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INFLATION POLICY IN 1979
I have enthusiastically supported the President's decision to inaugurate an active program to seek the adherence of labor and business to a set of quite specific guidelines limiting wage and price increases. On every appropriate occasion since 1958 I have strongly advocated that such a program be used against the increasingly familiar inflationary problem that arises not from an excessive demand for goods and services but from the interaction between wages and prices described as the "wage-price spiral.” Such a spiral may be initialed during a period of excessive demand; but the spiral may continue to turn long after excessive demand has disappeared.
A wage-price spiral can also be initiated-or its speed may be increased as the result of significant exogenous cost or price increases originating at home or abroad. Such exogenous cost increases include a one-time increase in rates of domestic excise or payroll taxation, an unexpected deterioration in the growth rate of productivity, a large increase in the minimum wage, newly imposed regulatory costs, an increase in farm price supports, a sharp increase in prices of imported products, new measures of protection from foreign competition, and many other events. Even though such events, in principle, have a one-time impact on one sector of the economy-raising particular costs and prices only once—the unwillingness of most of us to accept any reduction in the past or expected rates of growth of our own real incomes as the result of these events embeds their one-time impact into a continuing spiral of costs and prices.
By itself, such a spiral does not necessarily reduce real incomes—beyond the initial reduction or transfer which provided the impulse. But to attempt to stop the spiral by measures affecting only some of the participants in the spiral can impose severe burdens. I find the words of a New York Times editorial of January 24 most appropriate: “Inflation is an un-merry-go-round-a circular ride that brings neither business nor labor any closer to the brass ring, but promises a hard fall for the first to get off.” The guideline program proposes to have all parties participate more or less simultaneously in slowing down the spiral. Labor's smaller wage increases will be matched by a declining rate of price increase-a decline in turn made possible by the slowing down of the increase in labor costs, and, through the participation of other businesses, by a slowing of the increase in costs of purchased materials and services.
To be sure, workers still covered by previously determined wage scales will not participate in the slowdown until these previous determinations expire; consequently, some firms' and industries' wage cost increases do not slow down at once. This means that there is some bump for those that first step down. In a sense, the Times editorial was correct in suggesting that the Administration is asking labor to jump off first, and in describing the proposed "wage insurance" as a “cushion" for workers to land on.
I don't think that success of the wage-price restraint program necessarily depends on the adoption of the wage-insurance scheme; and I have myself been skeptical about our ability to solve some of the administrative problems that such a scheme presents. But I strongly urge that the Congress make a genuine and sympathetic attempt to enact even an imperfect scheme, which will give some assurance to unions that might be willing to cooperate with the program that the cost will not be too great.
INFLATION IN PERSPECTIVE
It is important for all of us to maintain some perspective about our inflationary problem-as serious as it truly is. One dimension of this perspective is a temporal one. Table III shows that the average annual rate of inflation in the United States during the period 1965–1978 has been less than in any of our previous four periods of inflation, whether measured by consumer or by wholesale prices. However, because inflation has persisted longer this time, the cumulative extent of inflation during this period has been of roughly similar magnitude as during previous bouts with inflation. (The other difference from earlier times is that, since World War II, inflationary episodes have not alternated with periods of deflation-falling pricesthe economic costs of which are fully comparable with the costs of inflation.)
Inflation is not a new problem. Nor is it confined to the United States. Table IV shows recent inflation rates in the twelve largest free-market industrial countries, for various periods since 1955. The numbers underlined are those rates lower than ours. Only Germany has had consistently lower inflation rates than ours, joined by Switzerland some of the time.
Over the entire period 1955–1977, the German average rate was 3.4 percent, the Swiss 3.6 percent, the American 3.8 percent. Looking only at the second half of
this period—since 1965—we are still consistently outperformed only by Germany. Of course, if one goes farther back than 1955, our record of price stability far exceeds any other.
One reason why Germany and Switzerland have better recent price records than ours is well known. In each of these countries, recent economic policy has either been far less concerned than ours has been with growth in real output and employment, or else has been less effective in promoting such growth. As Table V shows, both over the whole period since 1973, and even into 1978, Germany and Switzerland have not come close to realizing their growth potential, which substantially exceeds the growth rates shown for their real GNP and industrial production. This is true of Japan, as well, although its consumer-price record during each of the periods since 1965 is considerably worse than ours. Output and employment have grown considerably faster in the United States than in Germany or Switzerland, although U.S. output has not maintained pace with potential, either, at least over the period since 1973 taken as a whole. However, during each of the last three years, we have been recovering ground lost in the great recession of 1974–75, while Germany and Switzerland apparently continue to fall further behind potential.
Economic welfare surely includes the growth of per capita production and real incomes and the minimization of involuntary idleness, as much as it also includes the avoidance or minimization of inflation. That, too, may be a relevant perspective from which one should evaluate the recent U.S. inflation record.
TABLE 1.-GOVERNMENT DEFICITS IN PRINCIPAL OECD COUNTRIES AS PERCENTAGE OF GNP (OR GDP)
1 Data for 1978 and 1979 are OECD estimates.
Source: Adapted from table 11 in "OECD Economic Outlook," December 1978, p. 18. In the original, the title is "General government net lending on an SNA basis, 1975-1979: percentage of nominal GNP/GDP," and the signs are all minus. "General government'' means excluding the operations of "government enterprises" (e.g., nationalized industries). SNA means OECD "standardized national accounts"; GDP is gross domestic product (which differs insignificantly from GNP). Since the table compares data for federal countries (e.g., U.S.) with those for highly centralized governments (e.. Japan or France), data for all units of government are consolidated in each country.
(billions of dollars)
year) (1972=100) (billions of 1972 dollars)
1972 to 1975. 1975 to 1978. 1972 to 1978.
