Discussion on Inflation
In the past 10—15 years there has been a rather spectacular increase in Hungarian agricultural productivity due to a modest but steady increase in agricultural production combined with a rapid decrease in the agricultural labor force. This again was due partly to demographic factors and partly to internal migration. Since agricultural cooperatives have direct access to the cooperatives’ income, the real income in Hungarian villages went up much faster than the real income of city dwellers and of industrial workers. This created a social pressure which became intolerable. You might say that it was a mistake to tolerate such an unbalanced growth of incomes. In 1973, it was decided to carry through a onetime 8% wage increase for industrial workers. Now, regardless of whether it is done in this discrete way, or whether wage gaps are controlled in a continuous way, it is clear that a discrepancy between large variations in rates of change of productivity and small tolerable variations in rates of growth of real income and wages, require changes in relative prices. This means that all those activities where productivity is not increasing so fast are becoming relatively more expensive, while those activities where productivity grows faster (such as mass-production of industrial goods) become relatively less and less expensive. In a centrally planned economy with fixed prices, it is possible to maintain a stable price level and even fixed relative prices in spite of changes in costs and tastes. It may be possible to do it by redistributing profits among the sectors and enterprises. But such a policy would require ever growing state subsidies which would have to be drawn from the state budget. This is actually the practice of some Eastern European countries.
They are able to maintain amazingly stable prices, hut the price to pay for this stability is, of course, an increasingly distorted relative price system, which misguides both enterprises and households in their production and consumption decisions. If you do not want your relative prices to he completely distorted, you must, of course, correct them. For some mysterious reasons these price corrections can almost never be made by raising some prices and lowering others. Prices can move only upwards, although there are exceptions. From time to time the prices of new products which are being mass-produced can he reduced. However, on the average, it is usually true that relative prices can he corrected only by upward movements. This is the point where the price setting mechanism comes in. What is it in the price setting mechanism that prevents prices form going down? Maybe it is because money does not seem to he a commodity anymore. This fact seems to allow monopolistic producers to maintain their prices. It is not absolutely necessary to raise the prices of mass-produced, highly productive goods. It is enough not to let them fall, because keeping them stable means that the prices of products in those industries where productivity grows slowly will increase more rapidly. This is enough to produce an increase in the average price level. The nature of contemporary inflation results from the fact the that producers do not seem to be forced to reduce the prices of those products which have become relatively cheaper. Let me add that at least in Hungary the critical point seems to be in investment rather than consumer goods. The building industry is one of the worst price pushers. Perhaps because in the building industry each product is unique, while in consumer goods industries. mass-production and homogeneity of products are more prevalent. and this allows for easier control.
I think that Manove’s paper begins the search for the cause of inflation at the right places, namely, at labor productivity and at the price setting mechanism. To make the picture more realistic the structure of the economy and foreign trade should also be brought into the picture.
I would like to put both Clower’s and my paper in a more general framework. I think there are two underlying theories of inflation that we are talking about here. One theory is the monetary theory which claims that inflation is caused by the printing press turning too fast. The other theory is what I would call the piggy, or the swine theory of inflation and it goes something like this: somehow in the realm of the productive process, various producers are able to create obligations to themselves that add up to more than the total amount which they produce. It is in this income-generating stage that the groundwork for inflation is set up: these obligations add up to more than what is going to be produced. What is going to happen? Either the monetary authorities can let the obligations be paid out in liquid terms and stop the inflation right there, or the monetary authorities can let the obligations be paid out in liquid terms and let inflation automatically reduce the claims back to fit the total size of the pie.
I contend that generally the monetary authorities will be passive. They wont prevent inflation by controlling the money supply. but rather, they respond to the original forces that created the excess obligations in a passive way be meeting the demand for liquidity. For the simple reason that vested interests will be successful — in whatever system you are talking about — in forcing the monetary authority to create the liquidity to pay these obligations. Saying that printing too much money causes inflation is like saying that birth causes death. I think that it is a necessary condition. but not at all a cause. In my paper I tried to explain how the obligations that add up to more than the size of the pie are created. My view was that the government in a socialist economy tries to give labor a certain income and that the monopolistic producers try to get their share by raising prices. The payments to labor on the one hand and the retention of profits on the other, add up to more than one. That is the underlying mechanism of inflation.
