
least partially in terms of the increase in forced sav­
ings induced by changed tax laws. In addition, the
increase in allocative efficiency arising from the mar­
ket direction of resource flows may be construed as a
contributing factor to the observed growth in Brazil.
It must be noted that in Brazil there are relatively
small amounts of outstanding monetary contracts.
Since the existence of monetary contracts complicates
the implementation of indexation, it is likely that
opposition to such a proposal would be more muted
in a country like Brazil than in the United States.

Effect of Indexation on Existing Contracts
and Institutions
Professor Friedman strongly favored the issuance
of the purchasing power bond in 1951 and based the
continuation of his advocacy mainly on equity and
ethical grounds. He subsequently broadened the scope
- 6Ibid., pp. 22, 25. The Capital Market Law of 1965 author­
ized monetary correction for debt instruments and bank
deposits, and introduced authorized but unissued shares.
The Law also removed effective barriers to indexation and
lending at positive real rates in an inflationary environment
with usury limits of 12 percent, except in the short-term
letra market ( a letra is comparable to a banker’s acceptance).
27Ibid., pp. 56-65.
Page 8



of his proposal by including private securities and the
income tax systems (1973). Beinforced by the “eco­
nomic miracle” wrought by Brazil with an assist from
“monetary correction,” and compelled by accelerating
inflation domestically, he has recently mounted a
vigorous campaign for indexation reminiscent of his
advocacy of freely-fluctuating exchange rates and
Writing on October 29,1973, he conjectured that the
. . time is ripe for private purchasing power bonds.
A breakthrough awaits only our imaginative bond un­
derwriter.”29 The recently announced issue by Citi­
corp, a bank holding company anchored by the First
National City Bank, New York, seems to be the re­
sponse to Friedman’s challenge. It has a provision for
a variable interest rate one percent above the Treasury
bill rate and redemption options at face values twice
a year. This particular instrument may be interpreted
as a form of de facto purchasing power bond if one
regards changes in the Treasury bill rate as reflecting
only the changes in the actual, rather than the antici­
pated, inflation rate. To the extent that the changes in
the Treasury bill rate incorporate changes in the un­
derlying real interest rate, this instrument would have
the added feature of reducing relative price risk as
In order to explain the above assertion, let us an­
alyze the relationship which would hold between an
indexed and a nonindexed bond. Abstracting from
risk-aversion, at the time of issue the interest rate set
for a nonindexed bond would exceed the rate on an
indexed bond by the expected rate of inflation. As­
sume for simplicity that both are consols (bonds
without maturity dates) and the indexed bond is
protected for the full value of interest payments. What
would happen to the market (present) values of these
bonds as inflationary expectations change? Market
value of the indexed bond would be invariant with
changed expectations of inflation, whereas that of
the nonindexed bond would move inversely with the
changes. As far as the change in the real interest
rate is concerned, both bonds would be affected, but
the variability of the indexed bond would be greater
- s\lilton Friedman, “Purchasing Power Bonds,” Newsweek,
12 April 1971, p. 86, and Friedman, “Economic Miracles,”
Newsweek, 21 January 1974, p. 80.
-'•Milton Friedman, “More on Living With Inflation,” N ews­
w eek, 29 October 1973, p. 96.
30A “true” purchasing power bond protects the holder only
against price level changes, while leaving the holder vul­
nerable to relative price changes, that is, the risk of changes
in the real interest rate, which reflects the exchange rate
between present and future consumption options.