1, 171. 1
1, 171.1 1, 235.0 1,217.8 1, 202.3 1,271.0 1, 332.7 1, 385. 1
4. 96 6.91 5.93
9. 29 11. 28 10. 28
4. 11 4.08 4. 10
8. 34 6. 15 7.24
88 4.83 2. 84
All data in columns (2), (4), and (6) are annual totals; data in column (1) are monthly averages for December of year shown. 2 "Velocity of M,"is GNP divided by M1 I "Real Mi" is M divided by GNP deflator.
Source: ''Economic Indicators," December 1978, for data through 1977. Estimate of M, for December 1978 is average of published preliminary figures for 4 weeks in December. Data for 1978 for GNP, GNP deflator, and real GNP reflect prelimiiary fourth quarter estimates.
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TABLE III.-U.S. PRICE LEVEL CHANGES DURING AND BETWEEN PERIODS OF INFLATION, 1861-1978
1 Producer finished goods prices.
Source: U.S. Department of Commerce, "Historical Statistics of the United States: Colonial Times to 1970," Washington, D.C., 1975, pt. 1, pp. 199–201, 210-211; and "'Economic Report of the President," transmitted to the Congress January 1979.
TABLE IV-RECENT INFLATION RATES IN PRINCIPAL OECD INDUSTRIAL COUNTRIES
1 Spain is not included, although its GNP exceeds that of Sweden, Belgium, and Switzerland.
? Estimates by author based on partial data; for Australia through Switzerland, estimates by OECD (see OECD "Economic Outlook," December 1978, pp. 107-10).
3 Percentages are those lower than for the United States.
TABLE V.-ANNUAL GROWTH RATES OF EMPLOYMENT, INDUSTRIAL PRODUCTION AND REAL GNP: UNITED
STATES, GERMANY, AND SWITZERLAND, 1973–78
Real GNP growth rate:
1973 to 1977.
1977 to 1978 Industrial production growth rate:
1973 to 1977.
1977 to 1978. Employment growth rate:
1973 to 1977 1977 to 1978.
I 1977-78 data for Germany and Switzerland are OECD estimates; see "OECD Economic Outlook," December 1978. pp. 1, 3, 14, 81, and 110. '? OECD estimate for 1974-78, ibid., p. 14. 3 Not available.
The following letter was drafted by Professor Gardner Ackley of the University of Michigan and signed by over 500 professional economists.
ECONOMISTS' OPEN LETTER OPPOSING A CONSTITUTIONAL PROHIBITION
OF DEFICITS IN THE FEDERAL BUDGET
Proposals have been made to amend the Constitution of the United States to prohibit a Federal deficit in any fiscal year. As professional economists, the undersigned believe that such an amendment would be unwise, and even dangerous, for reasons given below. Not all of us are equally impressed by all of these reasons;
some have still other reasons for opposing the amendment. But for one or more of the following reasons, each of us believes that such an amendment is not in the national interest.
1. Given the existence or the clear threat of a severe economic disturbance, the potection of the jobs and incomes of large segments of the population may well require incurring a deficit. Most proposed amendments permit an exception in the event of a declared war; and provide that, in other "national-emergency" circumstances, the prohibition could be suspended by a two-thirds or three-fourths vote of each house of Congress. However, this means that (one-third or one-fourth) of the members in either House could veto an action vital to the economic, social, and political health of the society.
2. Whether a given expenditure plan and set of tax rates will, in fact, eventuate in deficit or surplus often cannot be determined in advance. A budget plan which in good faith predicts balance or surplus can fail to be realized if an unexpected weakening of private demand causes taxable incomes to decline, and increased unemployment causes Unemployment Insurance and similar payments to increase. Conformity to the amendment would thus require frequent unsystematic and inefficient revisions of tax rates and/or of more readily controllable expenditure programs.
3. Moreover, there will be times when the adjustment of tax rates and/or of expenditures necessary to assure budget balance could have truly disastrous economic effects. During the great Depression of the 1930's, and during each of the six recessions since WWII, Federal revenues have automatically declined, and expenditures have automatically increased, with no change in tax rates or spending programs. Under these circumstances, the deliberate expenditure cuts or tax increases necessary to balance the budget would further seriously depress an already weak economy.
4. Many governments whose constitutions prohibit deficits nevertheless frequently incur deficits based on current United States definitions. Thus, to be meaningful, the amendment needs to define a “deficit” as the difference between precisely defined "expenditures” and “revenues.” The definition of each of these terms in the official financial accounts of the United States has changed several times in the past 50 years. It might well become apparent that the definitions written into the Constitution had become inappropriate, requiring further constitutional amendment to correct them. We doubt that such technical matters belong in our Constitution.
5. In case of war or other serious national security emergency, a prohibition of deficits could make it impossible to protect the national interest, despite the exceptions permitted by most proposals. A national-security emergency does not always involve a declared war; and a threat to national security may not always be so obvious that three-fourths (or two-thirds) of the members of both Houses will perceive it. Moreover, in a situation of potential danger, the acknowledgment of an emergency by so public and explicit an action might be highly inappropriate or dangerous, and so could be the defeat of such a resolution.
6. Almost all of us agree that deficits have sometimes—perhaps even often—been incurred unwisely, at the wrong times, and with significant damage to the national interest. However, we do not believe that wise policy on so complex a matter, with such far-reaching implications, can be written into the Constitution. The people of the United States have other and better means available to improve the wisdom of national policy: by electing national officials who are competent, responsible, and responsive to the will of the electorate.
(The undersigned are professional economists engaged in research, teaching, consulting, or staff capacities. We sign this statement as individuals, and our institutional affiliation is provided only for purposes of identification, with no implication that we represent views other than our own.)