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University of Southern California Dissertations and Theses
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The Inflation Process: An Economic Analysis
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The Inflation Process: An Economic Analysis
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This dissertation h as been 64-2605
m icrofilm ed exactly a s received
SHAPIRO, Milton M oses, 1917-
THE INFLATION PROCESS: AN ECONOMIC
ANALYSIS.
U niversity of Southern California, Ph. D . , 1963
Economics, theory
University Microfilms, Inc., Ann Arbor, Michigan
Copyright
by
Milton Moses Shapiro
THE INFLATION PROCESS: AN ECONOMIC ANALYSIS
by
M ilto n Moses S h a p iro
A D i s s e r t a t i o n P r e s e n te d to th e
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In P a r t i a l F u l f i l l m e n t o f th e
R equ irem en ts f o r th e Degree
DOCTOR OF PHILOSOPHY
(E conom ics)
June 1963
UNIVERSITY O F SO UTHERN CALIFORNIA
G R A D U A T E S C H O O L
U N IV E R S IT Y PA R K
L O S A N G E L E S 7 . C A L IF O R N IA
This dissertation, written by
MILTON M OSES SHAPIRO
under the direction of h.~?.~.Dissertation Com
mittee, and approved by all its members, has
been presented to and accepted by the Graduate
School, in partial fulfillment of requirements
for the degree of
D O C T O R OF P H I L O S O P H Y
Dean
(DISSERTATION COMMITTEE
_ s? 8 Chairman
TABLE OP CONTENTS
C hapter
I . INTRODUCTION
Page
1
The Problem of I n f l a t i o n
S ta te m e n t of th e problem
S i g n i f i c a n c e o f t h e problem
O b je c tiv e s of t h i s study
B r i e f Review of th e Problem and L i t e r a t u r e
Methods o f R ese arch and A n a ly s is
D e f i n i t i o n s o f S p e c i a l Terms and C oncepts
P review o f F o llo w in g C hapters
F i s h e r ’s E q u a tio n o f Exchange
Terms and d e f i n i t i o n s
A w orld o f "exchange"
How can M, V, and T a f f e c t P?
S t r i c t l y lo n g - r u n approach
From Truism t o Theory
I m p l i c a t i o n s and E v a lu a tio n s
I n s t i t u t i o n s and p r i c e f l e x i b i l i t y
A s p e c i a l r o l e f o r money
U s e fu l framework f o r a n a l y s i s
Maj o r sh o rtc o m in g
Money As an E n a b lin g F a c to r
Summary and C o n c lu sio n s
The World o f Income Theory
The components o f a g g re g a te demand
D i f f e r e n c e s from Q u a n tity T heory
T h e o rie s o f Demand I n f l a t i o n
The c a se of " s e m i - i n f l a t i o n "
The case o f "excess-dem and" i n f l a t i o n
E l a b o r a t i o n s of ex ce ss-d e m a n d i n f l a t i o n
Some common d e n o m in a to rs
The I n f l u e n c e of M arket S t r u c t u r e
Some a s p e c t s of p r i c e th e o ry
I I . THE ROLE OF M ONEY
29
I I I . THE ROLE OF DEMAND 67
ii
C hapter
IV.
Page
R e la ti o n s betw een demand and c o s t s
D e f i n i t i o n s o f demand i n f l a t i o n
Summary and C o n c lu sio n s
THE ROLE OF WAGES............................................................................106
The W ag e -D ete rm in atio n P ro c e s s
The "dilem m a model"
The w a g e - d e te r m in a tio n s ta g e
The "econom ic" d e te r m in a n ts o f wages
Summary c o n s i d e r a t i o n s
The G e n e ra l Wage L evel
D e te rm in a n ts o f th e wage l e v e l
W a g e -tra n s m is s io n mechanisms
S tim u lu s or re s p o n s e
From W ag e -In c re a se t o P r i c e - I n c r e a s e
Unit l a b o r c o s t s
Unit t o t a l c o s t s
W e in tra u b ’ s c o n t r i b u t i o n
B asic A sp ects o f Wage-Puah
Wages and p r o d u c t i v i t y
Wages and econom ic c o n d it i o n s
Wages and th e en vironm en t
The c l a s s i f i c a t i o n of w a g e - in c r e a s e s
W age-P u ll: The O th e r S id e of Wage-Push
Some p r e l i m i n a r y comments
D ir e c t im p a c ts o f w a g e - p u ll
O th er d e t e r r e n t s to w a g e -p r ic e s p i r a l
I n d i r e c t im p a c ts of w a g e - p u ll
Summary and C o n clu sio n s
THE ROLE OF PRICING.......................................................................189
P r i c i n g In th e I n d i v i d u a l Firm
S o c i a l p r e s s u r e s
C l a s s i c a l p u re c o m p e titio n
P ro d u c t d i f f e r e n t i a t i o n
U n c e r ta in ty
Time h o r iz o n s
The zone o f i n d i f f e r e n c e
I n te r d e p e n d e n c e o f f ir m s
Some b a s i c c o n c lu s io n s
Modem p r i c i n g th e o ry
A d m in is te re d p r i c e s
C o s t- p lu s and markups
I m p li c a t io n s o f c o s t - p l u s
A d m in is te re d P r i c e s As a Source of I n f l a t i o n
Role o f markup p r i c i n g
i i i
C hapter Page
Markup p r i c i n g as an i n f l a t i o n mechanism
S t r u g g l e f o r f a i r income s h a r e s
E n la r g e d p r o f i t m argins
P r i c i n g P r a c t i c e s and th e G e n era l P r i c e L ev e l
The d e te r m in a n ts of p r i c e s
T ra n s m is s io n mechanism
Summary and C o n c lu sio n s
The I n te r d e p e n d e n c e o f Key V a r ia b le s
The f a c e t s o f money
The f a c e t s o f demand
The f a c e t s o f wages
The f a c e t s o f p r i c i n g
P r i c e s t a b i l i t y and th e " c a u se " of
i n f l a t i o n : a summary
I n f l a t i o n As a P ro c e s s
The r e s p o n s e s t o i n f l a t i o n
The e n v iro n m en t of i n f l a t i o n
The I m p l i c a t i o n s o f A n a ly s is
The m eaning o f " c a u s e s "
A lo n g - r u n p r o c e s s
I n f l a t i o n and r e d i s t r i b u t i o n
R e d i s t r i b u t i o n and p o l i t i c s
Summary and C o n c lu sio n s
V I I. IMPLICATIONS FOR ANTI-INFLATION POLICY . . . . 38 3
Problem s o f I n t e r p r e t a t i o n and
P o lic y P r o p o s a l
L eading p o l ic y a p p ro a c h e s
Problem s o f d a t a i n t e r p r e t a t i o n
The s e n s i t i v i t y of p r i c e s and wages
The " s t r a t e g i c " approach
P o l i c y I m p l i c a t i o n s of t h e P r e s e n t Study
Demand, s u p p ly , and i n f l a t i o n
P e r s p e c t i v e s on econom ic g o a ls
The r o l e o f governm ent in' i n f l a t i o n
Some f i n a l p e r s p e c t i v e s on p o l i c y making
Summary and C o n c lu sio n s
VI. THE PROCESS OF INFLATION 284
V I I I . SUMMARY AND CONCLUSIONS 455
The Role o f Money
The Role o f Demand
The Role o f Wages
The Role o f P r i c i n g
iv
C h a p te r Page
I n f l a t i o n As a P ro c e s s
I m p l i c a t i o n s f o r A n t i - I n f l a t i o n P o lic y
BIBLIOGRAPHY ....................................................................................................... HJH
v
CHAPTER I
INTRODUCTION
A stu d y on i n f l a t i o n i s n e c e s s a r i l y concern ed w ith
a p r o c e s s t h a t in d u c e s r i s i n g p r i c e s , s o o n e r o r l a t e r , o r
(w hich i s th e same t h i n g ) c a u se s a d e c l i n e in th e v a lu e o f
money. S in c e p r i c e s a r e so o m n ip r e s e n t, b e in g a t t a c h e d t o
i n t a n g i b l e s e r v i c e s a s w ell as t o p h y s i c a l p r o d u c t s , and
s in c e money i s such an i n t e g r a l i n s t i t u t i o n of s o c i e t y , th e
g e n e r a l s u b j e c t m a t t e r of t h i s stu d y n e e d s no s p e c i a l
i n t r o d u c t i o n f o r th e r e a d e r , n o r a s p e c i a l recom m endation
to him . As t h e econo m ist Knut W ic k s e ll once p u t i t : "So
soon as money becomes a g e n e r a l m easure o f v a lu e and i s
made l e g a l t e n d e r , t h e av o id a n ce of a l l v i o l e n t and
u n e x p e c te d f l u c t u a t i o n s in i t s v a lu e i s o f th e utm ost
i m p o r t a n c e ." 1 One may add, h ow ev er, t h a t th e a v o id a n ce of
" n o n - v i o le n t" o r " e x p e c te d " f l u c t u a t i o n s i n th e p r i c e l e v e l
and v a lu e of money can be r e g a rd e d as an e q u a l ly d e s i r a b l e
s o c i a l o b j e c t i v e .
■htnut W ic k s e ll , L e c tu re s on P o l i t i c a l Economy
(London: R o u tled g e and Sons, L t d . , 1935)* I I , 12b.
1
2
The Problem o f I n f l a t i o n
In th e p a s t t h i r t y y e a r s th e p ro b lem of i n f l a t i o n
and t h e d e c l i n i n g v a lu e of money has been th e s u b j e c t of
p u b lic d i s c u s s i o n — by p o l e m i c i s t s as w e ll as s c i e n t i f i c a l l y
d e ta c h e d o b s e r v e r s — i n a t l e a s t f i v e d i f f e r e n t fram e s of
r e f e r e n c e . The f o l lo w in g stu d y i s r e l e v a n t to eac h of
th e s e i n f l a t i o n e p is o d e s and c o n t e x t s , a lth o u g h I t s
em phasis i s on more r e c e n t and c u r r e n t e x p e r i e n c e .
D uring th e d e p r e s s io n o f th e 19 3 0 ’ s I n f l a t i o n was
d i s c u s s e d as an outcome of th e " r e f l a t i o n ” e f f o r t s o f the
New D eal t o in d u ce r i s i n g p r i c e s , re d u c e d d e b t b u r d e n s , and
economic r e c o v e r y . D uring th e Second W orld War, p o s t- w a r
i n f l a t i o n was f o r e c a s t becau se o f th e e x c e s s i v e w a r-tim e
e x p a n sio n o f money supp ly and l i q u i d a s s e t s In r e l a t i o n t o
th e p r o s p e c t i v e su p p ly o f c i v i l i a n go ods. In th e
Im m ediate p o s t-w a r y e a r s , marked by abnorm al r i s e s i n
consumer p r i c e s and w ages, and a g a in in t h e Korean War,
i n f l a t i o n was d is c u s s e d w ith in t h e fram ew ork of " e x c e s s
demand" (by h o u s e h o ld s , f i r m s , and governm ent) and th e
u n p re c e d e n te d f a i l u r e o f th e p r i c e In d e x e s t o f a l l a s in
p r e v io u s p o s t- w a r p e r i o d s .
There fo llo w e d a l e v e l l i n g - o f f i n th e consum er
p r i c e in d e x , b u t in l a t e 195^ p r i c e s once a g a in began t o
r i s e n o t i c e a b l y i n th e e n su in g e x p a n s io n a ry p e r io d o f
1955-1957* a r i s e which c o n tin u e d even i n t o 1958, d e s p i t e
th e a d v e n t of r e c e s s i o n . S ince t h e n , a lth o u g h p r i c e -
i n c r e a s e s have l e v e l l e d o f f t o a " c r e e p , " t h e problem of
i n f l a t i o n rem ain ed b e c a u se of th e d i s t u r b i n g e f f e c t o f
r i s i n g d o m estic p r i c e s on th e c o m p e ti t iv e n e s s o f e x p o rt
i n d u s t r i e s and th e d e f i c i t in th e b a la n c e o f paym ents.
S ta te m e n t of th e Problem
I n f l a t i o n has t r a d i t i o n a l l y been r e g a r d e d as a
p r i c e phenomenon, or a p r o c e s s sym ptomized by a r i s i n g
p r i c e l e v e l . To be s u r e , r i s i n g p r i c e s have n o t been i t s
only f a c e : i t has a l s o been t r a d i t i o n a l t o re g a r d i n f l a
t i o n a s a m onetary phenomenon, o r a p r o c e s s marked by an
i n c r e a s e d money su p p ly . Today, how ever, th e money s id e of
i n f l a t i o n i s p u t in i t s p r o p e r p e r s p e c t i v e : i t i s re g a r d e d
as b u t o n e , a l b e i t i n t e g r a l , component of a much more
c o m p lic a te d p r o c e s s which s e r v e s t o g e n e r a te r i s i n g p r i c e s .
I n f l a t i o n as a "p ro b lem " . — I n f l a t i o n a l s o h as
t r a d i t i o n a l l y been r e g a r d e d as a " p ro b le m ," o r more p r e
c i s e l y , a s e t o f prob lem s o f b o th an econom ic and p o l i t i c a l -
s o c i a l c h a r a c t e r . On th e one h a n d , r i s i n g p r i c e s and th e
c o n c o m ita n t d e c l i n e In m oney's p u r c h a s in g power a re p r e
sumed t o e x e r t d i f f e r e n t i a l econom ic im p a c ts on th e owner
sh ip o r d i s t r i b u t i o n o f s a v in g s and w e a lth — f a v o r i n g n e t
m onetary d e b t o r s a t th e expense o f n e t m on etary c r e d i t o r s
o r owners of c la im s t o f i x e d sums o f money^— as w e ll as
r e l a t e d e f f e c t s on c u r r e n t i n c o m e - r e c e i v e r s , d ep en d in g on
how s u c c e s s f u l th e y a re i n k e e p in g t h e i r money incom es
r i s i n g in s t e p w ith r i s i n g p r i c e s .
On th e o t h e r h a n d , t h e r e d i s t r i b u t i o n a l e f f e c t s of
r i s i n g p r i c e s on th e n a t i o n ' s h o l d e r s o f w e a lth and incom e-
r e c e i v e r s compound th e econom ic and s o c i a l f r i c t i o n s s e t i n
m o tio n by in d u c in g p e o p le t o re s p o n d w ith " d e f e n s i v e ”
a c t i o n s in o r d e r t o p r o t e c t t h e i r r e a l econom ic p o s i t i o n s
a g a i n s t th e e r o s i o n of t h e i r income and w e a lth by r i s i n g
p r i c e s .