F E D E R A L R E S E R V E B A N K O F ST . L O U I S

for anticipated inflation.31 Assuming risk aversion,
the relative attractiveness of the two bonds would
crucially depend on the perceived relative variability
of real interest rates and anticipated inflation rates.
If the market judged that the expected rates of infla­
tion were more volatile than real interest rates, again
assuming risk aversion, the indexed bond would be
relatively more attractive. Thus, it would command
higher prices and lower effective yields; that is, a
borrower may borrow at lower yield with the indexed
bond than with the nonindexed bond. Available evi­
dence from Israel is suggestive in this regard.32
The sometime advanced argument that the intro­
duction of indexed bonds would adversely affect the
price of existing bonds must then implicitly assume
that the mere introduction would raise either the ex­
pected rate of inflation, which is debatable, or the real
rate of interest, which is doubtful. The market price
of existing bonds may be substantially below the orig­
inal sale price, but this would be unrelated to the in­
troduction of indexed bonds. The reduction would sim­
ply reflect the past history of movements in the market
rates of interest, which reflect both the changes in the
real rate and the inflation rate.
The introduction of indexed bonds would adversely
affect the issuer of new nonindexed bonds. Under the
assumed condition of relatively greater attractiveness
for indexed bonds, the implied higher costs of bor­
rowing for the incumbent borrowers mean lower
wealth for the incumbent “conventional” borrowers. If
there are legal impediments to issuing an indexed
bond (possibly due to the statutory limits on both the
lending and borrowing rates), the incumbents would
lose wealth as the new indexed bonds joined the com­
petition for funds.
It would not be surprising if those who stand to
lose by the innovation would try to block access to
the market in order to protect their wealth. The cur­
rent lively counter-offensive by the thrift institutions
to deny access to markets to the issuers of de facto
31This is because the elasticities of market values of indexed
and nonindexed consols with respect to a once-and-for-all
change in the real rate of interest can be shown, respec­
tively, as
(1 + n o)rt
, _
(1 + fl0)rt
rt -(- rtrio — ron o
rt + rtn o + n o ’
where FI0 is the rate of inflation anticipated at the time of
contract formation, r0 is the real rate of interest at the time
of contract formation, and rt is the real rate of interest at
time t subsequent to contract formation. See the appendix,
available on request, for demonstration.
3-Alexander Rubner, “The Abdication of the Israeli Pound as
a Standard of Measurement for Medium and Long-Term
Contracts,” Review o f Econom ic Studies (October 1960),
pp. 69-75.



purchasing power bonds is instructive in this regard.33
The foregoing suggests that it is not so much the
values of existing bonds but the wealth of the exist­
ing equity owner and/or the viability of certain finan­
cial institutions which are threatened when indexed
bonds are introduced without appropriate changes
in the whole spectrum of legal and institutional
The barriers to the introduction of indexation by
the government and the private sectors are legal and
economic. Indexing of income taxes and the issuance
of index-linked government bonds would require leg­
islative acts and the required legislation appears to
entail significant political realignments. Opposition
would appear to be concentrated in thrift industries
such as savings and loan associations and mutual
savings banks. The motive underlying opposition to
indexation would appear to be the entailed loss in
wealth consequent to the introduction of indexation
without any provision to “socialize loss,” such as a
guaranteed purchase at par of the assets held by
these institutions.
As noted recently by Professor Friedman, indexing
income taxes would help facilitate the introduction
of a private index-linked bond by exempting interest
adjustments from the income tax levy. Indexing gov­
ernment securities would also stimulate the introduc­
tion of private indexed bonds by competitive forces
as well as by preempting the state usury restrictions
on loan contracts. The availability of index-linked in­
struments would facilitate the spread of indexation by
providing hedging opportunities to such financial in­
termediaries as savings and loan associations, life in­
surance companies, and commercial banks.