Obviously. I’m not a believer in the swine-theory of inflation, but I don’t think swine behave in accordance with exogenously given rules. If they don’t get enough swill they will behave in a different way than in the case when they do get enough swill. I am merely suggesting that the monetary authority provides the swill. That does not happen in a commodity money economy. Commonly we hear about the great depression, but that was a great deflation — not a great depression. In a commodity economy there should not appear any great depressions. Historically this was true except for the period of about five years in the 1870's. I quite agree that there are no particular costs to steady inflation but steady inflation is more difficult to maintain. To try to track a 10% rate of inflation is far more difficult than to track a zero rate with plus and minus deviations, because of the problem of maintaining some kind of correction with the past. Also the trend on prices, if there are no provisions for revising future contracts, creates problems. With small variations about a zero trend, it is possible for people to say that they gained on the upward movement and lost on the downswing. But that is not going to happen when you are on an exponential trend. If you are really on an exponential trend, then the fluctuations are not offset and all kinds of new industries that are concerned with beating the game will emerge, which does involve real social costs. What you get, effectively, are non-productive activities aimed clearly at taking advantage of government attempts to control excessive swings in inflation. You can see that particularly clearly in the case of the price control mechanism which has been introduced in the U.S. in recent years. We have whole industries concerned with researching recent government rules and regulations, in order to figure ways to make a million by knowing more about how to beat the regulations. This is the danger. In theoretical models, you can always invent systems where people, through various forms of indexing and the like, simply ignore the costs. But in a real economy it is not so simple. Obviously, for the economy as a whole, inflation is purely redistributional and it does not involve real costs, unless the inflationary process somewhat interferes with the productive mechanism. My suggestion is that varying rates of inflation do significantly interfere with the adjustment mechanism. My colleague Leijonhufvud has an interesting paper elaborating upon this theme at great length. What happens is that all kinds of social groups develop the feeling that they are being mistreated by the economic system and they look to the political authorities for salvation. Each person who feels that he has been mistreated by changes in prices will go to the government to get his case heard. The next thing we see is government interfering here, interfering there, trying to protect this group against that. etc. Pretty soon the trade intermediaries. who are mainly business firms or producers. can no longer calculate with any certainty what is going to happen within the economy’s framework, because there are no rules. It is like trying to play chess with people who want to take your queen by changing the rules. You cannot live in that sort of a world without feeling certain injustices. This is where the real costs appear — they are social as well as economic. If we are going to talk about economics, however. I think we should be very straight. There is no way in which you can change the behavior of the economy suddenly without causing certain consequences. No large scale shocks to the economy, such as a sudden change in the rate of increase of the quantity of money, or a change of the amount of defense or welfare expenditures, can possibly be absorbed without a certain impact upon other parts of the economy. This had already been recognized by Ricardo in his Principles, where he discusses, rather intelligently, the sudden changes in the terms of trade, and the effects of a sudden transition from peace to war, or from war to peace. There is no way of making these transitions without heavy costs.
My comments about unemployment were directed to those people who say that there are no costs in terms of inflation too high to pay to avoid a small increase in the level of unemployment. My proposition would be that we are going to have high unemployment figures whatever the rate of inflation is, as long as it is unstable. So it is false to say that we should not attempt to cure inflation without first curing unemployment. We are going to have unemployment anyhow. This is partly because of stop-go activities. There is no way of avoiding that in an unstable system where people feel mistreated by the government. Political action then begins to dominate the control of money supply. In western countries, and I suspect to some extent in the socialist economies also, we have slipped without knowing it into the real bills world where the quantity of money does not matter, because we do not really know what it is (the Radcliffe report etc.), and what really counts are the overall credit conditions. If we slip into that kind of thing and the monetary authorities say to themselves: we cannot really fix the cash base, then there is no fixed rule for the control of the supply of money. Such a rule, of course, existed under a commodity money system, or under the gold standard and fixed exchange rate systems. We should come back to the position that Keynes reached in his Tract on Monetary Reform (1924)— namely that the price level as a policy instrument must be of major concern to us, and that someone has to reassume the responsibility for holding the monetary base down. Everything else will adjust to that, given enough time. But we cannot follow the Friedman rule of looking at M1, M2, M3. etc.; we have got to pin down exactly what it is we think are the immediate means of payment in the economy and keep them separate from the means of settlement. It is the gap between means of settlement and means of payment that causes liquidity crises. I merely suggest that responsibility has to be focused here. Then you can argue about whether or not certain groups in the economy. such as labor unions. refuse to accept that responsibility. Obviously, political factors are ultimately going to dominate, but it will be a disaster if we don’t recognize what the crux of the matter is.