Such d e f e n s iv e a c t i o n s can ta k e th e form of
i n c r e a s e d m o n etary e x p e n d i t u r e s , demands f o r i n c r e a s e d
money incom es, th e r e v a l u a t i o n o f c la im s t o fix e d , sums o f
money, and s p e c u l a t i v e t r a n s a c t i o n s . These r e a c t i o n s ,
how ever, m ere ly se rv e t o f u r t h e r a c c e l e r a t e th e upward
p r i c e t r e n d ; and s o , i r o n i c a l l y , th e p r i c e s p i r a l o f i n f l a
t i o n may be f e d by th e v e ry a c t i o n s t a k e n t o d e fe n d a g a i n s t
i t , t h r e a t e n i n g to b r e a k o u t i n t o a " g a l l o p i n g " r a t e of
p r i c e i n c r e a s e ( i . e . , h y p e r - i n f l a t i o n ) o r , on th e c o n t r a r y ,
i t may be slow ed down t o a " c r e e p " t o th e e x t e n t t h a t
^ r m e n A. A lc h ia n and Reuben K e s s e l , "How t h e
Government G a in s from I n f l a t i o n , " P ro c e e d in g s of th e
T h i r t i e t h A nnual C on feren ce o f th e W estern Economic
A s s o c ia t io n ( S a l t Lake C i t y , U tah: U n i v e r s i t y o f U tah P re ss ,
i'9 5 5 ), PP. 1 3 -1 6 .
p e o p l e s ' r e s p o n s e s a re " p a s s i v e " o r a c q u i e s c e n t , p e r m i t t i n g
i n f l a t i o n t o e ro d e th e v a lu e o f money income and w e a lth .
The whole o f th e m a t t e r .--H o w e v e r, th e s e c o n s i d e r a
t i o n s o f th e i n f l a t i o n p roblem — i t s e f f e c t s on r e a l income
and w e a lth and th e s o c i a l f r i c t i o n s r e s u l t i n g from th e
d e f e n s i v e r e s p o n s e s t o r i s i n g p r i c e s — do n o t c o n s t i t u t e th e
whole o f th e m a t t e r . I f I n f l a t i o n o r r i s i n g p r i c e s a r e a
"sym ptom ," what a r e th e y a symptom o f? What a r e t h e u n d e r
l y in g f o r c e s — econom ic, p o l i t i c a l , s o c i o l o g i c a l — t h a t
a cc o u n t f o r , o r a r e e x p re s s e d th r o u g h , t h e r i s i n g p r i c e s ?
In o t h e r w ords, what i s t h e " p r o c e s s " which manages t o
r a i s e p r i c e s i n th e d i s t u r b i n g m anner i n d i c a t e d above?
Our r e c e n t e x p e r ie n c e w ith i n f l a t i o n , a t t r i b u t a b l e
s u b s t a n t i a l l y t o o u r World War I I e f f o r t s as w e ll as t o
p u r e l y p e a c e tim e f o r c e s — e s p e c i a l l y s i n c e th e m id - 1 9 5 0 's —
i n d i c a t e s t h a t answ ers t o t h e above q u e s t io n s have n o t come
v e ry e a s i l y . On th e one h a n d , th e answ ers t h a t were a b le
t o e x p l a i n e a r l i e r i n f l a t i o n e p is o d e s were n o t a b le t o
f u l l y e x p l a i n o u r more r e c e n t e x p e r ie n c e s in c e t h e Korean
War; on th e o t h e r h a n d , th e answ ers o f f e r e d In e x p l a n a t i o n
o f r e c e n t and c u r r e n t I n f l a t i o n t r e n d s have r e v e a l e d
s i g n i f i c a n t d isa g re e m e n t i n th e a r e a o f t h e o r y , a n a l y s i s ,
and i n t e r p r e t a t i o n and , h e n c e , in p o l i c y p r e s c r i p t i o n s .
A n o te o f p e r s p e c t i v e s h o u ld be added. I t i s
p o s s i b l e now, w ith th e b e n e f i t o f some h i n d s i g h t , t o r e g a r d
a s e x a g g e ra te d th e e x t e n t of r e c e n t I n f l a t i o n in th e
U n ite d S t a t e s , p a r t i c u l a r l y s in c e 195*1 ■ T here i s a
r e s p e c t e d judgm ent t h a t t h e a v e ra g e r a t e o f p r i c e i n c r e a s e
i n t h i s p e r i o d h a s n o t been "o u t o f l i n e " w ith p a s t e x p e r
ie n c e o r w ith co n tem p o rary e x p e r ie n c e in o t h e r maj or
i n d u s t r i a l c o u n t r i e s . However, i t i s n o t t h e e x te n t o f
r e c e n t i n f l a t i o n t h a t c o n s t i t u t e s t h e "prob lem " o f th e
p r e s e n t stu d y so much as t h e u n r e c o n c i l e d rem n a n ts of
d is a g re e m e n t among e c o n o m is ts i n (a ) th e a r e a of t h e o r e t i
c a l a n a l y s i s , (b) e m p i r i c a l i n v e s t i g a t i o n and i n t e r p r e t a
t i o n , and (c ) p o l i c y i m p l i c a t i o n s and p r e s c r i p t i o n s b a sed
on r e s p e c t i v e d ia g n o s e s and i n t e r p r e t a t i o n s . I t i s t o t h i s
problem which t h i s stu d y in g e n e r a l a d d r e s s e s i t s e l f , and
i t i s w ith th e t h e o r e t i c a l and m e th o d o lo g ic a l a s p e c t s o f
t h e p roblem — i . e . , th e d e te r m i n a t i o n o f th e n a t u r e and
p r o c e s s e s o f i n f l a t i o n — t h a t t h i s stu d y i s p r e o c c u p ie d .
S i g n i f i c a n c e of th e Problem
T hat i n f l a t i o n h as b e e n , so to s a y , " o f f i c i a l l y "
r e c o g n iz e d as an im p o r ta n t n a t i o n a l problem i s i n d i c a t e d
by th e prom inence g iv e n t o p r i c e s t a b i l i t y a s a m ajo r g o a l
o r o b j e c t i v e o f n a t i o n a l p o l i c y s i n c e th e Second World War.
More f u n d a m e n ta lly , a s tu d y on i n f l a t i o n can be
j u s t i f i e d by th e t r a d i t i o n a l c o n ce rn w ith t h e ten d e n cy o f
i n f l a t i o n t o s h r i n k th e v a lu e of money, t o r e d i s t r i b u t e
income and w ealth i n e q u i t a b l y , and t o in d u c e d i s t o r t i o n s i n
th e a l l o c a t i o n of r e s o u r c e s ( e . g . , away from m a r k e t-
o r ie n te d p r o d u c tio n and tow ard s p e c u l a t i o n ) , t h e r e b y
a f f e c t i n g t h e c y c l i c a l and g ro w th movements of t h e m ajor
economic m a g n itu d e s .
More r e c e n t l y a new d im e n sio n h a s been added to t h e
p u b lic d i s c u s s i o n o f th e i n f l a t i o n p ro b lem : th e f a c t t h a t
i n c r e a s e s i n the p r i c e s of i m p o r t - c o m p e ti t iv e and e x p o rt
p ro d u c ts a d v e r s e ly a f f e c t the c o m p e titiv e n e s s o f th e
n a t i o n 's o u t p u t at home and a b r o a d w h ic h , in t u r n ,
a d v e rs e ly a f f e c t s t h e balance o f i n t e r n a t i o n a l paym ents.
D e f i c i t s i n our e x t e r n a l b a la n c e of paym ents s i n c e 1950
have been t h e so u rc e o f r i s i n g s h o r t - t e r m l i a b i l i t i e s t o
f o r e i g n e r s , which i n t u r n have become t h e so u rc e o f gold
o u tf lo w s , d e p l e t i o n o f our m o n etary g o ld s to c k , and specu
l a t i o n o v e r th e d e v a l u a t i o n o f t h e d o l l a r . A lth oug h
dom estic p r i c e i n f l a t i o n has n o t been t h e o r i g i n a l source
o f concern over th e n a t i o n 's paym ents d e f i c i t s , i t has
se rv e d t o a c c e n t u a t e th e p ro b lem of re d u c in g t h e s e d e f i c i t s .
As a co n seq u e n ce , governm ent h a s f o r s e v e r a l y e a rs
now f o c u s s e d a t t e n t i o n upon t h e r e l a t i o n betw een d o m estic
p r i c e s , t h e balan ce o f paym ents d e f i c i t s , and t h e o u tflo w s
o f American g o ld , a n d has a c t e d a t home and a b ro a d to
r e d r e s s t h e s i t u a t i o n . In i t s a c t io n s on th e d o m e s tic
f r o n t i t h a s c o n c e n tr a te d on a tt e m p t s t o keep " k e y ” wage-
8
and p r i c e - a d j u s t m e n t s on a n o n - i n f l a t i o n a r y s c a l e . I n t h i s
c o n n e c tio n i t has ta k e n i n t e r v e n i n g a c t i o n s t h a t may e x e r t
f a r - r e a c h i n g im p a c ts on f u t u r e wage and p r i c e movements.
O b j e c t iv e s o f T h is Study
One o f th e m ost s t r i k i n g f e a t u r e s o f s t u d i e s and
a n a l y s e s o f r e c e n t i n f l a t i o n in th e U n ite d S t a t e s —
e s p e c i a l l y of th e p e r i o d 1955-1958, w hich may be re g a rd e d
a s th e n a t i o n ' s f i r s t f u l l " p e a c e tim e " i n f l a t i o n e p is o d e
s i n c e 1 9 4 5 - - i s th e s u b s t a n t i a l d iv e r g e n c e of o p in io n on th e
c a u s e s o r n a t u r e of t h i s e x p e r i e n c e . W ith some n o t a b l e
e x c e p t i o n s , ^ th e i n t e r p r e t a t i o n s o f r e c e n t i n f l a t i o n may be
c o n s id e r e d " m o n is tic " in th e sen se t h a t th ey p la c e s p e c i a l
em phasis on one key c a u se , su c h as money, e x c e s s demand,
w ages, or p r i c i n g p r a c t i c e s . 2
F o r e x am p le , F r i t z M achlup, "A n other View o f C o s t-
Push and D em and-Pull I n f l a t i o n , " The Review o f Economics
and S t a t i s t i c s , XLII (May, I 9 6 0 ) , 1 25-39 ; W illia m G. Bowen,
The W age-P rice I s s u e ( P r i n c e t o n : P r i n c e t o n U n i v e r s i t y P r e s s ,
I960).
2L eading exam ples o f such s t u d i e s , s t r e s s i n g t h e s e
c a u s e s i n th e o r d e r i n d i c a t e d , a re M ilto n F ried m an , "The
Supply o f Money and Changes i n P r i c e s and O u tp u t," In U .S .,
C o n g re ss, J o i n t Economic C om m ittee, Compendium, The R e la
t i o n s h i p o f P r i c e s t o Economic S t a b i l i t y and G row th, 85th
C o n g ., 2d S e s s . , 1958, PP* 2 4 1 -5 6 ; A r th u r F. B urn s,
P r o s p e r i t y W ithout I n f l a t i o n (New York: Fordham U n i v e r s i ty
P r e s s , 1"$57)» H a ro ld G. M o u lto n , Can I n f l a t i o n Be
C o n t r o l l e d ? (W ash in g to n , D . C .: Anderson Kramer A s s o c i a t e s ,
1 9 5 8 ); and G a r d in e r C. M eans, P r i c i n g Power and th e P u b lic
I n t e r e s t (New York: H a rp er & B r o t h e r s , 19625”.
9
An em ergin g p l u r a l i s m . — N e v e r t h e l e s s , upon c l o s e r
e x a m in a tio n of t h e s e m o n is tic a p p ro a c h e s , a s t r o n g
im p r e s s io n i s g a in e d from them t h a t th e i n f l a t i o n p r o c e s s
i s a c t u a l l y a m u l t i - f a c e t e d o n e, em bracing th e w orkings of
more t h a n one o f th e key " c a u s a l " f a c t o r s and in v o lv i n g th e
i n t e g r a l c o o p e r a tio n of " r e s p o n s e " and " t r a n s m i s s i o n "
m echanism s as w e ll a s th e s u p p o rt o f " p e r m is s iv e " e n v ir o n
m e n ts , p a r t i c u l a r l y of t h e m o netary and f i s c a l sy ste m s.
T his im p re s s io n i s by no means new. Some y e a r s ago
th e e co n o m ist A. J . Brown a s s e r t e d t h a t i n f l a t i o n i s
e s s e n t i a l l y a " b e w ild e r in g v a r i e t y of phenomena" c o n s i s t i n g
o f s e v e r a l d i f f e r e n t p r o c e s s e s which may be o p e r a t i v e in
any g iv e n p r i c e e p is o d e , a lth o u g h n o t alw ays t o g e t h e r . 1
More r e c e n t l y th e e c o n o m ist J . P. Lewis r e f e r r e d t o
th e te n d e n c y o f r e g a r d i n g th e 1955-1958 p r i c e e p is o d e a s
th e p r o t o ty p e o f a "new" i n f l a t i o n as an exam ple o f
u n w a rra n te d r e a d i n g of " to o many lo n g - r u n i m p l i c a t i o n s . "2
What d i s t i n g u i s h e s th e p r e s e n t stu d y i s t h e a tte m p t
t o ( a ) s p e l l o u t th e i n t e r r e l a t i o n s h i p s o f th e v a r i e t y of
f o r c e s c o n t r i b u t i n g to t h e i n f l a t i o n p r o c e s s , (b) d e r i v e
th e r e f r o m a g e n e r a l i z e d model o f th e i n f l a t i o n p r o c e s s —
^■A, J . Brown, The G re a t I n f l a t i o n , 1939-1951
(London: Oxford U n i v e r s i t y P r e s s , 1 9 5 5 ), pp. 1-2 .
2John P. L ew is, "The Problem o f P r i c e S t a b i l i z a t i o n :
A P r o g r e s s R e p o r t," The American Economic R eview . XLIX
(May, 1 9 5 9 ), p. 313.
10
a n alo g o u s i n p r i n c i p l e t o th e g e n e r a l i z a t i o n o f " b u s i n e s s
c y c le s " which l i n k im p u ls e s , c u m u la tio n m echanism s, and.
t u r n i n g p o i n t s i n r e p e t i t i v e p a t t e r n s — and (c ) draw
p o s s i b l e i m p l i c a t i o n s o r i n f e r e n c e s f o r th e sh a p in g o f
a n t i - i n f l a t i o n p o l i c y .
Two p e r t i n e n t q u e s t i o n s . — Two q u e s t io n s t h e r e f o r e
become p e r t i n e n t . F i r s t , i n t h e a r e a o f a n a l y s i s , t o what
e x t e n t do " m o n is tic " e x p l a n a t i o n s o f r e c e n t i n f l a t i o n
e x p e r ie n c e r e f l e c t in c o m p le te o r p a r t i a l view s? T h is stu dy
t h e r e f o r e a d d r e s s e s i t s e l f p r i m a r i l y t o a t h e o r e t i c a l
e x p l o r a t i o n of th e r a m i f i c a t i o n s of e a c h m ajo r component of
th e i n f l a t i o n p r o c e s s , i n c l u d i n g th e i n f l u e n c e e x e r t e d by
th e s e v e r a l b ra n c h e s o f governm ent on th e p r i c e l e v e l .