Longer-Term Contracts Would Result
Under indexation longer-term contracts would likely
result — a development which, on net, could be re­
garded as a benefit. Under a nonindexed regime with
high and variable rates of inflation, the tendency to­
ward shortening of maturity emerges because short­
term instruments provide a relatively higher degree
of income and capital certainty. The above holds as
long as the perceived variability in the expected rates
of inflation is greater than that in the real interest
rate. The Israeli experience, referred to earlier, tends
to confirm this view.
Effective indexation would shelter the parties to a
monetary contract from the effects of unanticipated
■ '“Savings Associations Oppose Proposed Citicorp Note Issue,”
New York Times, 2 July 1974, p. 55.
Page 9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

changes in the price level. However, the outcome
would be different from that of a nonindexed regime
only if changes in the price level that occur are im­
perfectly anticipated. The transactors would eventu­
ally provide for anticipated changes in the price level
in their contracts. The case for indexation, therefore,
is essentially based on the judgment that anticipations
about price level changes are neither uniform nor very
accurate. Since divergent price expectations tend to
restrict the extent of markets, indexation would ap­
pear to share most of the merits of a maintained
stable price level which generates zero expectations
of price level change.

Appropriate Index Not Resolved
The claim of Irving Fisher, made over sixty years
ago, that the theory and technique of index number
construction was advanced enough to provide a stand­
ard monetary yardstick, appears to have been pre­
mature.34 The debate on indexation forcefully redi­
rects our attention to a fundamental issue, namely,
what is inflation and how do we measure it?
The concept of inflation can be defined only for an
economy where money buys goods and goods buy
money. Inflation is the sustained depreciation in the
purchasing power of money and is measured by the
construction of an appropriate price index. The refer­
ence to appropriate is crucial in underscoring the
difficulty involved in any attempt to construct a gen­
eral price index. It brings into the open the funda­
mental issue of the appropriate universe of commodi­
ties in constructing the price index.
Should it contain intermediate goods or only final
goods? Should it include only newly- produced
goods and exclude all existing assets such as land
and houses? Should it include only the currently pro­
duced flow of services (such as housing services as
measured by implicit rental payments) and exclude
the currently produced sources of the future flow of
services (such as houses and automobiles)? These are
weighty and important issues to which satisfactory an­
swers are yet to be given, even at a purely con­
ceptual level.35 The potential divisiveness over the
choice of an appropriate index is discernible in labor’s
current opposition to the prospective revision of the
consumer price index.38
34Fisher, Purchasing Power.
:,riArmen A. Alchian and Benjamin Klein, “On a Correct
Measure of Inflation,” Journal o f Money, Credit and Bank­
ing, Part I (February 1973), pp. 173-91.
36“Labor Bristles at a Broader CPI,” Business W eek, 6 April

1974, p. 18.

Page 10



If we abstract from history and ignore the inherited
stock of outstanding monetary contracts and special­
ized financial institutions, the case for indexation ap­
pears persuasive. It would prevent the emergence of
an unintended distribution of income and thereby
serve the cause of fairness. If indexation of income
taxes and government obligations facilitates an effec­
tive check on “unauthorized” growth in the govern­
ment’s share of resources, its adoption would likely
lead to government policies which would moderate
the rate of inflation rather than exacerbate it. Infla­
tionary policies would indeed lose constituency since
the “honey” would have been sucked from such
But, surely, the above reasoning is incomplete. It
leaves unanswered the question of how and why the
shifting of the balance of political power, required
to introduce indexation, would occur. Indexation per
se would not cause the realignment. Rather, realign­
ment, should it occur, would be a reflection of the
“exogenous” shift in attitudes and distributions of ef­
fective political power.
We cannot, however, escape from our past nor re­
make the world anew at will by abolishing existing
monetary obligations and financial institutions. We
have an inherited stock of monetary contracts which
incorporate past expectations of the paths of price
level movements. Should the introduction of indexed
bonds cause the previously held price expectations to
change, a fortuitous change in the relative wealth of
sellers and holders of outstanding monetary contracts
would ensue. Specifically, should the anticipated ( and
experienced) rate of inflation fall as a consequence of
the introduction of indexed bonds, net monetary debt­
ors would lose wealth relative to net monetary credi­
tors; conversely, net creditors would lose wealth rela­
tive to net debtors in the case where indexation
induces a higher anticipated rate of inflation than was
formerly held.
We have a set of institutions operating under in­
herited legal and regulatory constraints which restrict
their range of asset and liability choices. Should in­
dexation be perceived as inimical to the vested in­
terests of certain groups, opposition to its adoption
would undoubtedly be mobilized in the absence of a
credible plan to “socialize” the total cost of transition.
Advocacy of indexation seldom is accompanied by
such a plan, and hence will be met by the organized
opposition of those who are likely to be hurt by its