At first glance Manove seems to be supported by empirical data. In socialist countries wages increase in the long run at a lower rate than labor productivity, and there is almost no inflation. In western countries wages increase at the same rate as labor productivity and we see inflation. But the tendency of wages to grow as fast as productivity can be observed over the last 20 years, and we have had high inflation only in the last five years. Maybe this is due to changed behavior of enterprise owners. Considering the experience of past Keynesian policies of governments, they may believe that any recession will be quickly succeeded by a boom, and therefore tend to increase prices even during recessions to have a better starting point for the next boom.
I do not understand why Manove’s reasoning should pertain just to socialist economic systems. There is a positive rate of profit if n is not infinite. Since there is no growth, and all social overhead and public transfers are already included in the cost, profit will result in a claim on net output. i.e. on consumer goods. It is therefore obvious that if inflation is to be avoided, the workers’ claim on net output cannot be equal to average productivity (including all necessary transfers). This, however, is a fair description of exploitation, even by von Weizsäcker’s standards.
The problem is plainly visible in equations (19) and (20). Since g is average labor productivity (g = Qt/Lt), either (19) holds, and then there are no profits, or (20) holds, then profits exist. It would be good to know who appropriates these profits and on what grounds. If they are distributed to workers of monopolistic firms, fine. Then either you employ the total labor force in consumption-goods industries and produce intermediate goods by automata, or the problem remains. Exploitation does not become less frivolous if the number of exploiters and exploited is more evenly distributed. From the paper of Professor Bajt we learned that this can be a cause of inflation in a socialist economy.
What Manove says is that the interaction of people who want to exploit others and those who try to avoid being exploited causes inflation in an institutional framework which allows such instincts. I could not agree more, and I think that this theorem is universally applicable, especially in economic systems whose institutions broadly allow exploitation. In my view, such a system par excellence is the present day capitalist system with strong monopolies and trade unions. In Professor Bajt’s reasoning the ability to pay higher wages stems from productivity differentials and monopoly power based on sectoral and group appropriations of scarce resources. The institutional factor converting the ability to pay higher wages into a necessity, is regarded to be the differential endowment of workers’ collectives with substitutable factors of production such as skills. stock of productive capital. natural resources, entrepreneurship. political power. etc. Since all these factors are in the possession of collectives. as the author stresses conflicting interests in the production process are excluded as causes of inflation. Inflation becomes rather a beggar-my-neighbor policy of workers’ collectives in the course of exchange. It shows a lack of solidarity and planning between the individual collectives, stemming from what Marx called commodity fetishism.
I wonder whether there really are no conflicting interests within the collective. namely whether entrepreneurship is in fact possessed and executed uniformly by all workers. My question would be: is the combination of generally high wages and low profits - I would prefer to call it high incomes and low capital costs external to producers --. which the author calls a sign of fading capitalism, really characteristic of the Yugoslav situation? If it is, it indeed proves that all factors of production are under the control of producers and it there are no institutional provisions to retain large-scale profits. But then question arises: how are investments decided upon and how are they financed? My view of Yugoslav inflation is that it is related to this question. In dividing revenue the collective votes for high income, which implies a reduction in her outlays. Then investment is proposed and pushed by managers to retain e advantages of preferential factor endowment through accumulation. This growth is financed by inflation, i.e. by drawing on future revenues (via bank edit). Such an inflation could be described with the concepts somewhat modified perhaps — used in Professor Manove’s paper.
I have just a brief comment on Professor Clower’s talk. What struck me most as that you argued that Neo-Walrasian analysis is not useful for the analysis f the problems of stability, self-adjustment, and homeostasis in large-scale economies. Then you suggested that we shift our attention to intermediaries ho play the role of information centers. Now, what I missed in your talk was n explanation of what kind of function the information centers or the intermediaries perform. How are preferences generated within these centers? I do not understand how you come then to stability. In what sense do you talk about stability and control?