Toward t h i s end th e s tu d y w i l l e n d ea v o r p r i m a r i l y
to p ro v id e t h e o r e t i c a l p e r s p e c t i v e s on t h e p o t e n t i a l r o l e
p la y e d by each component in t h e i n f l a t i o n p r o c e s s as a
w hole; t h a t i s , i t w i l l a n a ly z e th e c o n d i t i o n s n e c e s s a r y
f o r e a c h component t o e x e r t an upward p r e s s u r e on th e p r i c e
l e v e l . I n t h i s c o n n e c tio n i t w i l l r e f e r t o r e l e v a n t
a s p e c t s o f r e c e n t e x p e r ie n c e w hich s e r v e as th e i n s p i r a t i o n
f o r p a r t i c u l a r m odels and c o n s t r u c t s .
The r e l a t e d p e r t i n e n t q u e s t i o n , which has t o do
w ith p o l i c y i m p l i c a t i o n s , i s e s s e n t i a l l y r h e t o r i c a l : t o
what e x t e n t i s i t v a l i d t o u se p a r t i a l o r n a rro w ly conceived
a n a l y s e s as th e m odel f o r a n t i - i n f l a t i o n m easu res or
11
l e g i s l a t i o n which may in v o lv e s i g n i f i c a n t changes in t h e
p a t t e r n s o f econom ic freedom s and i n s t i t u t i o n s ?
W hile t h i s study i s n o t d i r e c t l y a d d re s s e d t o t h i s
l a t t e r q u e s t i o n , i t may be n o te d t h a t to th e e x te n t
a n a l y s i s s e r v e s as th e handmaiden t o p o l ic y m a k e rs, improved
a n a l y s i s sh o u ld make f o r im proved p o l i c y p r e s c r i p t i o n s . I t
i s hoped t h a t t h i s s t u d y 's t h e o r e t i c a l and m e th o d o lo g ic a l
c o n s i d e r a t i o n s w i l l p ro v id e (a) s u g g e s t i v e i d e a s f o r f u t u r e
r e s e a r c h and (b) p e r s p e c t i v e s f o r th e f o r m u la tio n o f a n t i
i n f l a t i o n p o l ic y .
L i m i t a t i o n s of s t u d y . — The l i t e r a t u r e on i n f l a t i o n
and r e l a t e d m a t t e r s has t r a d i t i o n a l l y been among th e most
volum inous i n eco nom ics. While t h i s l i t e r a t u r e g e n e r a l l y
r e f l e c t s th e t h e o r e t i c a l , e m p i r i c a l , and p o l i t i c a l a s p e c t s
o f th e I n f l a t i o n p r o c e s s , th e em phases of p a r t i c u l a r
s t u d i e s may be on o n ly one o f t h e s e a s p e c t s . The p r e s e n t
s tu d y , by c o n c e n t r a t i n g on t h e o r e t i c a l and m e th o d o lo g ic a l
a s p e c t s , r e f l e c t s a judgm ent t h a t i n th e p r e s e n t s t a t e of
knowledge o f the i n f l a t i o n p r o c e s s i t i s t h i s a r e a w hich
needs th e most im m ediate a t t e n t i o n and which may y i e l d th e
l a r g e s t m a r g in a l r e t u r n s t o i n q u i r y .
As im p lie d above, th e stu d y o f i n f l a t i o n may be
s u f f e r i n g from a te n d e n cy t o c o m p a rtm e n ta liz e o r segment
t h e u n d e rs ta n d in g o f r e a l i t y th ro u g h " m o n is tic " m odels o r
c o n s t r u c t s . T his i s not t o deny a p r i o r i t h e v a l i d i t y or
12
u s e f u l n e s s o f any p a r t i a l a n a l y s e s ; in d e e d , t h e p r e s e n t
s tu d y r e l i e s h e a v ily upon p a r t i a l m odels and c o n s t r u c t s f o r
t h e b r i c k and m o rta r of i t s t h e s i s . R a th e r, t h i s stu d y
co n te n d s t h a t i n f l a t i o n p e r se may c o n s t i t u t e a typ e o f
p r o c e s s whose w o r k i n g s .i n h e r e n t l y in v o lv e t h e p a r t i c i p a t i o n
and c o o p e r a tio n o f s e v e r a l s t r a t e g i c v a r i a b l e s or segm ents
of r e a l i t y i n an i n t e r d e p e n d e n t , i n t e r r e l a t e d f a s h i o n .
In o t h e r w o rd s, i f the i n f l a t i o n p r o c e s s i s
i n h e r e n t l y a m u l t i - f a c e t e d , dynamic r e a l i t y , th e a r b i t r a r y
seg m entin g o f i t s a n a l y s i s f o r th e purp o se o f d e v e lo p in g
p a r t i a l m odels may p r e v e n t us from a f u l l e r u n d e rs ta n d in g
o f r e a l i t y i t s e l f . In o r d e r to c o n c e n tr a te on th e demon
s t r a t i o n o f I n f l a t i o n as such a m u l t i - f a c e t e d , dynamic
p r o c e s s , t h i s study h a s l im i te d i t s e l f to an e x a m in a tio n Of
th e key components and p a r t i c i p a n t s o f th e i n f l a t i o n
p r o c e s s , and t h e i r i n t e r r e l a t i o n s .
B r i e f Review o f th e Problem and L i t e r a t u r e
H i s t o r i c a l c a s e s of i n f l a t i o n t h a t a r e r e l e v a n t t o
modern e x p e r ie n c e can be t r a c e d b a ck t o t w e l f t h c e n tu r y
C h in a , which had i s s u e d e x c e s s iv e q u a n t i t i e s o f p a p e r money
as a means o f payment f o r m i l i t a r y e x p e n d i t u r e s .^ -
^ T h is h i s t o r i c a l summary i s b ased m a in ly on an un
p u b lis h e d su rv e y by th e a u th o r , " G r e a t I n f l a t i o n s o f World
H i s t o r y , " p r e p a r e d f o r The Scherman F o u n d a tio n , New Y ork,
N .Y ., S ep tem b er, 19^7; R. G. L ip s e y , "Does Money Always
D e p r e c ia te ? " Lloyds Bank Review, New S e r ie s No. 58
(O c to b e r, 196U) , pp. 1-1'3.----------
13
S ub sequent o u t s t a n d i n g c a se s in c lu d e t h e i n f l a t i o n s o f th e
C o n t in e n t a l C ongress c u rre n c y o f th e American R e v o lu tio n ,
th e A s s ig n a ts o f th e F ren ch R e v o lu tio n , th e G reenbacks and
C o n fe d e ra te p a p e r c u rre n c y of th e American C i v i l War, and
th e h y p e r - i n f l a t i o n o f German money a f t e r World War. I .
A lthough t h i s l i s t i s by no means e x h a u s t i v e — i t
o m its , f o r i n s t a n c e , th e g r e a t i n f l a t i o n e p is o d e s of John
Law's e x p e rim e n ts w ith c r e d i t d u rin g 1716-1720 and o f
C hina, J a p a n , and Greece a f t e r World War I I — i t s u f f i c e s to
i n d i c a t e t h a t t h e g r e a t I n f l a t i o n s of th e p a s t have f o r th e
most p a r t been a s s o c i a t e d w ith l a r g e - s c a l e wars and r e v o l u
t i o n s , r e s u l t i n g in heavy m i l i t a r y e x p e n d i tu r e s and
d i s r u p t e d c i v i l i a n p r o d u c tio n on th e one han d, and t h e
f i n a n c i n g o f governm ent d e f i c i t s l a r g e l y by th e e x p e d ie n t
means o f e x c e s s iv e i s s u e s o f p a p e r money and d e b t i n s t r u -
f
m ents r a t h e r t h a n by t a x a t i o n . 1 I t sh o u ld be n o t e d ,
how ever, t h a t t h e r e have a l s o been m a jo r i n f l a t i o n a r y
p e r i o d s In p e a c e tim e a t t r i b u t a b l e t o debasem ent o f th e
c o in ag e and l a r g e i n c r e a s e s i n th e money sup ply ( e . g . , th e
i n f l u x o f S p a n ish g o ld and s i l v e r from th e New World t o
Europe In th e s i x t e e n t h c e n t u r y , and t h e r a p i d g row th o f
banks i n e i g h t e e n t h c e n tu ry B r i t a i n ) .
^ o r a d i s c u s s i o n o f w artim e problem s o f i n f l a t i o n
and t a x a t i o n , s e e W illiam H. A nderson, T a x a tio n and th e
American Economy (New York: P r e n t i c e - H a l l , I n c . , 19 51),
pp. 5 21 -3 9.
14
I n th e U n ite d S t a t e s th e p a t t e r n o f i n f l a t i o n was
r e p e a t e d in two w orld w a rs. I t i s b e lie v e d t h a t th e w ar-
in d u ce d p r e s s u r e s on demand, c o s t s , and s u p p ly f o llo w in g
th e Second World War were n o t f u l l y sp en t u n t i l th e m id -
1950* s.
T h is does n o t mean t h a t p e ac etim e i n f l a t i o n
e x p e r ie n c e s in c e 1955 i s n e c e s s a r i l y th e m ost r e l e v a n t to
t h i s s tu d y . I n d e e d , th e a n a l y s i s and u n d e rs ta n d in g o f
c u r r e n t and p r o s p e c t i v e p e a c e tim e I n f l a t i o n must in any
e v e n t make due a llo w a n c e s f o r p o s s i b l e changes In any of
th e u n d e r ly in g f o r c e s im p in g in g on th e p r i c e l e v e l i n g iv en
s i t u a t i o n s . These f o r c e s may be e q u a l ly o p e r a t i v e in
p eace as i n war and may t h e r e f o r e c o n s t i t u t e one or more of
th e " b e w ild e r in g v a r i e t y o f phenomena" w hich i n f l a t i o n
p r o c e s s e s have been a b le t o throw up th ro u g h o u t h i s t o r y .
B ecause th e h i s t o r y o f g r e a t i n f l a t i o n s has been
d om inated by wars and r e v o l u t i o n s and th e n e ed t o f in a n c e
l a r g e d e f i c i t s , i t i s n o t s u r p r i s i n g to f i n d th e l e a d i n g
works on i n f l a t i o n — a t l e a s t u n t i l th e 1 9 5 0 's — c o n c e rn e d
m a in ly w ith w ar- and r e v o l u t i o n - i n d u c e d c a s e s of i n f l a t i o n .
Among th e more o u t s t a n d i n g works may be l i s t e d those
by A. D. W h ite ,-C . B r e s c i a n i - T u r r o n i , R. N u rk se, J . M.
K eynes, W. F e l l n e r , and S. E. H a r r i s . 1 The f i r s t d e a l s
^ h e s e works i n c l u d e , r e s p e c t i v e l y , Andrew D ickson
W h ite, F l a t Money I n f l a t i o n i n F ra n ce (New York: F o u n d a tio n
15
w ith th e A s s ig n a t I n f l a t i o n o f th e F re n ch R e v o lu tio n , and
th e second w ith th e German h y p e r - i n f l a t i o n a f t e r World War
I . The re m a in in g f o u r works d e a l w ith v a r i o u s p h a se s o f
t h e i n f l a t i o n e x p e r ie n c e d i n World War I I . F or th e most
p a r t t h e s e d i s c u s s i o n s a re fram ed in th e " c l a s s i c " mold
w hich r e g a r d s i n f l a t i o n as an e x p r e s s io n o f e x c e s s iv e
money sup ply and m onetary demand, t h a t i s , o f " to o much
money" o r " e f f e c t i v e demand" s e e k in g t o buy up " to o few
g o o d s ."
However, e q u a l ly s u b s t a n t i a l works have a ls o been
con cern ed l a r g e l y w ith p e a c e tim e i n f l a t i o n . ^ - S ince many of
t h e s e w i l l a l s o be r e f e r r e d t o In su b se q u e n t c h a p t e r s , only
a s e l e c t few need be l i s t e d h e r e . These i n c l u d e th e
c l a s s i c work o f I . F i s h e r , w hich I s a n a ly z e d i n C h a p te r i i ,
th e t r e a t i s e s o f J . M. Keynes, t h e work o f H. P. W i l l i s and
J . M. Chapman on th e " r e f l a t i o n " e f f o r t s of t h e 1930’ s and
th e r e c e n t works by G. C. M eans, G. L. B ach, C. L. Schultze,
f o r Economic E d u c a tio n , 1959); C o s ta n tin o B r e s c i a n i -
T u r r o n i , The Economics of I n f l a t i o n (London: A lle n & Unwin,
L t d . , 1937); R agnar N u rk se, The Course and C o n tr o l of
I n f l a t i o n ( P r i n c e t o n : League o f N a t io n s , 19**6); John
Maynard K eynes, How t o Pay f o r t h e War (New York: H a r c o u r t,
B race and C o ., 19*10); W illiam F e l l n e r , A T r e a t i s e on War
I n f l a t i o n ( B e rk e le y : U n i v e r s i t y of C a l i f o r n i a P r e s s , 19*12);
Seymour E. H a r r i s , I n f l a t i o n and th e American Economy (New
York: M cGraw-Hill BOOK CO ., 1 9* 4 5 ) . lL
■ '" A n o te w o rth y stu d y c o v e r in g b o th w a r-tim e and
p e a c e - tim e i n f l a t i o n i s by L e s t e r V. C h a n d le r, I n f l a t i o n
i n t h e U n ite d S t a t e s , 19*10-1948 (New York: H a rp e r &
B r o t h e r s , 1951)*
and W . G. Bowen.1 S c h u l t z e 's work i s a c t u a l l y one o f a
s e r i e s o f s t u d i e s p re p a r e d in r e c e n t y e a r s by academ ic and
p r o f e s s i o n a l e c o n o m is ts f o r th e J o i n t Economic Committee o f
th e U n ited S t a t e s C o n g r e s s .2
T h is m a t e r i a l ra n g e s from th e t h e o r e t i c a l and
a n a l y t i c a l t o t h e e m p i r i c a l and p o l e m i c a l, and r e l e v a n t
p o r t i o n s o f i t a r e b a s i c t o t h i s s tu d y . W hile some o f
t h e s e works a re a l s o c a s t more o r l e s s i n th e fram ework o f
excess-dem and t h e o r i e s — p a r t i c u l a r l y th o s e o f F i s h e r ,
K eynes, and Bach— th ey and th e o t h e r s a l s o acknow ledge th e
o p e r a t i o n o f o t h e r i n f l a t i o n a r y f o r c e s , su c h as t h e upward
t h r u s t o f w a g e -c o s ts and p r o f i t - m a r g i n s ( e . g . , Keynes,
■^These works a r e , r e s p e c t i v e l y , I r v i n g F i s h e r , The
P u rc h a s in g Power of Money (New York: M acm illan C o ., 1 9 1 1 7 7
John Maynard K eynes, A T r e a t i s e on Money (London:
M acm illan & C o ., L t d . , 1 9 3 0 ), I , 137* 1 66-69 , and The
G e n e ra l Theory o f Employment. I n t e r e s t , and Money (New York
H a r c o u r t , Brace and C o ., 1 9 3 6 ), PP* 2tift-b6, 2 9 5 -9 6 , 301;
H. P a rk e r W i l l i s and John M. Chapman, The Economics of
I n f l a t i o n (New York: Columbia U n i v e r s i ty P r e s s , 1 9 3 5 );
M eans, op. c l t . ; George L elan d B ach, I n f l a t i o n (P ro v id e n c e :
Brown U n i v e r s i t y P r e s s , 1 9 5 8 ); C h a rle s L. S c h u l t z e , Recent
I n f l a t i o n in t h e U n ited S t a t e s . U . S . , C o n g re ss, J o i n t
Economic C om m ittee, 3 tud y P aper No. 1 (W ashington: U.S.