F E D E R A L R E S E R V E B A N K O F ST. L O U I S



adoption. The opposition will not likely be assuaged
by a demonstration that indexation will serve the
general interest.

( 3 ) Indexation may, of course, be rejected even if
the balance of benefits over losses is shown to
be positive.

We can discern the following three possible de­
nouements for indexing government revenues and

As noted earlier, however, a partial indexation in
the sphere of private wage contracts and public pen­
sion contracts is with us already. The question of
removing the legal barriers to indexing private loan
and deposit contracts still remains. The recent proposal
by the Canadian government to “inflation-proof” its
income tax structure may be the wave of the future.
The overriding question, however, is the degree of
restraint that revenue indexation would impose on the
government’s demand for a greater share of scarce

(1 ) Indexation may be adopted over opposition
through the contest of relative political power.
( 2 ) Indexation may be adopted with the consent of
the former opposition when a credible plan to
com pensate the potential losers is appended as
a rider. Such a plan may include a guaranteed
purchase at par of existing mortgages held by
thrift institutions.

Grain Export Quotas: The Short View
and the Long

AIN export controls have been suggested as a
means of reducing the unfavorable impact on domes­
tic consumers of the relatively small feed grain crop
this year. The nation’s feed grain crop has been esti­
mated at 175 million tons, or 15 percent less than a
year ago, as a result of extremely dry weather.1 Pro­
duction this year plus an estimated carryover of 22
million tons totals 198 million tons available for domes­
tic use plus exports. This is 16 percent less than the
total last year. The quantity of wheat and other con­
centrates available for feed plus exports is no greater
than last year, thus there are no offsetting gains from
these feed sources.
Exports of feed grains have risen sharply in recent
years and accounted for 43.7 million tons or 20 percent
of total usage last year. Such exports were up 50 per­
cent from the 1972 level and 150 percent from 1971.
As a consequence of the sharp decline in the quan­
tity of feed grain available and the prospects for large
exports again this year, proposals have been made to
establish export quotas.2 Such quotas would limit ex­
ports to levels below those determined by market
forces and increase the quantity of grain available to
feed domestic animals. One writer argued that the
establishment of export quotas “offers the only way in
which the present food and feed situation can be
fairly dealt with. It amounts to protection, on a rea­
sonable basis, of the interests of the United States;
timely warning to foreign claimants; and the estab­
lishment of fair and equitable access for them to a
generous share of total U.S. supplies.”3
1Short tons (2,000 pounds) of com, sorgum grain, barley, and
2For example, see “Government Weighs Grain Export Curbs
. . .,” The W all Street Journal, 14 August 1974; “Midwest
Drought: Economic Time Bomb,” U.S. N ews and W orld
Report, 26 August 1974; “World Trade,” New York Journal
o f Com m erce, 22 August 1974; and “Butz Sees the Light,”
The Com m ercial A ppeal, 24 August 1974.
3J. Hans Richter-Allschaffer, “Farm Exports: Toward Timely
Controls,” New York Times, 4 September 1974, p. 38M.
Page 12

Grain export controls, as implied in the proposed
quotas, could serve the nation with tolerable satisfac­
tion in the short run. Such actions are simple and
direct, and thus tend to appeal to many people. Direct
export controls would have an early impact on the
domestic food supply. The nation possesses a given
amount of grain, and the less that is exported, the
greater would be the amount available for domestic
use. An increase in the quantity available for domestic
use would tend to lower domestic grain prices, in­
crease livestock feeding, and increase output of beef,
pork, poultry, milk, and eggs, thus reducing food costs.
Early results are assured in terms of smaller increases
in food costs to domestic consumers than would have
otherwise occurred, and this is the overriding factor
to the proponents of export quotas.

