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LIVING WITH INFLATION An Address to the Rotary Club West P oint, Georgia September 12, 1974 by Monroe Kimbrel, President Federal Reserve Bank o f Atlanta LIVING WITH INFLATION You heard that the t i t l e o f my ta lk is "L iving with I n f la t i o n ." But before I get in to that t o p ic , I want to say ju s t a few words about the broader economic clim ate in which we find ourselves today. People in Washington and elsewhere are s t i l l debating whether we are in a re ce s sio n . Those who say, "Y e s," allude to back-to-back d eclin es in G P adjusted fo r p rice changes; those who say we are not in a re ce ssio n N f e e l the d e clin e s are too small to be s ig n ific a n t . As important as that question i s , I b e lie v e the more important ques tio n is whether the economy w il l s lid e o f f fu rth er, head upward, or ju st keep rocking along on a plateau. From what I can t e l l , the economy is more or less holding it s own, and there is l i t t l e evidence that anything w i l l rep la ce th is economic sluggishness very soon. Many people are concerned about the economy's performance, and rig h tly so. But the p u b lic 's main economic concern, according to a Gallup p o ll, is s t i l l in fla t io n . I t was not too many years ago when some o f us shuddered when we heard mention that a 1- or 2-percent r is e in p rice s was in e v ita b le and harmless to b oot. Contrast th is with la st y e a r 's 9-percent increase in consumer p rice s in th is country, the worst in fla t io n sin ce 1951. P a rticu la rly d is tre s s in g is that p rice s keep clim bing at an alarming ra te . The in fla t io n rate h it a d o u b le -d ig it 14-percent fig u re in th is y e a r 's f i r s t quarter and was s t i l l a thumping 9 percent in the second One. What some o f us have long suspected has become abundantly c le a r : No matter how much we f r e t , the problem o f in fla t io n simply is not going away. I fin d several aspects about th is problem e s p e c ia lly d istu rb in g . I t used to be that p rices would r is e ra p id ly only a fte r wars. But we cannot -2 - say that any more. h a lf ago. The tra g ic war in Southeast Asia ended a year and a Our country is at comparative peace; yet in fla t io n remains rampant. For years, we used to say: "Sure, we have in fla t io n but look how much milder ours is compared to the re s t o f the w o r ld ." But now we cannot take com fort in the thought we are not as bad o f f as everybody e ls e . The i n f l a tio n in th is country is as serious, or almost as se rio u s, as that o f most major in d u stria l co u n trie s. This change is important, not ju st fo r our own sake but, because i f i t contin ues, foreig n ers w i l l buy. less American products. That would hurt our economy as w ell as our balance of payments. The g a llop in g p rice trend in th is country has it s seeds in the Vietnam War, when we tr ie d to have guns without givin g up b u tte r. Before the Vietnam buildup, th is country a ctu a lly enjoyed a period o f p rice s t a b ilit y that many o f us have fo rg o tte n . For s ix yea rs--from 1958 to 1964--the Consumer P rice Index rose only 1 percent per year. Vietnam. Then came our involvement in The Government stepped up it s spending on d efense, while consumers and businessmen continued to spend at rates fa s te r than the economy could su stain . The r e s u lt was the sta rt o f an in fla tio n a r y clim ate that except fo r temporary successes has never been broken. Instead o f mounting an attack when th is problem surfaced, the Federal government delayed and v a c illa t e d . a temporary b a s is . down spending. I t fa ile d to increase taxes except on And, perhaps even more s ig n ific a n t ly , i t fa ile d to hold A ll of th is produced horrendous Federal d e f i c i t s that added to our in fla t io n . In f a c t , only once sin ce 1964 has the Federal budget been in surplus; and fo r the la s t four years, i t has been in the red to the tune o f $65 b i l l i o n . -3- I b e lie v e that the unw illingness o f businessmen and consumers to reduce th e ir spending during the Vietnam c o n f l i c t and in s u ffic ie n t f i s c a l re stra in t during and a fte r bear much o f the blame. only causes o f in fla t io n . But these are by no means the For example, some persons say that p rice s would have increased le ss i f the Federal Reserve had follow ed greater r e s t r a in t. In r e tro s p e ct, th is is probably tru e, though in the main the in fla t io n r e sulted from a se rie s of d istre ssin g developments. Who e lse is to blame? was an important fa c t o r . That wages went up fa ste r than p ro d u ctiv ity Another was the devaluation o f the d o lla r . While a necessary step , i t had the e f f e c t o f making American products too a ttra ctiv e in world markets. Acting as a stimulant to U. S. ex p orts, i t cut in to domestic su p p lie s, notably food , and