Government P r i n t i n g O f f i c e , 1959); Bowen, o p . c i t .
2U .S ., C o n g re ss, J o i n t Economic C om m ittee,
Compendium, C om m entaries, H e a r i n g s . The R e l a t i o n s h i p o f
P r i c e s t o E c o n o m ic T s ta b ility and G row th, 85t h C o n g ., 2d
S e s s . , March 3 1 , 1958, May 1 2 -2 2 , 1958, O c to b er 3 1 , 1958,
and December 1 5 -1 8 , 1958, and H e a r in g s , Study P a p e rs , S t a f f
R e p o r t, Study o f Employment. Grow th, and P r i c e L e v e l s , 66th
C ong., 1 s t S e s s . , M a r c h20, 1959-J a n u a ry 5 , I9 6 0 .
17
S c h u l tz e , and M e a n s ),1 and th e e x c e s s i v e Income claim s o f
p r e s s u r e g ro u p s and s p e c i a l i n t e r e s t s ( e . g . , W i l l i s and
Chapman, B ach ).
I n t h i s c o n n e c tio n i t may be added t h a t r e c e n t
p r i c e i n f l a t i o n , p a r t i c u l a r l y s in c e 1955, h as been c h a r
a c t e r i z e d as a "new" i n f l a t i o n b e c a u se i t i s p u r p o r te d t o
emanate p r i m a r i l y from " in d ig e n o u s " c au se s w i t h i n th e
m arket economy — w ith in th e g o o d s- and s e r v i c e - p r o d u c i n g
s e c t o r s and t h e i r wage- and p r i c e - s e t t i n g i n s t i t u t i o n s , and
i s t h e r e f o r e c a l l e d "w age-push" and " p r o f i t - p u s h , "
r e s p e c t i v e l y — r a t h e r th a n from "exogenous" s o u rc e s such a s
w a r-in d u c e d d i s l o c a t i o n s , i n c r e a s e d s u p p l i e s o f p r e c io u s
m e t a l s , o r e x c e s s iv e c r e a t i o n o f money by governm ent and
t h e banking system .
Methods of R e se a rc h and A n a ly s is
T h is study was o r i g i n a l l y i n s p i r e d by c u r i o s i t y
about th e n a tu r e o f th e n o t a b l e i n c r e a s e s i n p r i c e l e v e l s
d u rin g 1955-1958. T his u p su rg e o f p r i c e s s e r v e d to provoke
^ t i s i n t e r e s t i n g to n o t e t h a t a s e a r l y as 1911
I r v i n g F i s h e r had c a l l e d a t t e n t i o n t o p r e v a i l i n g t h e o r i e s
("much u n d e r d i s c u s s i o n " ) t h a t h ig h p r i c e s were caused by
" i n d u s t r i a l and la b o r c o m b in a tio n s " ; F i s h e r , op. c i t . ,
P. 179.
2Hence th e term "m ark et p r o c e s s i n f l a t i o n " i n Hyman
P. Minsky, "Employment, Growth and P r ic e L e v e ls : A Review
A r t i c l e , " The Review o f Econom ics and S t a t i s t i c s . XLIII
( F e b r u a r y , 1 961 ), p. 6^
18
c o n s i d e r a b le p u b l i c d i s c u s s i o n v e ry e a r l y i n t h e e p is o d e .
One of t h e c h i e f re a s o n s f o r t h i s p u b l ic d e b a te and c o n ce rn
may have been th e sh a rp c o n t r a s t t h a t th e r i s i n g p r i c e s
( w h o le s a le and consum er) o f 1956 and 1957 p r e s e n t e d when
compared w ith th e p r i c e - l e v e l p l a t e a u o f 1952-1955*
I n v e s t i g a t i o n o f t h e a v a i l a b l e s t a t i s t i c s ,
a n a l y s e s , and i n t e r p r e t a t i o n s r e v e a l e d a p r o v o c a t iv e d e g re e
of d is a g re e m e n t i n th e t h e o r e t i c a l , e m p i r i c a l , and p o lic y
a s p e c t s o f th e m a t t e r . Many of th e r e s p e c t i v e c o n t r i b u
t i o n s te n d e d t o em phasize o r c o n c e n t r a t e on a s i n g l e
dom inant " c a u s e " o f th e p r i c e r i s e a t th e expense of
s l i g h t i n g th e s t r a t e g i c r o l e o f o t h e r c o n t r i b u t i n g f a c t o r s .
A c lo s e e x a m in a tio n o f t h e s e m a t e r i a l s a l s o
r e v e a l e d t h a t th e d is a g re e m e n ts were a t t r i b u t a b l e p r i m a r i l y
t o p a r t i a l or n a rro w ly c o n c e iv e d a n a l y s e s . C o n v e rse ly ,
and more i m p o r t a n t , i t r e v e a l e d t h a t (a) a b r o a d e r g r a s p of
th e d i f f e r i n g p o i n t s o f v iew , a s w e ll as (b) a draw ing of
p ro p e r i n f e r e n c e s from t h e i n d i v i d u a l " m o n is tic " m odels o r
a p p ro a c h e s would y i e l d (c) a more com prehensive and
a c c u r a t e a p p ro a c h t o th e a n a l y s i s of i n f l a t i o n — one t h a t
was s u b s t a n t i v e l y more r e a l i s t i c and m e th o d o lo g ic a lly more
a tt u n e d t o th e a c t u a l n a t u r e o f th e i n f l a t i o n p r o c e s s — as
w e ll a s (d ) a more r e a l i s t i c fram ework f o r th e s h a p in g of
p o l i c y .
19
I n o t h e r w o rd s, th e r e s p e c t i v e s t u d i e s o f r e c e n t
i n f l a t i o n had i n d i c a t e d t h a t n o t one b u t s e v e r a l f o r c e s and
mechanisms were w orking t o r a i s e i n d i v i d u a l p r i c e s ( o f
p r o d u c ts and f a c t o r s e r v i c e s ) , on th e one han d , and th e
g e n e r a l p r i c e l e v e l , on th e o t h e r . F u rth e rm o re , they
r e v e a l e d t h a t many o f th e p o p u la r " c a u s e s " of i n f l a t i o n —
such a s money s u p p ly , demand, w ages, and p r o f i t s — c o u ld n o t
a f f e c t th e p r i c e l e v e l ( d i r e c t l y o r i n d i r e c t l y ) w ith o u t th e
m e d i a t i o n , c o o p e r a t i o n , o r p e rm is s io n of o t h e r p a r t i c i p a t i n g
a g e n t s .
I t was t h e r e f o r e b e l i e v e d m andatory t o e x p lo r e th e
r a m i f i c a t i o n s o f each o f th e m ajo r p o t e n t i a l s t i m u l i o f
i n f l a t i o n — money s u p p ly , demand, and c o s t s — i n o rd e r t o
d e f i n e th e c o n d i t i o n s u n d e r which each co u ld a f f e c t
i n d i v i d u a l p r i c e s and th e p r i c e l e v e l in g e n e r a l . In t h i s
f a s h i o n i t would be p o s s i b l e to d e te rm in e t o what e x t e n t
each o f t h e s e m ajor " c a u s e s " o f I n f l a t i o n (a ) c o u ld a f f e c t
p r i c e s "autonom ously" and " in d e p e n d e n tly " of o t h e r c a u se s
o r a g e n t s , o r (b) r e q u i r e d t h e c o o p e r a tio n of o th e r a g e n ts
w ith o u t whose a s s i s t a n c e o r p e rm is s io n th e y could n o t much
a f f e c t th e p r i c e l e v e l .
F o r t h i s t a s k i t was n e c e s s a r y t o examine p r i m a r i l y
a wide v a r i e t y of a n a l y t i c a l and i n t e r p r e t i v e m a t e r i a l s
s p e c i f i c a l l y d e v o ted t o th e problem of i n f l a t i o n . In t h i s
c o n n e c tio n i t was n e c e s s a r y t o supp lem ent t h e s e s o u r c e s
20
w ith more fu n d a m e n ta l o r g e n e r a l w r i t i n g s i n economic
th e o ry on th e fo r m a tio n of i n d i v i d u a l p r i c e s and o v e r - a l l
p r i c e l e v e l s . I t was a l s o n e c e s s a r y t o r e f e r to p rim a ry
and d e r i v a t i v e s t a t i s t i c a l d a t a t o e s t a b l i s h a p p r o p r i a t e
e m p i r i c a l fram es o f r e f e r e n c e , such as th e r a t e o f i n c r e a s e
i n o v e r - a l l p r i c e l e v e l , o r t h e c o m p a ra tiv e r a t e of
i n c r e a s e o f d i f f e r e n t p r i c e s e r i e s .
D e f i n i t i o n s o f S p e c i a l Terms and C oncepts
The s p e c i a l term s and c o n c e p ts employed i n t h i s
s tu d y have been d e f i n e d and e x p la in e d in t h e f i r s t c o n te x ts
in which th e y a p p e a r. A few o f them ; h ow ever, a r e u se d
r e c u r r e n t l y th ro u g h o u t th e s t u d y , and t h e s e may be b r i e f l y
e x p la in e d h e re m ain ly f o r r e f e r e n c e p u r p o s e s .
" I n f l a t i o n ” . — M ainly f o r i n s t r u m e n t a l p u rp o se s t h i s
stu d y d e f i n e s " i n f l a t i o n " as a g e n e r a l r i s e i n th e p r i c e
l e v e l . T h is d e f i n i t i o n does n o t im ply o r r e f e r t o any
s p e c i f i c r a t e of p r i c e i n c r e a s e , such as a " c r e e p in g " or
"m oderate" r a t e o f i n c r e a s e ( s a y , of one o r two p e r cen t a
y e a r ) , o r a " g a l l o p i n g " or " h y p e r" r a t e s u f f i c i e n t l y
d i s t u r b i n g to ind uce an e a r l y l o s s of c o n fid e n c e i n th e
v a lu e of th e money and a " f l i g h t " from money i n t o goods o r
s p e c u l a t i o n .
S in c e t h i s s tu d y i s b a s i c a l l y c o n cern ed w ith th e
u n d e r ly in g f o r c e s , m echanism s, and i n s t i t u t i o n s t h a t
21
s t i m u l a t e , in d u c e , o r e n a b le p r i c e s to r i s e — and n o t only
w ith th e p r i c e symptoms of i n f l a t i o n — t h e s i g n i f i c a n c e o f
th e r a t e o f i n f l a t i o n p e r se f o r t h i s s tu d y would d e r i v e
m a in ly from th e d i f f e r e n t i a l e f f e c t s t h a t v a r io u s r a t e s
m ig h t e x e r t on th e n a t u r e and p r o c e s s o f i n f l a t i o n .
Nor does o u r d e f i n i t i o n imply t h a t i n f l a t i o n i s
alw ays e x p re s s e d as a p r i c e r i s e . I n f l a t i o n a r y f o r c e s may
be o p e r a t i v e but governm ent may seek t o p re v e n t p r i c e s from
r i s i n g t h e r e f o r e ( i . e . , i t may t r y t o " r e p r e s s " them ) by
means of s e l e c t i v e o r g e n e r a l c o n t r o l s o v e r p r i c e s and
wages and r a t i o n i n g of m a t e r i a l s . Such c a s e s of
" r e p r e s s e d " o r " s u p p r e s s e d " i n f l a t i o n a r e e s s e n t i a l l y no
l e s s i n f l a t i o n a r y t h a n th e "open" ty p e s marked by a c t u a l l y
r i s i n g p r i c e s : on ly th e p r i c e symptom h a s been r e p r e s s e d ,
by p r e v e n t in g th e u n d e r ly in g I n f l a t i o n a r y f o r c e s o f demand
and c o s t s from e x e r t i n g t h e i r l o g i c a l im p a c ts on p r i c e s f o r
a p o stp o n e d p e rio d o f tim e . In o t h e r w o rd s, th e
" p o t e n t i a l i t y " of p r i c e r i s e s rem ain s so long as t h e
" r e a l i z a t i o n " o f t h a t p o s s i b i l i t y i s r e p r e s s e d . * * ■
"Money" . —N orm ally th e te rm "money" i n c l u d e s only
c u rr e n c y ( c o in s and p a p e r b i l l s ) and d e m a n d -d e p o s it money
( o r " c h e c k s " ) , and e x c lu d e s a l l ty p e s o f "near-m oneys" o r
"money s u b s t i t u t e s " o f v a r y in g d e g re e s o f l i q u i d i t y ( e . g . ,
^Brown, op. c i t . , pp . 2 -3 .
22
s a v in g s d e p o s i t s , U n ited S t a t e s governm ent b o n d s). T h is
stu d y a d h e re s t o t h i s p r a c t i c e , b u t w i l l i n d i c a t e when
a n o th e r m eaning i s em ployed. However, i t must be n o t e d
t h a t , a lth o u g h th e near-m oneys a r e n o t n o rm a lly u s e d a s a
means of payment— th e key c r i t e r i o n in t h e u s u a l d e f i n i t i o n
o f money— t h e i r p o s s e s s i o n by h o u se h o ld s and n o n - f i n a n c i a l
c o r p o r a t i o n s does e x e r t i n d i r e c t i n f l u e n c e s on th e r a t e of
e x p e n d i tu r e s and e n a b le p o t e n t i a l e x p a n s io n of th e v e l o c i t y
o f c i r c u l a t i o n .