Quotas Might Reduce Returns to Producers
and Domestic Consumers
The early gains to consumers in terms of lower food
prices is not the whole story, however, even in the
short run. A decrease in feed grain exports resulting
from the imposition of quotas might have an un­
favorable impact on the incomes of grain producers
and on the prices of imports. Given a relatively fixed
quantity of grain following harvests, changes in the
market price until the next harvest year largely reflect
changes in demand conditions in the United States
and abroad. If exports were limited by quotas the
effective demand for U. S. grain would be less, and
domestic prices would be lower. If the effects of
lower domestic prices were not offset by higher re­
turns from exports, gross returns to grain producers
would decline.4
4Grain producer incomes could rise in the short run provided
an export quota system is applied to each producer and for­
eign demand for U.S. grain is inelastic — that is, low cost feed
grain substitutes are not available.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

At the same time, the imposition of quotas could
reduce the volume of imports available to domestic
consumers. A reduction in the amount of grain avail­
able in world markets would raise world grain prices.
Depending upon the availability of substitutes, total
expenditures on U. S. grain by foreign buyers might
either increase or decrease.
If relatively low-cost substitutes are available, then
the increase in grain prices would be relatively small
and would not offset the decrease in the quantity
sold; total expenditures by foreign buyers of U. S.
grain would decline. Any such reduction in total ex­
penditures by foreign purchasers of U. S. grain would
result in a decline in the demand for dollars and a
decrease in the international value of the dollar. This
would imply that the domestic price of our imports
would rise. Consequently, the imposition of quotas
would increase prices to U. S. consumers of imported
commodities and those commodities which use im­
ports as inputs to production. The gain to U. S. con­
sumers in terms of reduced food prices could then
very well be offset by an increase in the prices of other
commodities. In this case there is a loss sustained by
U. S. consumers and grain producers and a gain by
producers of other exports.
If low-cost substitutes are not available, however,
total expenditures by foreign grain purchasers would
increase. An increase in total foreign expenditures in
the United States would lead to a rise in the exchange
rate and thus a lowering of the domestic price of im­
ports and a rise in the foreign price of U. S. exports.
If substitutes are available for our other exports, then
U. S. exporters of these goods would incur losses. As
a result, domestic grain producers and domestic grain
consumers gain at the expense of other U. S. exporters
and foreign consumers.
Thus, consumers in the United States would stand
to gain in the short run from the controls only if de­
mand for grain in the world market were inelastic —
that is, if few grain substitutes were available and the
reduced quantity of grain were sold to foreign pur­
chasers for more dollars.
Another consideration in the imposition of quotas
is that they might induce retaliation. Suppose, for ex­
ample, that oil-producing nations decided to retaliate
by imposing quotas on their oil exports to the United
States. This would raise the domestic price of oil, and
again, U. S. consumers could be worse off than before.
The above analysis indicates that in the short run
the net effect of the quotas could be a decrease in
the quantity of imports and an increase in the quan­



tity of grain available to consumers in the United
States. One should be reminded, however, that if feed
grains were more valuable to domestic consumers than
the imports, the market itself would guarantee that no
grains would be exported. In other words, if domestic
consumers were willing to pay more for grain than for
products from abroad, grain producers would be able
to sell their grain for higher returns in the United
States than in the world market. In this context, in­
stead of purportedly increasing consumer well-being,
the imposition of export quotas, even for a period of
one year, would actually decrease well-being.