in th is way p ropelled U. S. p rices upward. Along with these developments, we have experienced shortages. It used to be that you could buy almost anything you wanted as long as you could pay fo r i t . But th is has not been the case fo r some time now. It is true that ga solin e is no longer sca rce ; but s t e e l, c o a l, ce rta in kinds o f paper, and many other products are s t i l l in short supply. Booming w orld wide demand fo r many commodities and the embargo, in the case o f g a so lin e , are to blame in p art. To these events can be added the co n tro ls on p rice s and p r o fit margins that discouraged investment in some b a sic in d u strie s. Environmental co n tro ls further com plicated the s itu a tio n . A ll o f these fa cto rs generated shortages; and, o f cou rse, shortages give r is e to higher p r ic e s . The point o f th is r e c it a t io n o f reasons fo r the in fla t io n is to suggest that there has been no one v i l l a i n , but a great many. Indeed, I b e lie v e -4 - that those who blame the high prices on a single factor oversimplify a problem that reminds one of the many-headed Hydra. Nor has the problem been m ostly one o f soaring food and fu e l p r ic e s . True, higher energy and food p rice s were resp on sible fo r 60 percent o f la s t y e a r 's consumer p rice r is e . However, the major impact is now coming from other commodities and from se rv ice s which have racked up very rapid p rice increases th is year. There is c e rta in ly no sign yet o f any marked slowing in in fla t io n . On the con trary, the recent big jump in farm p rice s that follow ed e a r lie r d eclin es could make lia r s o f those p re d ictin g the worst on the in fla t io n fron t is over. And as I look more deeply at the p rosp ects, I am p a r tic u la rly disturbed at the emerging pattern o f wage in crea ses. Wage gains fo r con tra cts that include cost o f liv in g adjustments have averaged out a b it more than 10 percent thus fa r th is year. R ising wages have long put upward pressures on co sts and, hence, on p r ic e s . Quite fo rtu n a te ly , 1973 proved to be an ex cep tion . ra tes la s t year rose much less than p r ic e s . In f a c t , wage I t i s , th e re fo re , understand able that workers are demanding greater pay ra ise s th is year. What concerns me about these ra ise s is th a t, unless p r o f it margins get pinched, the in crease in labor co sts is passed along in higher p r ic e s . I express th is concern about soaring wage hikes not because I am o b liv io u s to the fa c t th a t, taking account o f the r is e in p rice s and taxes, the takehome pay o f fa cto ry workers has declin ed by about 5 percent th is past year. That is a dramatic drop in purchasing power and in economic well-being and underscores the tragedy of inflation. -5- Workers, o f course, have not been the only group fe e lin g the pinch. Savers, r e t ir e e s , and others have a l l paid d early . Check with them about what they have lo s t , not only in terms o f income, but in savings, fin a n c ia l a sse ts, and--not the le a st--p e a ce o f mind. The consequences o f in fla t io n do not stop th ere. opinion has accepted i t as a tra n sito ry m isfortune. In the p ast, m ajority When p rice s rose ra p id ly , most Americans would cut down on th e ir spending, trim th e ir s a i l , and try rid in g i t out. But when people think in fla t io n has become a permanent way o f l i f e , they begin to rea ct d if f e r e n t ly . Expecting p rice s to go ever upward, they throw caution to the wind and rush to buy products before p rices go up even fu rth er. Such a rush to buy can compound an in fla t io n , while the expectations o f s t i l l more in fla t io n w i l l eventually discourage people from saving. an environment. Home con stru ction would not fin d financing in such State and lo c a l governments, co rp o ra tio n s, and other borrowers would not be able to finance th e ir needs. Economic growth would be sev erely c u r t a ile d . The impact o f ra p id ly r is in g p rice s would f a l l h ea v ily on the low and middle income groups. than our income. The co st o f everything we buy would go up fa ste r Everyone, fo r example, would lo se i f things d eteriora ted to what Germany, fo r example, experienced during the h y p e rin fla tio n o f the m id-1920s. In c it in g these dangers, I do not wish to leave you with the impression that th is country is about to experience a su p e rin fla tio n or even a Latin American type, where p rice s increase in double d ig it s each year. wish to r e it e r a t e the dangers. I simply These are e s p e c ia lly relevant to us today, not only because p rice s in th is country have been in creasin g at a fa ste r than 10-percent rate but because the longer an in fla t io n is allowed to e x is t , -6- the more i t becomes entrenched. harder i t is to e ra d ica te . And the more entrenched i t becomes, the In f a c t , even in re ce s sio n s, when