Thus a g iv en money su p p ly can be u t i l i z e d more
f u l l y by a v a r i e t y of a c t i o n s — e . g . , by t h e s a l e o f g o v e rn
ment s e c u r i t i e s w i t h in th e non -b an k s e c t o r o f th e economy
f o r r e l a t i v e l y " i d l e " cash b a la n c e s and sp e n d in g p ow er, o r
th e s h i f t of demand d e p o s i t s i n t o time d e p o s i t s , w hich
i n c r e a s e s th e le n d in g power of t h e b ank ing system — so t h a t
th e v e l o c i t y of c i r c u l a t i o n o r t u r n o v e r r a t e of money may
be i n c r e a s e d , w ith th e same e f f e c t s as an i n c r e a s e i n th e
money supply.^- To th e e x te n t t h a t th e s e near-m oney
-^-Velocity of c i r c u l a t i o n r e f l e c t s t h e r a t e a t which
eac h d o l l a r i s sp e n t i n a g iv e n tim e p e r i o d ; a h i g h e r
v e l o c i t y h a s th e same e f f e c t as an a b s o l u te i n c r e a s e in
money s u p p ly . On i n s t i t u t i o n a l i n n o v a t i o n s t h a t have
r e s u l t e d in i n c r e a s e d v e l o c i t y d u r in g th e 1 9 5 0 's , s e e
Hyman P. M insky, " C e n t r a l B anking and Money M arket Changes,"
The Q u a r te r l y J o u r n a l o f E co n o m ics, LXXI (May, 1 9 5 7 ), pp.
171-87* r e p r i n t e d i n Lawrence S. R i t t e r ( e d . ) , Money and
Economic A c t i v i t y (2d e d . ; B o sto n : Houghton M i f f l i n
Company, 1 9 6 1 ), pp. 338-45.
23
i n f l u e n c e s b e a r upon th e o p e r a t i o n o f the i n f l a t i o n p r o c e s s
they a r e acknow ledged i n t h i s s tu d y .
T h is s tu d y a l s o f r e q u e n t l y r e f e r s t o "m o n e ta ry -
f i s c a l " s y s te m s , a u t h o r i t i e s , and p o l i c i e s . The te rm i s
used p r i m a r i l y i n th e f u n c t i o n a l s e n s e , as s i g n i f y i n g th e
r e s p e c t i v e i n f l u e n c e s o r im p a c ts on (a ) t h e money supply^-
a n d /o r v e l o c i t y o f c i r c u l a t i o n , and (b) th e income and
e x p e n d itu r e s tre a m s of th e economy t h a t can be e x e r t e d ,
a l t e r n a t i v e l y , by th e a c t i o n (o r i n a c t i o n ) o f th e F e d e r a l
Reserve System , th e T r e a s u r y , and t h e C ongress o f th e
U nited S t a t e s .
I n o t h e r w o rd s, t h e m onetary and f i s c a l a c t i o n s of
th e s e v e r a l a g e n ts of governm ent a r e viewed as a f f e c t i n g
the p r i c e l e v e l by t h e i r i n f l u e n c e ov er th e n a t i o n ’ s
e x e r c i s e o f m on etary demand ( p r i v a t e and p u b l i c ) , v i a (a)
c o n tr o l o f th e a v a i l a b i l i t y and c o s t of money and c r e d i t ,
(b) th e s i z e o f a f t e r - t a x incom e, ( c ) th e s i z e of g o v e rn
ment s p e n d in g , and (d) th e d e g re e o f l i q u i d i t y of
p r i v a t e l y - h e l d f i n a n c i a l a s s e t s .
D em an d -p u llv s. C o s t- p u s h . — The most p o p u la r m odels
of th e i n f l a t i o n p r o c e s s a r e known as (a) ex cess-d em an d
o r d em a n d -p u ll i n f l a t i o n and (b) c o s t- p u s h i n f l a t i o n , the
•*-This s i g n i f i e s t h e means o f payment which t h e
F e d e ra l Reserve, a u t h o r i t i e s most d i r e c t l y c o n t r o l o r
i n f l u e n c e .
24
l a t t e r c o m p risin g two v a r i a n t s , w age-push and p r o f i t - p u s h .
The e x cess-d em an d model i s u sed t o r e p r e s e n t s i t u a
t i o n s where t h e r i s e i n p r i c e s can be a t t r i b u t e d m ain ly t o
th e a tte m p ts o f h o u s e h o ld s , f i r m s , a n d /o r governm ent t o
spend sums o f money i n e x c e ss o f th e v a lu e o f c u r r e n t l y
a v a i l a b l e s u p p l i e s a t c u r r e n t p r i c e s ( i . e . , " to o much money
c h a s in g to o few g o o d s " ) ; s in c e t h e e x c e s s p u r c h a s in g power
cannot be a b so rb e d in th e form o f a d d i t i o n a l p h y s i c a l
s u p p l i e s , p r i c e s must r i s e s o o n e r o r l a t e r in o r d e r t o
a b so rb th e e x c e s s .
The w age-push v a r i a n t o f c o s t- p u s h a p p l i e s t o c a s e s
where th e p r i c e r i s e can be a t t r i b u t e d t o a r i s e i n u n i t
t o t a l c o s t s which i n t u r n can be a t t r i b u t e d t o a r i s e i n
u n i t l a b o r c o s t s . The p r o f i t - p u s h v a r i a n t r e f e r s t o (a ) a
p r i c e i n c r e a s e a t t r i b u t a b l e u n iq u e ly t o an i n c r e a s e i n th e
p r o f i t m argin o r m arkup, where t h e l a t t e r i s th e s o l e
o p e r a t i n g c a u s e , o r (b) t h a t p a r t o f a p r i c e i n c r e a s e
a t t r i b u t a b l e t o a p r o f i t - m a r g i n i n c r e a s e w hich f o llo w s on
th e h e e l s of a w age-push.
I n t h i s c o n te x t may be e x p la in e d t h e term
" w a g e - p u l l ." in tr o d u c e d by t h i s s tu d y . A g iv e n wage
i n c r e a s e n o t o n ly can e x e r t an upward p r e s s u r e on c o s t s
b u t , b e c a u se wages a l s o c o n s t i t u t e an income payment and a
s o u rc e o f p u r c h a s in g pow er, th e l a t t e r ty p e o f demand
p r e s s u r e on p r i c e s h as been term ed " w a g e -p u ll" by th e
a u t h o r , to c o n t r a s t w ith th e c o s t p r e s s u r e on p r i c e s
e x e r t e d by th e "w age-p ush ” s id e o f th e wage i n c r e a s e .
P re v iew o f F o llo w in g C h a p te rs
The f o llo w in g f o u r c h a p t e r s ( i i - v ) d e a l r e s p e c t i v e l y
w ith th e f o u r m o s t - d is c u s s e d p o t e n t i a l " c a u s e s " o r s t i m u l i
o f th e i n f l a t i o n p r o c e s s — money s u p p ly , demand, wage
i n c r e a s e s , and p r i c i n g p r a c t i c e s o f f i r m s — t o d e te rm in e th e
c o n d i t i o n s u n d e r which e a c h can in d u ce a r i s e i n p r i c e s .
These c h a p t e r s r e v e a l (a) c h a r a c t e r i s t i c i n t e r
r e l a t i o n s among t h e f o u r key s t i m u l i , as w e l l as (b) th e
t y p e s o f r e s p o n s e and t r a n s m i s s i o n mechanisms which se rv e
t o sp re a d o r p r o p a g a te t h e s e i n i t i a l i n f l a t i o n a r y p r e s s u r e s ,
and (c) th e v a r i o u s " e n v ir o n m e n ta l" f a c t o r s which e n a b le o r
s u p p o rt t h e o n -g o in g i n f l a t i o n p r o c e s s .
T hereupon i t i s p o s s i b l e , in C h a p te r v i , t o
g e n e r a l i z e a b o u t I n f l a t i o n as a m u l t i - f a c e t e d , dynamic
p r o c e s s g e n e r a t e d n o t by a s i n g l e p red o m in an t c au se but by
an i n t e r r e l a t e d s e t of f o r c e s . F i n a l l y , i n C hap ter v i i ,
t h e o r e t i c a l and m e th o d o lo g ic a l c o n s i d e r a t i o n s become th e
s o u rc e of s e v e r a l i m p l i c a t i o n s f o r a n t i - i n f l a t i o n p o l i c y .
The r o l e o f money.--M oney i s d is c u s s e d f i r s t
b e ca u se o f i t s t r a d i t i o n a l p la c e o f p r i o r i t y in d i s
c u s s io n s o f i n f l a t i o n , a t l e a s t u n t i l r e c e n t
26
d e c a d e s . ^ T h is h i s t o r i c a l f o c u s on money stem s from i t s
p e r v a s iv e r o l e as a means o f payment and as t h e in s tr u m e n t
by which in c o m e s, c o s t s , demand, and p u r c h a s in g power a r e
e x p re s s e d . As such i t a l s o c o n s t i t u t e s th e e s s e n t i a l
i n s t i t u t i o n o r agency o f th e i n f l a t i o n p r o c e s s .
Thus in C h a p te r i i t h e c l a s s i c work o f X. F i s h e r ,
The P u r c h a s in g Power o f Money, w i l l s e r v e as t h e v a n ta g e
p o i n t f o r e x p lo r i n g t h e c o n d it i o n s u n d e r which money su p p ly
can e x e r t i n f l a t i o n a r y p r e s s u r e s . In th e f i r s t i n s t a n c e ,
F i s h e r ' s t r a n s a c t i o n s model o f th e e q u a tio n o f e x ch a n g e,
P = MV/T, p r o v id e s t h e l o g i c a l demand and su p p ly fram ework
th ro u g h w hich the u n d e r l y i n g f o r c e s im pinge on th e p r i c e
l e v e l .
S e c o n d , the e x p l o r a t i o n of th e " e n a b lin g " r o l e o f
money as an a g en t o f t h e i n f l a t i o n p r o c e s s w i l l p r e p a r e (a)
th e i n s t i t u t i o n a l b ackg rou nd f o r su b se q u e n t r e f e r e n c e s
th ro u g h o u t t h e stu dy t o th e m o n e t a r y - f i s c a l "en v iro n m en t"
o f i n f l a t i o n , and (b ) th e m e th o d o lo g ic a l groundw ork f o r
C h a p te r v i i n which " e n a b lin g " c o n d it i o n s a re d i s c u s s e d as
a s p e c ie s o f "cause" a s i n t e g r a l l y s i g n i f i c a n t f o r
^N o tab le e x c e p tio n s a r e th e m on etary t h e o r i s t s
Howard S. E l l i s and M ilto n F ried m an , who c o n tin u e t o p l a c e
m a jo r e m p h asis on m onetary f a c t o r s i n th e i n f l a t i o n
p r o c e s s . F o r exam ple, see t h e p a p e r by E l l i s , " L i m i t a t i o n s
o f M onetary P o l i c y ," i n The American Assem bly, U n ited
S t a t e s M onetary P o lic y (New York: Columbia U n i v e r s i t y , 1958}
p p . 149-70.
27
i n f l a t i o n as any s t i m u l i , such as excess-dem and o r
c o s t- p u s h im p u ls e s .
Demand, wages, and p r i c i n g p r a c t i c e s . — The f o llo w
in g t h r e e c h a p t e r s ( i i i - v ) w i l l se rv e t o show how money i s
" m e d ia te d ." b y , . r e s p e c t i v e l y , th e sp e n d in g b e h a v io r of th e
community ( i . e . , h o u s e h o ld s , b u s in e s s f i r m s , and g o v e rn
m e n t), th e w a g e -a d ju stm e n t p r o c e s s e s of l a b o r and b u s i n e s s ,
and th e p r i c i n g p r a c t i c e s o f b u s in e s s f i r m s .
The c h a p t e r on demand s p e c i f i c a l l y w i l l a n a ly z e th e
c o n d i t i o n s u n d e r which th e i n c r e a s e d m onetary demand— as
th e c h a n n e l l i n g i n s t i t u t i o n o f t h e money s u p p ly — i s a b le to
c ause a r i s e i n p r i c e s . I n t h i s c o n n e c tio n i t w i l l be
n e c e s s a r y t o examine t h e r o l e p la y e d by th e mechanism s o f
r i s i n g w ages, p r o f i t s , and o t h e r c o s t s a s w e l l.
C h a p te r i v , on w ag es, i s t h e f i r s t o f two on c o s t -
push p r e s s u r e s . I t w i l l exam ine th e c o n d it i o n s u n d e r
which wage i n c r e a s e s can o p e r a t e as an "autonom ous" cause
o f c o s t and p r i c e i n c r e a s e s , i . e . , in d e p e n d e n tly of any
p r i o r i n c r e a s e s i n demand f o r p r o d u c ts o r " d e r iv e d " demand
f o r l a b o r , p r e v i o u s l y e n c o u n te re d In C h a p te r i l l .
The l a s t o f t h i s t r i o (C h a p te r v) w i l l , on th e one
hand, c r y s t a l l i z e th e p r e c e d in g d i s c u s s i o n by showing how
t h e p r i c i n g p r a c t i c e s o f b u s i n e s s fir m s " m e d ia te " o r
r e f l e c t th e demand and c o s t (s u p p ly ) f o r c e s o f t h e m arket
and t r a n s l a t e them i n t o p r i c e c h a n g e s, w h ile on th e o th e r
2tf
)
hand i t w i l l have t o d e s c r i b e th e c o n d i t i o n s u n d e r which
the p r i c e s s e t by f i r m s c o n s t i t u t e an " in d e p e n d e n t"
p r e s s u r e f o r i n f l a t i o n .
The c u lm in a tin g C h a p te r v i w i l l be m a in ly co n ce rn e d
w ith d e d u c in g an i n t e g r a t e d g e n e r a l m odel of th e i n f l a t i o n
"p r o c e s s , " one w hich i s i n i t i a t e d by " s t i m u l i " and i s
s u p p o r te d and p r o p a g a te d by th e r e s p o n s e and t r a n s m i s s i o n
m echanism s and e n v ir o n m e n ta l f a c t o r s a n a ly z e d i n th e p r e
ce d in g c h a p t e r s . I n t u r n , an a tte m p t w i l l be made to
deduce an u n d e r ly in g m otive f o r c e f o r an o n -g o in g
i n f l a t i o n p r o c e s s .
On th e b a s i s o f t h e s e c o n s i d e r a t i o n s t h e f i n a l
C h a p te r v i i w i l l a tt e m p t t o draw i m p l i c a t i o n s and
p e r s p e c t i v e s f o r t h e sh a p in g o f n a t i o n a l a n t i - i n f l a t i o n
p o l i c y . However, b e cau se p r i c e - s t a b i l i z a t l o n p o l i c y i s but
one o f s e v e r a l m a jo r economic o b j e c t i v e s of th e n a t i o n —
i n c l u d i n g hig h l e v e l s of em ploym ent, econom ic g ro w th , and
income m a in te n a n c e — t h i s c h a p t e r w i l l a l s o have t o con
s i d e r th e p o s s i b l e i m p l i c a t i o n s of t h e s e o t h e r n a t i o n a l
g o a ls f o r p r i c e s t a b i l i t y . I n t h i s c o n t e x t , th e r o l e o f
t h e p o l i t i c a l - s o c i a l en v iro n m en t In t h e i n f l a t i o n p r o c e s s
w i l l be g iv e n i t s f i r s t e x p l i c i t t r e a t m e n t .
CHAPTER I I
THE ROLE OP MONEY
T h is c h a p t e r d e a ls m ain ly w ith th e c a u s a l r e l a t i o n
s h i p s betw een money s u p p ly , M, and t h e p r i c e l e v e l , P. The
r e l a t i o n s h i p betw een i n c r e a s i n g money su p p ly and r i s i n g
p r i c e s has t r a d i t i o n a l l y been d i s c u s s e d in t h e body of
d o c t r i n e e n t i t l e d th e Q u a n tity T heory of Money.