In contrast to the possibility of some short-run gains
to domestic consumers from grain export quotas, over
the longer run such quotas would be harmful to both
domestic and foreign consumers. Given time for retali­
atory policies and resource adjustments, export quotas
on grain would, in the long run, tend to: ( I ) reduce
grain exports; (2 ) reduce domestic grain production;
(3 ) decrease domestic farm incomes; (4 ) reduce the
overall quantity of goods and services produced,
thereby lowering the well-being of consumers in the
United States and the rest of the world; and (5) cause
further increases in domestic prices.

Reduces Grain Exports
In addition to their immediate impacts, export quo­
tas which limit the quantity of grain exported in the
current year would tend to reduce the value of
future grain exports. For example, if the United States
permits grain importing nations free access to our grain
markets only during years when production is equal
to or above the trend level, this nation would cease to
be a dependable source of grain supplies. Conse­
quently, those nations which have heretofore depended
on the United States for a portion of their grain would
likely take action to assure a relatively stable supply,
rather than depend on U. S. imports on an intermit­
tent basis. Food consumption habits develop over a
period of years and do not change readily for the
convenience of such on and off trade.
Grain importing nations could provide for alterna­
tive sources of grain supplies in several different ways.
They could increase their own production in the long
run because of the increase in the cost and unreli­
ability of U. S. grain. They might also negotiate
bilateral trade agreements with other grain producing
nations for a greater portion of their grain supply.
Such agreements might be accompanied by protective
Page 13

F E D E R A L R E S E R V E B A N K O F ST . L O U I S



tariffs and import restrictions applied during the years
that this nation had larger than average supplies, or
had surpluses if price supports were used to prevent
price declines. Either of the above routes to a more
dependable source would ultimately result in less U. S.
grain exports and a corresponding reduction in im­
ports of foreign goods and services.

ceived for grain combined with a reduction in grain
output would probably result in a sizable decline in
gross sales. Consequently, incomes to grain producers
and returns to their resources would decline.

Reduces U.S. Grain Production

In the discussion of the short-run effects of the im­
position of grain export quotas, the possibility of a
decline in the well-being of U.S. consumers was dis­
cussed. The possibility exists because of a potential
increase in the prices of imports. In the long run,
instead of just the possibility of a loss, the loss be­
comes a certainty. If quotas were effective, grain pro­
duction and grain exports would decline. In the short
run, domestic consumer gains or losses would depend
on whether foreigners could find substitutes for our
grain. In the long run, substitutes are always available
and the quotas would result in trade losses.

If the quotas were at all effective, they would re­
sult in lower domestic grain prices and, therefore, in
decreased production. Since farmers operate under
competitive conditions, they produce at the level
where the estimated cost of producing the last unit of
output is equal to the projected price. Production of
additional units entails higher per unit costs of pro­
duction, and a decrease in price caused by export
quotas implies that some of the output is being pro­
duced at a loss unless the producer anticipated the
lower prices at the time of planting. Consequently,
each farmer would reduce production and total grain
output would decline.
From the domestic consumers’ point of view, such a
decline in production is not objectionable. He would
get a somewhat larger quantity of grain at a mar­
ginally lower price than otherwise. Hence, the direct
burden of reduced U. S. grain output would be borne
by foreign consumers who receive less grain at higher
prices and domestic grain producers who would incur
capital losses as resources were transferred from the
production of grain to the production of other prod­
ucts. But, as will be seen later, there are secondary
effects which would work towards reducing the well­
being of U. S. consumers.
Another factor which tends to reduce production
under a quota regime is the greater price risks taken
by producers. Under export controls the price signals
received by producers reflect not only world supply
and demand conditions but also the uncertainty with
respect to the restrictions. The political forces which
determined the controls would be the result of com­
promises between feed grain producers, feed users,
and consumer groups. The result of such compromises
and their impact on prices is difficult to predict.
Hence, producers and farm credit suppliers would
have to make allowance for these additional risks in
their production and lending plans.