Professor Clower, from your paper I was left with a rather confused impression is to your views concerning stability. At the outset you criticized Friedman’s view that the economy is strongly stable. In your theoretical discussion. however. you said that markets organized in terms of intermediaries are quite strongly table for evolutionary reasons.
In the long run: I did not imply short-run stability.
You said that perhaps economists do not understand it from an empirical point of view, and that Friedman’s own position is essentially an ideological one. But the fact is that out of Chicago has come a tremendous amount of empirical research on monetary phenomena. Also, Friedman and Schwartz’s book on the monetary history of the U.S. contains many detailed examinations of historical episodes, where they apparently demonstrate that exogenous shocks coming from the monetary sector caused particular cyclical crises or episodes. Furthermore, you yourself empirically took an essentially Friedmanesque stance and to earlier economic history. when you said that it is probably not applicable to the institutional setup which we have today. I believe that if we want to make statements about reality, this essentially arm-chair kind of theorizing is not going to be very convincing.
‘Theory should be an efficient instrument in explaining what we observe. I do not know too much about economic history but I do know that inflation has always been a very variable phenomenon. It varied greatly in time and in place. I question very much whether the focus on monopoly power is an efficient way of explaining that variation.
I thought we should stop squabbling about the word causation. Of course, birth causes death, I mean you cannot have one without the other. I do not see any distinction between a necessary event and a cause.
You were not in the philosophy course I took.
On another issue: It is not impossible to imagine secularly falling prices. We have even observed it historically. The only necessary condition for secularly falling prices is to have a proper economic environment and that means that secularly falling prices have to be expected. Such expectations can be created and sustained by proper monetary conditions. The U.S. episode which I am familiar with — from the 1870’s to the 1890’s— is a perfect example of such a situation, when prices were falling steadily on the average. That situation was sustained by expectations that prices would continue to fall and also by monetary conditions. Now. even in that environment, competition for distributive shares can go on and may be a very important phenomenon. But whether or not the competition for distributive shares takes place in an inflationary or deflationary context does depend on monetary conditions. In the U.S. between 1870 and 1890 the competition for distributive shares, especially between agricultural and nonagricultural interests was very, very severe, and most American politics during that episode dealt just with that question. Yet that competition did take place within a context of secularly and steadily falling prices.
E. von Böventer:
Just a few words on the issue of zero versus ten percent inflation. It is certainly much easier to see whether prices have gone slightly up, down, or remain unchanged, than it is to see whether prices have gone up by more or less than 20%. Correspondingly, it is much easier to arrive at a feeling of injustice and insecurity if prices rise very fast. You never know whether your price rose more or less than the other prices.
In some sense Manove’s model seems to be incomplete. Your idea about exploiting labor basically means that not all of the pie goes to the workers. The question is, what happens to this left-over piece? It seems to me the simplest way of closing the model (since it is socialism and everything is owned by state) is to redistribute these monopoly profits. What will happen then? It may change your conclusion that the real wage is being depreciated by inflation. Also your assumptions about what is going on in the oligopolistic situation goes somewhat in favor of your conclusion. According to your story each producer decides both on price and quantity, takes the other producers’ decisions as given, and then does the best he can. Now, the alternative story you could tell may include, for example, manipulating just one of these two things, say price. Then everyone who sets the minimum price gets an equal share of demand and those who set the price above do not get anything. In that case you would have a price war phenomenon. The effect of what you call monopoly power would be diminished. On the other hand you could make an even stronger case by not talking about oligopoly, but about price monopoly, or price collusion. That would presumably strengthen your reasoning.
I want to express a very strong opinion that the creation of money and monetary policy should be endogenous to the study of inflation. What really ought to be studied is the creation of claims. Obviously, in some economic structures the creation of claims against the product is such that claims exceed the product, whereas in other economic environments the creation of claims against the product is such that they do not exceed it. I think we should try to explain monetary behavior as a function of that kind of activity. In that way we shall reach much more interesting conclusions about inflation. In my paper I showed one particular aspect of the creation of claims which was due to monopoly.