The main s t r a n d s o f t h i s s p e c i a l group o f t h e o r i e s
may be t r a c e d back t o the s i x t e e n t h c e n t u r y , when s p e c i a l
n o t i c e began t o be ta k e n of th e p r i c e r i s e s t h a t s e t i n
aro u n d 15 2 5 .^ F o r e x am p le, Je a n B odin (1530-1596) w rote on
th e c o i n c i d e n t a l r i s e of p r i c e s i n Europe and t h e i n f l u x of
p r e c i o u s m e ta ls from a b ro a d ; W illia m P e t t y (1623-1687)
p o i n t e d t o th e v e l o c i t y o f c i r c u l a t i o n of money as a d e t e r
m in an t of i t s v a l u e ; w h ile R ic h a rd C a n t i l l o n (1697— 1731 *)
^ H i s t o r i c a l developm ent o f th e q u a n t i t y th e o r y and
a n a l y s i s o f lo n g - ru n p r i c e movements has been t r e a t e d in
th e f o llo w in g s o u r c e s : Edmund W h itta k e r , A H i s t o r y of
Economic I d e a s (New York: Longmans, Green and C o ., 194 0),
p p . 62 8 -8 4 ; H a ro ld G. M oulton, Can I n f l a t i o n Be C o n t r o l l e d ?
(W ash ing ton , D. C . : Anderson Kramer A s s o c i a t e s , 1 9 5 8 ),
pp. 189-212; I r v i n g P i s h e r , The P u r c h a s in g Power o f Money
(New York: M acm illan Company, 19 1 2 ), pp. 234 -3 18; R. G.
L ip s e y , "Does Money Always D e p r e c ia te ? " L lo y d s Bank R eview .
New S e r i e s No. 58 (O c to b e r, i 960) , p p . 1-13»
29
30
r e l a t e d p r i c e movements to b o th money su p p ly and v e l o c i t y ,
v i a consum ption e x p e n d itu re s .- ^
I f one in c l u d e s u n d e r th e q u a n t i t y th e o r y e a r l i e r
d i s c u s s i o n s of m onetary debasem ent and i t s e f f e c t on th e
v a lu e of money, th e n th e t h e o r y ’ s l in e a g e may be e x te n d ed
even f a r t h e r b a c k , t o th e m o netary w r i t i n g s o f N ic o le
Oresme (1 3 2 0 -1 3 8 2) . 2
These e a r l y v e r s i o n s o f th e q u a n t i t y th e o r y sim ply
s t a t e d t h a t th e p r i c e l e v e l v a r i e s i n d i r e c t and im m ediate
p r o p o r t io n t o th e q u a n t i t y of money ( s p e c i e ) : i f th e
q u a n t i t y o f M d o u b le d , th e n P d o u b le d ; i f M was h a lv e d , so
was P.
T his crude v e r s i o n o f th e q u a n t i t y th e o r y h e ld sway
even i n t o th e w r i t i n g s o f John S t u a r t M i l l , a lth o u g h M ill
m o d ifie d th e th e o r y by ackno w ledg ing th e new r o l e p la y e d by
c r e d i t or d e p o s i t c u rre n c y i n th e money s u p p l y . ^
By th e l a t t e r p a r t o f th e n i n e t e e n t h c e n tu ry i t was
r e a l i z e d t h a t th e r e l a t i o n s h i p betw een M and P was n o t so
■*-For s e l e c t e d w r i t i n g s on th e s e t o p i c s by B odin,
P e t t y , and C a n t i l l o n , see A r th u r E l i Monroe ( e d . ) , E a rly
Economic Thought (Cam bridge: H a rv a rd U n i v e r s i t y P r e s s ,
1 9 5 1 ), PP. 1 2 1 -4 1 , 2 0 1 -2 0 , 2 4 7 -7 7 .
2I b i d . , pp. 79- 102.
^Roy L. G a r i s , P r i n c i p l e s of Money, C r e d i t , and
B anking (New York: M acm illan Company, 1 9 3 4 ), pp. 234-35;
M oulton, op. c i t . , p. 191.
d i r e c t and im m ediate: a c c o u n t a l s o had t o be ta k e n o f the
number o f t r a n s a c t i o n s i n which M was in v o lv e d , a m agnitude
t h a t c o u ld r e f l e c t e i t h e r (a) th e r a t e of grow th o f t h e
economy, o r (b) th e r a t e of f l u c t u a t i o n s i n th e l e v e l of
economic a c t i v i t y , o r a c o m b in atio n of b o t h . P io n e e r work
i n t h i s d i r e c t i o n was a c h ie v e d by Simon Newcomb, i n 1885,
upon whose work I r v i n g F i s h e r e l a b o r a t e d some t w e n ty - f i v e
y e a r s l a t e r . 1
These more modern v e r s i o n s s t i l l r e g a r d e d M
( i n c l u d i n g c u rre n c y and c h ec k s) as th e dom inant i n f l u e n c e
on P, b u t a c c e p te d t h e p o s s i b i l i t y t h a t t h e v e l o c i t y o f M
and th e volume o f t r a d e ( i n c l u d i n g p r o d u c tio n ) may, w ith in
c e r t a i n l i m i t s , a l s o p la y a r o l e in p r i c e ch an g e s. T his
t h e o r e t i c a l developm ent was f o r m a l iz e d in Newcomb's and
F i s h e r ' s " e q u a tio n o f e x c h a n g e ."
F i s h e r ' s E q u a tio n o f Exchange
F o r the p u rp o s e o f t h i s P a r t , I , F i s h e r 's The P ur
c h a s in g Power of Money— r e g a r d e d by some a s th e c l a s s i c
s t a te m e n t o f th e q u a n t i t y t h e o r y 2— w i l l s e r v e w e ll a s th e
B o u l t o n , op. c i t . . p p . 192-93 J A. C. L. Day and
S t e r i e T. B eza, Money and Income (New York: Oxford U n iv e r
s i t y P r e s s , i 960) , p. 277.
2A lb e r t G a i lo r d H a rt and P e t e r B. K enen, Money,
Debt and Economic A c t i v i t y ( 3 r d . e d . ; Englewood C l i f f s ,
N. J . : P r e n t i c e - H a l l , I n c . , 1 9 6 1 ), p . 178.
32
p o in t o f d e p a r tu r e f o r a d i s c u s s i o n of how M, by i t s e l f ,
can a f f e c t P .^
Terms and D e f i n i t i o n s
A ccording t o F i s h e r , th e l e v e l o f P depends most
d i r e c t l y on t h r e e c h i e f m a g n itu d e s : M, w hich s ta n d s f o r
th e q u a n t i t y o f money i n c i r c u l a t i o n , V, f o r th e v e l o c i t y
of c i r c u l a t i o n ( i . e . , th e a v e ra g e number o f tim e s a y e a r
t h a t M i s exchanged f o r g o o d s ) , and T, th e volume o f t r a d e
or b u s i n e s s ( i . e . , th e amount of goods p u r c h a s e d w ith M,
i n c l u d i n g goods c u r r e n t l y p ro d u c e d ) . 2
To be c o m p le te , two more m ag n itu d es sh o u ld be added
t o th e s e " d i r e c t i n f l u e n c e s " on P : M' and V?, which s t a n d ,
r e s p e c t i v e l y , f o r t o t a l d e p o s i t s s u b j e c t t o t r a n s f e r by
check, and t h e i r v e l o c i t y . T his acknow ledges th e f a c t t h a t
" c r e d i t a c t s on P in th e same m anner as m o n e y . "3
F i s h e r r e l a t e s t h e s e b a s i c m a g n itu d e s in h i s
famous E q u a tio n o f Exchange as f o l l o w s : M V + M'V' =X pQ =pT.
To s i m p li f y d i s c u s s i o n o f th e q u a n t i t y th e o r y and th e
e q u a tio n of e x c h a n g e , i n t h i s s tu d y M and V w i l l a l s o s ta n d
■^Fisher, op. c l t . See a l s o summary o f th e t r a n s
a c t i o n s model o f th e e q u a t io n of exchange i n L e s te r V.
C h a n d le r, An I n t r o d u c t i o n t o M onetary Theory (New York:
H arper & B r o t h e r s , 1 9 4 0 ), pp. 2 1 -4 5 .
2F i s h e r , op. c i t . , p. 1 4 , 152, 155.
3I b i d . , p. 48, 74 -8 9.
33
f o r M' and V' ( u n l e s s o th e rw is e s p e c i f i e d ) ; th e e q u a t io n o f
exchange w i l l be g e n e r a l l y s t a t e d as M V = PT.^
An a p p ro x im a tio n to r e a l i t y . — I t i s e s s e n t i a l to
e x p la in i n what se n s e F i s h e r re g a r d e d M, V and T a s the
" c a u s e s " o f changes i n P , and as th e " o n ly d i r e c t
i n f l u e n c e s " on P. F i s h e r r e p e a t e d l y acknow ledged th e
e x i s t e n c e of "m y riad s" o f " i n d i r e c t " i n f l u e n c e s on P ( o t h e r
th a n M, V and T) which a re n o t e x p l i c i t l y i n c lu d e d in th e
e q u a tio n o f exchange b u t which n e v e r t h e l e s s " a c t th ro u g h "
M, V and T to i n f l u e n c e P . 2 These i n d i r e c t i n f l u e n c e s
ran g e from i n s t i t u t i o n a l p a t t e r n s a f f e c t i n g t h r i f t , f in a n c e ,
and paym ents, t o such s t r u c t u r a l e le m e n ts as p o p u l a t i o n ,
t r a n s p o r t a t i o n , te c h n o lo g y , r e s o u r c e s , and p r o d u c t i o n of
m onetary m e t a l s .
The t h r e e b a s i c c a u se s o f changes in P ( ^ P ) , w hich
"a lo n e a f f e c t t h e p u r c h a s in g power of m oney," F i s h e r
r e g a r d e d as b e in g m ere ly th e " e f f e c t s o f a n te c e d e n t c a u s e s "
l y in g e n t i r e l y o u t s i d e o f th e e q u a t io n of e x c h a n g e . The
o n ly re a s o n F i s h e r o m itte d th e a n te c e d e n t c au se s from h i s
e q u a tio n o f exchange i s t h a t th e y c an n o t d i r e c t l y
i n f l u e n c e P b u t may a f f e c t i t o n ly v i a M, V and T. By
W i s h e r b e l i e v e d t h a t M 'V behav ed very s i m i l a r l y ,
o v e r th e long r u n , t o MV, a lth o u g h in t h e s h o r t r u n he
acknow ledged t h i s "no rm al" r e l a t i o n s h i p tend ed t o weaken.
2F is h e r , op. c i t . , pp. 7 4 -8 9 , 149-50.
34
means of h i s e q u a tio n o f exchange F i s h e r b e l i e v e d he was
" s i m p li f y i n g " th e p ro b le m , by i s o l a t i n g M, V and T as th e
most "p ro x im a te " c au ses th ro u g h w hich a l l i n d i r e c t o r
a n te c e d e n t c a u se s must o p e r a t e .
A World o f "E xchange"
Why does F i s h e r r e l a t e M, V, T and P i n th e
s p e c i f i c form s t a t e d by h i s e q u a tio n M V = PT? The answ er
i s t h a t th e e q u a t io n of exchange i s a m odel o f a w o rld o f
"exchange" o r " t r a n s f e r s " o f w e a lth and g o o d s, a w orld in
which p e o p le engage o n ly i n " p u rc h a s e and s a l e " (exchange)
t r a n s a c t i o n s , and in w hich the s o l e f u n c t i o n of money,
t h e r e f o r e , i s t o " c i r c u l a t e " o r be exchanged f o r g o o d s.
T h is model im p l i e s t h a t p e o p le do n o t d e s i r e M f o r i t s own
sa k e b u t spend i t as soon as r e c e i v e d , and t h e r e f o r e do n o t
h o ld any i d l e b a la n c e s ( i . e . , v e l o c i t y i s i n f i n i t e ) . ^
The o nly e x c e p ti o n i s t h e s t a b l e amounts o f "money and
d e p o s i t s " which "c o n v e n ie n c e " has t a u g h t p e o p le t o "keep on
h a n d . " 2
I n t h i s w orld o f exchange and " t r a d e " t r a n s a c t i o n s
members o f th e community engage o n ly in e x ch a n g in g a stre a m
o f " r i g h t s in goods" f o r an e q u i v a l e n t s tre a m o f money or
1I b i d . , pp. 7, 1 3 , 153-54; G ard n er A ckley , M acro-
econom ic Theory (New York: M acm illan Company, 1 9 6 1 ), pp.
I l l , 119.
2
F is h e r , op. c i t . , p. 153*
35
money s u b s t i t u t e s , t h e l a t t e r which F i s h e r r e g a r d e d as th e
p r o c e s s o f money " c i r c u l a t i o n . 1 1
I t I s a p p a r e n t l y t h i s a s p e c t o f exchange t h a t
prom pted one w r i t e r t o n o te t h a t th e e q u a tio n o f exchange
I s a c t u a l l y a " s p e c i a l " t h e o r y , r e l e v a n t only t o a "pure
exchange" economy, where "b u y e rs w ith money c o n f r o n t
s e l l e r s w ith g o o d s, and th e p r i c e l e v e l re s p o n d s t o th e
p r e s s u r e o f t h e money t o t a l and th e w i l l i n g n e s s t o spend i t
on th e a v a i l a b l e g o o d s. " 1 Thus i t does n o t r e f e r p r i m a r i l y
to th e f a m i l i a r " p r o d u c tio n economy" o f th e t e x t b o o k s , in
which m arket p r i c e s r e c e i v e d f o r c u r r e n t l y pro d u ced goods
s u b s t a n t i a l l y " r e f l e c t c o s t s and move w ith them." 2 And, i t
may be a d d ed , where P a l s o r e f l e c t s demand c o n d i t i o n s .
Hence th e t r u i s m . — The e q u a t io n o f exchange t h e r e
f o r e emerges In F i s h e r ' s hands as a " s ta te m e n t i n m athe
m a t i c a l form" o f t h e s e two s t r e a m s , of goods and money,
which c o n s t i t u t e t h e a g g re g a te of exchange t r a n s a c t i o n s
e f f e c t e d In th e community d u rin g a g iv e n tim e p e r i o d . 3
S i d n e y W e in tra u b , A G e n e ra l Theory o f th e P r i c e
L e v e l, O u tp u t, Income D i s t r i b u t i o n , and Economic Growth
( P h i l a d e l p h i a : C h ilto n Company, 1 9 5 9 ), p. 2.
2I b i d .
3The f o l lo w in g i s b a se d on F i s h e r , op. c i t . , pp.
1 5 -1 7 , 152, 169.