Reduces Farm Incomes
Farm incomes would be less under export quotas
than with free trade. The lower prices per unit re­
Page 14

Reduces Well-Being for U.S. and
World Consumers

The losses occur because in the long run our for­
eign currency earnings would decline and we would
be able to buy less foreign products, such as oil, sugar,
coffee, and raw materials for the manufacture of steel
and aluminum. Again, one could make an argument
that a decline in the domestic price of grain would
offset the increase in the price of oil and other im­
ported products, and that domestic consumers would
be as well off with the export quotas as prior to their
imposition. This reasoning, however, completely over­
looks the source of the foreign trade gains. Why, for
example, was the United States producing wheat in
the first place and exchanging it for oil rather than
producing all of the oil that the nation consumed? The
simple answer is that by producing wheat and trading
it for oil we gained wealth. That is, the process used
up less of our resources than if we had taken resources
used in the production of wheat and used them to
increase the production of oil. Through trade we
have obtained more oil and more wheat than we could
acquire by attempting to become self sufficient in the
production of both wheat and oil.
This is the fundamental reason for all specialization
and for all trade, domestic and international. Individ­
uals, as well as countries, have different natural and
technological endowments, and by specializing in the
production of some goods and services and exchanging
them for others, they can increase the total amount of
all products that are available for consumption.
Despite the artificial quadrupling of oil prices by
the oil producers’ cartel, it may still be cheaper to ex­

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

change grain for oil than to produce additional quan­
tities of oil domestically. An imposition of quotas
would shift our resources from the production of grain
to the production of oil and we would thus forego the
savings accrued from exchange. The opposite shift
would take place in foreign countries. As a result, all
consumers, both domestic and foreign, would be worse
o ff.

Thus, what appears to many people as a reduction
in food prices and an increase in the welfare of U. S.
consumers from the establishment of grain export
quotas, actually becomes a net loss. This country has
opposed the imposition of artificial restrictions on oil
output by the oil-producing countries. It is argued
that such restrictions could cause a worldwide decline
in the standard of living. Yet, some analysts are pro­
posing that the United States practice the same tac­
tics and the same consequences would likely be in

Increases Domestic Prices
Grain export controls over the long run would tend
to cause the domestic price level to be higher than
would have prevailed without the controls. To the ex­
tent that the controls reduced international speciali­
zation of production and exchange of goods, they
would reduce the total quantity of goods available to
consumers in both the United States and foreign coun­
tries. This reduction in supply, assuming no offsetting
change in the rate of monetary growth, would cause
higher prices. Thus, instead of contributing to a lower
rate of inflation, as contended by some of the pro­
ponents, export controls would actually cause further
price increases.



The quantity of feed grain available for domestic
use plus exports is down this year from the level of a
year ago. The decline will tend to reduce livestock
feeding and cause higher food prices.
Proposals have been made to limit feed grain ex­
ports through export quotas to avoid the upward
pressure on food prices from the reduced grain sup­
plies. This proposed solution is simple and direct, and
may appeal to many people. However, such quotas
could actually reduce the economic well-being of the
nation in the short run and would certainly reduce
well-being over a longer period.
In the short run domestic food prices would be
lower with the quotas than without them. However,
depending on whether or not there are substitutes for
U. S. grain in foreign markets, the prices of U. S. im­
ports could rise significantly. As a result, U. S. con­
sumers could end up with more grain and fewer
imports than they would have in a free exchange sys­
tem. In such a situation, both this nation and grain
importing nations would lose as a result of the quotas.
In addition, the quotas might trigger some harmful
retaliatory measures by foreign nations, such as the
actions of the oil cartel last year.
Over the longer run, export quotas would be even
more damaging than in the short run. In the long run
they inhibit domestic grain production and reduce
domestic farm incomes. But of greater importance,
they reduce the long-run gains from international
specialization, thereby greatly reducing the overall
output of goods and services, the well-being of con­
sumers, and cause further price increases in both this
nation and abroad.

Page 15