one might expect reduced demand to bring about lower p r ic e s , p rice s ra re ly f a l l because our economy is not highly com petitive as i t once was. The record shows that only in those se cto rs where com petition is strong are p rice reductions during recession s commonplace. This brings me to an issue that has received increasing d iscu ssio n . This is the view that in fla t io n is in e v ita b le and the further view, some times given in the same breath, that we should begin to liv e with i t . P rofessor M ilton Friedman, fo r example, has stated that we ought to sta rt a process by which we reg u la rly compensate fo r in fla t io n . advocated is a broad system o f indexing. What he has Under indexing, the value o f assets (wages, re n ts, and so fo rth ) are adjusted fo r p rice in crea ses. You can fin d examples o f indexing or e sca la to r clauses in recent aluminum, s t e e l, and can workers' co n tra cts, where wages are adjusted autom atically fo r increases in the Consumer P rice Index. B ra zil uses th is d evice e x te n siv e ly . Not only are workers compensated fo r th eir loss o f purchasing power, but B ra zilia n banks and savings in s t it u tion s w il l a l l c o rr e ct accounts with an amount equal to the rate o f in fla t io n . Loans, mortgages, bonds, personal tax exemptions, and tax brackets are s im ila rly adjusted fo r higher p r ic e s . H ailing the success B razilian s have had in trimming th e ir p rice in crea ses, which in c id e n ta lly are s t i l l much greater than ours, P rofessor Friedman and others b e lie v e the U. S. economy should copy B ra zil and have indexes fo r wages, in te re s t payments, fin a n c ia l a sse ts, business accounting p r a c tic e s , taxes, le g a l o b lig a tio n s , and other con tra cts as a form o f coping with in fla t io n . -7- Now, one need not b e l i t t l e Dr. Friedman's co n trib u tio n to conclude that when i t comes to his view on across-th e-b oa rd indexing he is a b solu tely wrong--wrong, indeed, on several counts. F ir s t, on a s t r i c t l y tech n ica l le v e l, there is nothing magical about indexing. Right now, fo r example, there is a heated dispute going on over the way the o f f i c i a l p rice indexes in th is country are con stru cted. are enormous. The te ch n ica l d i f f i c u l t i e s o f indexing Secondly, even i f p e rfe ct p rice indexes could be developed, some groups are bound to come o f f second best in the co r r e c tio n p rocess. T hirdly, some things are im possible to index. fo r money. That is e s p e c ia lly true Can you imagine anyone wanting to hold money in an economy where most everything is indexed? I cannot. Indexing, to my way o f thinking, is not what i t is cracked up to be. On the con trary, i t has serious shortcomings. Indexing could give momentum to a s t i l l fa s te r p rice s p ir a l as people become convinced there is no longer a need to fig h t in fla t io n . The more people learn to liv e with in fla t io n , the less reason they have to take action s co rr e ctin g i t . To suggest that indexing is a way o f liv in g with in fla t io n means throw ing in the tow el, and to some o f us old -fash ion ed people i t is almost unthink able that our country would be part o f accepting in fla t io n as a permanent way o f l i f e . I t seems to me that there should be enough statesmanship and common sense to deal with i t d ir e c t ly and fo r t h r ig h tly . How then can the in fla t io n be countered? From what I have said b e fo re , i t should be cle a r that the economy has been on an in fla tio n a ry bent fo r a long time and fo r a great many reasons. T herefore, I b e lie v e i t w ill take not one but many d iffe r e n t a ctio n s, ranging from greater production to greater leadership. -8- Such an attack must ce rta in ly include f i s c a l and monetary r e s t r a in t. This, in turn, requires statesmanship not only by the Federal Reserve but a lso by the Adm inistration and the Congress and the necessary fo rtitu d e to act in ways they know w il l re stra in p rice pressures. R estraint--w hether f i s c a l , monetary, or any other k in d --is unfortunately never p a in le ss. Can i t be achieved without some adverse e f f e c t on jo b s , on housing, or on other economic programs? The answer most experts would give to th is question i s , o f cou rse, "N o." F is c a l and monetary re s tra in t i s , th e re fo re , often unpopular and requires support from key business leaders and opinion molders such as you. On the other hand, what ch oice is there? is never easy. There w il l be rough days ahead. A fter a l l , b a ttlin g in fla t io n But i f we continue to accept in fla t io n at recent ra te s, we w il l pay a far greater p rice in the long run than i f we accept some d is lo c a tio n s tem porarily. I b e lie v e the way to deal with in fla t io n is to fig h t i t , not to liv e with i t .
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