36
The l e f t s i d e of th e e q u a tio n o f exchange ( th e
"money s i d e " ) , w hich r e p r e s e n t s th e t o t a l amount o f money
p a i d o u t i n a l l ex ch an ge t r a n s a c t i o n s , i s th u s " e q u i v a l e n t "
t o th e r i g h t s id e ("g o o d s s i d e " ) r e p r e s e n t i n g th e t o t a l
v a lu e o f goods p u r c h a s e d i n such t r a n s a c t i o n s ( i . e . , the
q u a n t i t y o f goods ex changed m u l t i p l i e d by t h e i r r e s p e c t i v e
p r i c e s ) .
Thus th e e q u a t io n o f exchange "by i t s e l f " does n o t
say what c a u se s w h a t, b u t i s m ere ly an " a l g e b r a i c r e l a t i o n "
t h a t i s n e u t r a l . Any t h e o r i e s of " c a u s e s " o f p r i c e changes
b ased on t h i s e q u a tio n of exchange ( e . g . , by u s i n g i t s
v a r i a b l e s as a v e h i c l e f o r expounding th e q u a n t i t y t h e o r y ) ,
F i s h e r b e l i e v e d , m ust a w a it th e su b s e q u e n t use of
d e d u c tiv e and i n d u c t i v e r e a s o n i n g , and t h e use o f s p e c i a l
a ssu m p tio n s c o n c e rn in g th e b e h a v io r o f i t s v a r i a b l e s .
How Can M, V, and T A f f e c t P ?
I t i s i m p o r t a n t , f i r s t of a l l , t o s t r e s s a g a in th e
v a lu e e q u iv a le n c e betw een b o th s i d e s of F i s h e r ’ s e q u a tio n
o f ex ch an g e: t h e r e i s an " i d e n t i t y " or t r u i s t i c r e l a t i o n
betw een t h e e x p e n d i tu r e s (money) s i d e and th e r e c e i p t s
(goods) s i d e . I n o t h e r w o rd s, th e e q u a tio n of exchange
sim ply s t a t e s t h a t in a l l p u rc h a se t r a n s a c t i o n s , th e money
e x p e n d i t u r e s a r e e q u i v a l e n t i n v a lu e t o what th e y buy. In
c o n se q u e n c e , any change in th e v a lu e of one s i d e n e c e s s i
t a t e s a m e c h a n ic a lly e q u i v a l e n t change in th e v a lu e of th e
37
o t h e r s i d e , i n th e same d i r e c t i o n . F o r e x am p le , i f M V
d o u b le s i n v a l u e , so a u t o m a t i c a l l y does P T .1
M e ch a n ica l m u t u a l i t y . — These "m u tu al" r e l a t i o n s h i p s
e x te n d , as w e l l , t o e a c h o f th e f o u r b a s i c m ag n itu d es o r
v a r i a b l e s . T hat i s , no m a t t e r how much any one of th e f o u r
v a r i a b l e s may ch an g e, th e e q u a tio n o f exchange i n a l l c a s e s
"must be f u l f i l l e d " by a p p r o p r i a t e co m p e n sa tin g o r
o f f s e t t i n g changes in one o r more of t h e o t h e r t h r e e
v a r i a b l e s .
F o r exam ple, d o u b lin g of M a lo n e i n v o l v e s n e c e s
s a r i l y a d o u b lin g of P, p ro v id e d V and T "re m a in the sam e."
I f , in t h i s c a s e , P does n o t change, th e n T m ust double
( w ith V s t a y i n g c o n s t a n t ) . A gain, i f P and T b o th rem ain
u n ch an g ed , th e n V must be re d u c e d by h a l f t o o f f s e t th e
d o u b lin g of M.
As F i s h e r sum m arized i t , in h i s famous th r e e
th e o re m s: th e p r i c e l e v e l as a whole must v a ry (a) p r o
p o r t i o n a l l y w ith M, (b) p r o p o r t i o n a l l y w ith V, or (c)
i n v e r s e l y w ith T , o r i n v a r i o u s c o m b in a tio n s o f th e s e
c a u s a l movements.
P r i c e s must be f l e x i b l e . — F i s h e r ' s m odel th us
i m p l i e s t h a t P must be p e r f e c t l y f l e x i b l e i n b o th
d i r e c t i o n s . F o r exam ple, i f members o f a community who
-^-For th e f o l lo w in g se e i b i d . , pp. 1 8 -1 9 , 157.
n o rm a lly h o ld no I d l e c a sh b a la n c e s (b e c a u se th e y a u to
m a t i c a l l y spend a l l t h e i r money r e c e i p t s on goods and
s e r v i c e s ) changed t h e i r minds a b o u t s p e n d in g , and d e s i r e d
i n s t e a d t o add t o t h e i r s to c k s o r h o ld in g s o f money,
th e r e b y sp e n d in g l e s s th a n p r e v i o u s l y f o r th e p u rc h a s e o f
goods and r e d u c in g t h e v e l o c i t y o f c i r c u l a t i o n , t h e n ( i f
s e l l i n g p r i c e s a re f l e x i b l e ) no g e n e r a l e x c e s s of su p p ly
ov er money demand f o r goods c o u ld r e s u l t . In t h i s c a s e ,
f l e x i b i l i t y o f p r i c e s would a s s u r e an a u to m a tic and
s im u lta n e o u s drop i n p r i c e s (b e c a u se o f e x c e s s su p p ly )
s u f f i c i e n t t o s t i m u l a t e a r i s i n g demand t o c l e a r th e
m ark et o f th e u n p u rc h a se d goods.
S i m i l a r l y , i f p u r c h a s e r s should a t some l a t e r
d a te d is g o r g e i d l e c a sh b a la n c e s p r e v i o u s l y h e l d , th e n P
must s im u lta n e o u s ly r i s e s u f f i c i e n t l y t o ab so rb th e e x c e s s
o f money demand o v e r su p p ly a t th e p r e v i o u s l y low er l e v e l
of P . 2
The r o l e o f v e l o c i t y . — N o rm ally , how ever, t h i s
quant i t y - t h e o r y model had no room f o r any h o ld in g o r d i s
g o r g in g of i d l e cash b a l a n c e s , w ith t h e i r c o rre s p o n d in g
A c k l e y , 0£ . c i t . , p . 111.
2I b i d . , p. 112 .
39
changes i n V. As a c o n se q u e n c e , th e so u rc e o f f l u c t u a t i o n s
i n P c o u ld only be t r a c e d to changes i n M.^
F o r exam ple, i f someone d i s c o v e r e d a q u a n t i t y o f
v a lu a b le g o ld c o in s i n h i s a t t i c , he would be presum ed t o
spend i t im m e d ia te ly ( r a t h e r th a n h o ld i t i d l e ) , t h e r e b y
a u t o m a t i c a l l y c a u sin g money p r i c e s o f e x i s t i n g goods
su p p ly t o r i s e in d i r e c t p r o p o r t i o n to t h i s i n c r e a s e i n M.
However, th e q u a n t i t y th e o ry a l s o had to acknow
le d g e th e p o s s i b i l i t y t h a t some cash b a la n c e s would
n o rm a lly have t o be " h e ld " (not s p e n t) by members of a
m oney -u sin g economy. In th e r e a l w o rld , i n d i v i d u a l s who
spend money may be presum ed t o have f i r s t r e c e iv e d such
money i n payment f o r p r o d u c t i v e s e r v i c e s r e n d e re d by them ;
th e y th e n spend only p a r t of t h i s money income each su b
se q u e n t day ( r e t a i n i n g t h e b a la n c e in c a sh ) u n t i l th e n e x t
p a y -d a y . In t h i s k in d o f an economy, i n d i v i d u a l s do n o t
h o ld c ash f o r i t s own sake b u t only t o " b r id g e a gap in
tim e betw een r e c e i p t s and outpaym ents o f f u n d s ."
V e l o c i t y r e l a t e d t o t r a n s a c t i o n s . — T h is demand f o r
c ash may be term ed a " t r a n s a c t i o n s dem and," I n d i c a t i n g t h a t
c a sh i s h e ld o nly i n o r d e r t o co n d u ct th e n e c e s s a r y t r a n s
a c t i o n s , n o t only by i n d i v i d u a l s b u t by b u s i n e s s f ir m s as
1The f o l lo w in g i s b ased on i b i d . , pp. 112-19;
F i s h e r , op. c i t . , p p . 152-*!; Day and B eza, op. c i t . . pp.
279- 80.
* 1 0
w e ll. The e f f e c t o f h o l d in g such cash b a la n c e s i s t o slow
down what would o th e r w is e be an i n f i n i t e V; n e v e r t h e l e s s ,
once i t h as o c c u r r e d , V rem ain s a t a c o n s ta n t l e v e l .
T h is m a t t e r of h a n d lin g c ash betw een in c o m e - r e c e ip t
p e r io d s may be d e s c r i b e d from two v ie w p o in ts : (a) from
p o in t o f view o f t h e v e l o c i t y , o r r a t e o f sp e n d in g o f money
r e c e i v e d , and (b) from p o i n t of view o f th e le n g t h o f time
m o n e y - r e c e ip ts a re h e ld a s cash b a la n c e s ( f o r t r a n s a c t i o n s
p u rp o s e s ) b e fo re th e y a re a c t u a l l y s p e n t. But t h e s e two
view s a r e m erely a l t e r n a t e ways of d e s c r i b i n g th e same
phenomenon, a lth o u g h th e l a t t e r c o n s t i t u t e s a s w itc h of
em phasis from m e c h a n ic a lly p u rsu e d t r a n s a c t i o n s t o p sy ch o
l o g i c a l l y m o tiv a te d r e a s o n s f o r h o ld in g M.
Mechanism as a fram ew ork. — I t would seem F i s h e r
chose h i s words c a r e f u l l y i n s t a t i n g t h a t h i s e q u a tio n of
e x ch an g e, when view ed m ere ly as an a l g e b r a i c s ta te m e n t
(not as a c a u s a l t h e o r y ) , r e p r e s e n t e d a "mechanism” o f
exch an g e. T ru e , t h i s m echanism , w hich he f i r s t e l a b o r a t e s
as a t r u i s m , em erges l a t e r as framework f o r a f u l l- b l o w n
th e o ry t h a t he d e fe n d e d as f o llo w in g in th e t r a d i t i o n of
th e " g r e a t e s t g e n e r a l i z a t i o n s " of th e p h y s i c a l s c i e n c e s ,
and one w h ic h , when " d u ly su p p lem en ted by s p e c i f i c d a t a , "
t r a n s c e n d s th e l i m i t a t i o n s o f mere t r u is m and becomes a
"most f r u i t f u l " s o u rc e o f " m e c h a n ic a l" k n o w led g e.^
•^Fisher, op. c i t . , pp. 71* 157*
41
But f o r F i s h e r th e m e c h a n is tic t r u is m i t s e l f h as t h e u s e f u l
p u rp o se of s e r v i n g , a s a c o n v e n ie n t way of lo o k in g a t th e
complex economic system i n term s o f f a c t o r s t h a t c o u ld
i n f l u e n c e P.
S t r i c t l y Long-Run Approach
I t i s e v id e n t from F i s h e r 's a n a l y s i s o f lo n g - r u n
p r i c e movements s i n c e th e y e a r 1200, i n c o n t r a s t t o h i s
t r e a tm e n t of p r i c e movements d u r in g " t r a n s i t i o n " o r
c y c l i c a l p e r i o d s , t h a t he meant h i s th e o r y t o a p p ly p r i
m a r ily t o th e lo n g r u n . 1 I t i s o v e r th e long run t h a t we
can d i s c e r n how M behaves as th e c h i e f d e te rm in a n t of
changes i n P. The main re a s o n he gave was h i s b e l i e f t h a t
" n o rm a lly " V and T te n d to rem ain unchanged, so t h a t th e
r e l a t i o n betw een changes i n M ( a m ) and changes i n P ( A P )
i s re a s o n e d to be d i r e c t and p r o p o r t i o n a l .
F i s h e r b a s e d t h i s b e l i e f on two t h i n g s : a good
d e a l o f a p r i o r i r e a s o n in g ( in h i s C h a p te r v i i i ) and on
s t a t i s t i c a l s t u d i e s by h i m s e l f and o t h e r s on p r i c e move
m e n ts , and on changes i n M, V and T.
F i s h e r 's r e s e r v a t i o n s . — As a lr e a d y i n d i c a t e d ab ove,
F i s h e r was f u l l y aware o f a l t e r n a t i v e s o u rc e s of i n f l u e n c e
■^For th e fo llo w in g s e e , i n th e o r d e r i n d i c a t e d ,
F i s h e r , i b i d . , p p . 14, 320, 149-83, 234-318, 21, 158, 234,
i x , 56, Fo7 ~159- 6l , 321, 56, 60, 71, 159, 274-75, 246-47,
263.
42
on P; n o r d i d he b e l i e v e t h a t th e d o u b lin g of M w ould
alw ays c a u se a d o u b lin g of P. He e x p l i c i t l y c a u tio n e d t h a t
M i s only one of t h r e e f a c t o r s , a l l " e q u a l ly im p o r ta n t" in
d e te r m in in g th e l e v e l o f P. On o c c a s io n he would even
rem ind th e r e a d e r i t was " a b s u rd " to e x p e c t " e x a c t"
c o rre s p o n d e n c e betw een AM and A P , In d e e d , he a s s e r t e d
t h a t the q u a n t i t y t h e o r y "does n o t deny" t h a t , e v e n w hile
M i s i n c r e a s e d , o t h e r causes may a l s o s e r v e to i n f l u e n c e M,
V and T, and thu s " n e u t r a l i z e " th e d i r e c t e f f e c t o f M on P.
T r a n s i t i o n p e r io d s an e x c e p t i o n . — In h i s P r e f a c e ,
F i s h e r b r i e f l y s t a t e d t h a t M n o t only a f f e c t s P b u t a ls o
p ro d u ce s " a l t e r n a t e c r i s e s and d e p r e s s io n s o f t r a d e " and
t h e " e v i l s " o f m o n etary " i n s t a b i l i t y . " I t was m a in ly
d u r in g such " t r a n s i t i o n " or c y c l i c a l p e r i o d s of m arked
changes i n P t h a t t h e "perm anent" o r " u l t i m a t e " r e l a t i o n
s h i p s (betw een M and P, and t h e tandem r e l a t i o n betw een M
and M*) b ro k e down, t o give way t o " c h a r a c t e r i s t i c " changes
i n M ', V! a n d T as w e l l .
F o r exam ple, F is h e r c la im e d t h a t i n c r e a s e d M d u rin g
a p e r io d o f r i s i n g p r i c e s s t i m u l a t e d a r i s e In T. In
a d d i t i o n , c y c l i c a l v a r i a t i o n s in P a p p e a re d to be dom inated
by v a r i a t i o n s i n b a n k in g c r e d i t . T hus, i n t r a n s i t i o n
p e r i o d s , I n c r e a s e d M n o t only a f f e c t e d P b u t M’ , V, V' and
T as w e ll. F u rth e rm o re , he acknow ledged t h a t ch an g e s In
M*, V, V1 and T a l s o c o n t r i b u t e d to changes In P. In d e e d ,
t h e s e v a r i a b l e s a l s o a f f e c t e d th e r a t e o f i n t e r e s t , whose
" p e c u l i a r " la g g in g b e h a v io r d u rin g th e c y c le F i s h e r
r e g a r d e d a s "m ainly r e s p o n s i b l e " f o r " c r i s e s and
d e p r e s s i o n s ."
F i n a l l y , F i s h e r a l s o s t a t e d t h a t th e c h a r a c t e r
i s t i c a l l y " o s c i l l a t i n g " t r a n s i t i o n p e r i o d was t h e r u l e
r a t h e r th an t h e e x c e p t i o n , and t h a t t h e mechanism of
exchange was alm ost alw ays i n a "dynam ic r a t h e r th a n a
s t a t i c c o n d i t i o n ."
F i s h e r t h e r e f o r e co n clu d ed t h a t th e q u a n t i t y th e o r y
would n o t h o ld " s t r i c t l y and a b s o l u t e l y " d u rin g t r a n s i t i o n
p e r i o d s , and t h a t th e s t r i c t l y p r o p o r t i o n a l e f f e c t on P of
an i n c r e a s e in M i s to be r e g a r d e d as th e "norm al" or
" u l t i m a t e " e f f e c t o n ly a f t e r t h e t r a n s i t i o n p e r i o d i s o v e r.
L ong-run e x c e p t i o n s , t o o . — The long r u n , to o ,
p r o v id e d e x c e p tio n s t o F i s h e r ' s lo n g - r u n a p p ro a c h . Although
he had n o te d t h a t o v e r th e lo n g span from th e y e a r 1500 th e
ten d e n cy o f i n c r e a s e d M to cau se r i s e s i n P w as, f o r him,
th e p red o m in an t f a c t o r , F i s h e r a l s o n o te d t h a t d u rin g th e
s u b - p e r io d o f th e n i n e t e e n t h c e n tu ry t h e broad upward and
downward movements i n P were a l s o s u b s t a n t i a l l y a s s o c i a t e d
w ith th e r i s i n g "volume of b u s i n e s s " ( o r T ), w hich he
a t t r i b u t e d m ain ly t o th e gro w in g r o l e o f modern b a n k in g ,
c r e d i t and d e p o s it c u r r e n c y , and t o v a r i a t i o n s i n th e
p r o d u c tio n and u se o f g o ld and s i l v e r f o r m on etary p u rp o se s.
On b a l a n c e , F i s h e r d i s c e r n e d i n the n i n e t e e n t h
c e n tu r y m ostly a " r a c e ” betw een th e r i s e in M and M * , on I
th e one hand, and th e i n c r e a s e in t r a d e (T ). At th e same
t i m e , how ever, he c o n s id e r e d the r i s e i n T as b e in g r a t h e r 1
" s t e a d y . " As f o r V, he b e l i e v e d t h i s v a r i a b l e had changed !
i
i
i n even "much l e s s d e g re e" th a n T d u r in g th e p r e c e d in g i
c e n t u r y , and t h a t u n d e r " o r d i n a r y c ir c u m s ta n c e s " v e l o c i t y
I
o f M c o u ld r i s e o n ly " s l i g h t l y , " w i t h i n the l i m i t s s e t by
th e i n c r e a s e in M. He t h e r e f o r e c o n clu d ed i t was more
f r u i t f u l t o pay " c h i e f a t t e n t i o n " t o v a r i a t i o n s in M and M'
a s th e d e te r m in a n ts of c h an g e s in P.
From T ru ism to T heory
F i s h e r Ts seem in g ly ambiguous comments on th e p o s tu
l a t e d p r o p o r t i o n a l r e l a t i o n betw een M and P i s a c t u a l l y
more a p p a re n t t h a n r e a l . F o r F i s h e r p ro c e e d e d t o d e v o te
h i s e n t i r e C h a p te r v i i l t o " j u s t i f y i n g " the q u a n t i t y
th e o r y as " e x p r e s s in g a c a u s a l as w e l l as an a l g e b r a i c
r e l a t i o n . ■
J u s t i f i c a t i o n of h i s t h e o r y . — In s u c c e s s i o n , he
r e a s o n s through t h e p o s s i b l e ( o r im p u ta b le ) u l t i m a t e
^The f o l lo w in g i s b a s e d on i b i d . , pp. 151-59*
1 6 9 -7 4 , 261-63, 2 9 7 -9 8 , 3 0 7 ; H a r t, op. c i t . , p p . 178-79. 1
See a l s o H a r t, op . c i t . t p p . 135-37 f o r a d i s c u s s i o n of
th e b ro a d s i m i l a r i t y of lo n g - r u n movements i n M and P,
a f t e r a d ju stm e n t o f M f o r t h e grow th o f T.
e f f e c t s o f ch an ges i n t h e f o u r m ajo r v a r i a b l e s upon each
o t h e r , and f i n a l l y f e e l s v i n d i c a t e d in a s s e r t i n g th e
f o l lo w in g b a s i c p re m is e s r e q u i r e d by h i s v e r s i o n o f th e
e q u a t io n o f ex ch an ge: t h a t M' g e n e r a l l y changed in p r o
p o r t i o n t o M; t h a t b o th V and VT were " n o rm a lly " n o t
a f f e c t e d by changes in M, but were " in d e p e n d e n t" o f b o th
M and M*; and t h a t T was n o t a t a l l a f f e c t e d by M e x c e p t
d u rin g th e " t r a n s i t i o n " p e r i o d s . F u r t h e r , M, M ', V and V'
were e a c h a b le t o u l t i m a t e l y a f f e c t P; o nly T f a i l e d t o do
th e same. F i n a l l y , F i s h e r a s s e r t e d , P i t s e l f was n o t only
n o rm a lly in c a p a b l e o f b e in g an in d e p e n d e n t cause o f changes
in th e o t h e r v a r i a b l e s , b u t i s e s s e n t i a l l y ( u l t i m a t e l y )
" a b s o l u t e l y p a s s i v e , " no more th a n an " e f f e c t . "
T his p a s s i v i t y o f P, how ever, seems a p p l i c a b l e o n ly
t o th e long r u n . In th e s h o r t r u n , F i s h e r acknow ledges
t h a t P can be p r e t t y a c t i v e , a b le t o c au se r e a c t i o n s i n V,
T and even M i t s e l f . I n d i s c u s s i n g th e paper-m oney i n f l a
t i o n s o f th e p a s t , F i s h e r p o i n t s t o a d i r e c t r e l a t i o n
betw een " c o n fid e n c e " i n th e p u r c h a s in g power o f M and p r i c e
e x p e c t a t i o n s o r " a n t i c i p a t i o n s . "
For e x am p le , F i s h e r r e a s o n s t h a t e x p e c t a t i o n s o f
m onetary d e p r e c i a t i o n in d u c e owners o f money t o spend i t
f a s t e r and g o o d s - s e l l e r s t o h o ld goods l o n g e r , t h e r e b y
l e a d in g to i n c r e a s e d V and re d u c e d T, w hich in t u r n cau se
th e e x p e c te d r i s e in P. T hus, i n p e r io d s of p r i c e f lu x
46
(up o r down), p r i c e e x p e c t a t i o n s a p p e a re d t o F i s h e r t o be
th e f o c a l p o i n t s o f in d u ced movements i n V ( in t h e same
d i r e c t i o n ) and i n T ( in th e o p p o s ite d i r e c t i o n ) . N e v e rth e
l e s s , F i s h e r c o n c lu d e d t h a t i t was changes in M t h a t la y a t
th e r o o t of e x p e c t a t i o n s , and c o n s t i t u t e d th e " r e a l "
mechanism w orkin g to cause r i s e s i n P.
With r e s p e c t t o " t r a n s i t i o n " p e r i o d s , p r i c e s
behaved no l e s s a c t i v e l y . In th e s e p e r i o d s of " d i s t u r b
a n c e ," F is h e r n o t e d , r i s i n g p r i c e s can th e m s e lv e s g e n e r a te
a r i s i n g demand f o r bank lo a n s and new money.
U ltim a te ly money d o m in a te s . — S t a t e d a n o th e r way,
F i s h e r j u s t i f i e s h i s c la im t o s c i e n t i f i c g e n e r a l i z a t i o n as
f o l lo w s : d e s p i t e th e o p e r a t io n of o t h e r i n f l u e n c e s on P
(which may " n e u t r a l i z e " th e e f f e c t of M on P ) , i n s o f a r as
M "by i t s e l f " i s c o n c e rn e d , i t s u l t i m a t e e f f e c t on P i s
s t r i c t l y p r o p o r t i o n a l , a lth o u g h t h i s p r o p o r t i o n a l e f f e c t
may be d i s g u i s e d by or "b le n d e d w ith" t h e e f f e c t s of V, V*
and T— " j u s t as th e e f f e c t s of g r a v i t y on a f a l l i n g body
a re b le n d e d w ith th e e f f e c t s o f r e s i s t a n c e of a tm o s p h e re «"
In o t h e r w ords, in d e p e n d e n t changes in V and T can only
d i s g u i s e , b u t n o t d e s t r o y , th e u n d e r l y i n g p r o p o r t i o n a l
r e l a t i o n s h i p betw een M and P.
T h is r e a s o n i n g i s b a se d on F i s h e r ' s s p e c i a l c o n c e p t
of th e economy a s a n etw o rk of e x c h a n g e s. Thus i t seemed
p l a u s i b l e f o r him t o p ro c e e d from i n d u c t i v e knowledge of
I n d i v i d u a l exchange p r o c e s s e s t o th e a g g r e g a tio n o f
s o c i e t y ' s t o t a l exchange t r a n s a c t i o n s , on th e b a s i s of
which he could " re a s o n out d e d u c tiv e ly th e g e n e r a l e q u a tio n
of e x c h a n g e ." T h is e q u a tio n o f e x c h a n g e , p u re ly by i t s e l f ,
does n o t " c o m p le te ly " e s t a b l i s h a q u a n t i t y th eo ry f o r
F i s h e r , b e ca u se i t does n o t r e v e a l which v a r i a b l e s a re
ca u se s and which a re e f f e c t s . F o r F i s h e r , i t was only by
means o f a p r i o r i r e a s o n i n g , a s i n h i s C h a p te r v i i i , t h a t
the c a u s a l r e l a t i o n s h i p s c o u ld be drawn out of th e m erely
" a l g e b r a i c r e l a t i o n " a n d , i n t h i s f a s h i o n , a ls o be
" p ro v e d ."
To use th e analog y g iv en by F i s h e r h i m s e l f , the
"law o f d i r e c t p r o p o r t i o n " betw een M and P may behave in
r e a l l i f e no more i n e x a c t l y th a n B o y l e 's law of d i r e c t
p r o p o r t i o n betw een d e n s i t y and p r e s s u r e . As an exam ple of
h is own "law" i n o p e r a t i o n , F i s h e r o f f e r s h i s d e t a i l e d
s t a t i s t i c a l a n a l y s i s o f th e p e r i o d 1896-1909. A cco rd in g t o
F i s h e r , th e t w o - t h i r d s r i s e in P r e g i s t e r e d in t h i s p e r io d
o c c u rr e d d e s p i t e th e g r e a t i n c r e a s e in T only b e c a u se of
the g r e a t e r i n c r e a s e i n M and M ', w ith a s m a ll a s s i s t from
V and V*.
I m p l i c a t i o n s and E v a l u a t i o n s
F or th e q u a n t i t y t h e o r y — as o r i g i n a l l y c o n c e iv e d —
to have s i g n i f i c a n c e o r r e l e v a n c e , i t must be a b le t o show
48
why th e e x p l i c i t r e l a t i o n betw een M and P i s d i r e c t and
p r o p o r t i o n a l .
I n s t i t u t i o n s and P r i c e F l e x i b i l i t y
In th e q u a n t i t y t h e o r y 's w o rld o f exchange t r a n s
a c t i o n s , th e d i r e c t and p r o p o r t i o n a l r e l a t i o n s h i p betw een
M and P can be m a in ta in e d o n ly under t h e s p e c i a l assump
t i o n s of g iv e n paym ents h a b i t s ; of g iv e n v e r t i c a l s t r u c t u r e
o f p r o d u c t i o n ; of p r i c e s p e r f e c t l y f l e x i b l e in b o th
d i r e c t i o n s . F u rth e rm o re , p e o p le must have no d e s i r e f o r
i d l e cash b a la n c e s ; t h e i r money s t a y s i n b a la n c e s only lo n g
enough t o make n e c e s s a r y t r a n s a c t i o n s paym ents; and i n s t i
t u t i o n a l f a c t o r s w hich d e te rm in e t h e s e minimum b a la n c e s a r e
a l s o g i v e n .^
Only un der such assu m p tio n s w i l l V behave as a
c o n s t a n t . What a b o u t T 's c o n sta n c y ? I f p r i c e s a re
p e r f e c t l y f l e x i b l e , t h e n T can always be presum ed t o h o v e r
a t t h e maximum (o r f u ll- e m p lo y m e n t) l e v e l s p e r m i t t e d by
te c h n o lo g y and the w i l l i n g n e s s o f th e community t o work.
^■For th e f o llo w in g s e e A ck ley , op. c i t . , pp. 117-18
S id ney W e in tra u b , C l a s s i c a l K e y n e s ia n ism , M onetary Theory
and t h e P r i c e L ev el ( P h i l a d e l p h i a ; C h i lt o n Company, 1 9 6 1 ),
p p . 75-8l» 9 8-99; K enneth K. K u r i h a r a , M onetary Theory and
P u b l i c P o lic y (New Y ork: W. W. N orton & C o ., 1 9 5 0 ), p. 21;
W e in tra u b , A G e n e ra l Theory . . . . N ote F i s h e r ' s own
i n t e r p r e t a t i o n of h i s book as a “r e c o n s t r u c t i o n " of the
q u a n t i t y t h e o r y , and h i s a p p ro a ch as b e in g " c o n s e r v a t iv e "
r a t h e r th a n " r a d i c a l . " F i s h e r , op. c i t . , p. v i i i .
t o *
49
At any g iv e n moment, t h e r e f o r e , th e l e v e l o f T (o r
s u p p ly ) can be ta k e n as " c o n s t a n t " or i n e l a s t i c . I t
f o llo w s t h a t , b ecau se V and T a re s t a b l e , P i s n e c e s s a r i l y
p r o p o r t i o n a l to M.
C i r c u i t o u s a p p ro a c h ?— Because th e e q u a tio n of
exchange c o n s t i t u t e s , in e s s e n c e , a f u r t h e r though f r u i t f u l
l i n k fo rg e d in a f a i r l y w e ll-w o rn , t r a d i t i o n a l c h ain of
d o c t r i n e on p r i c e d e t e r m i n a t i o n , r a t h e r t h a n an in d e p e n d e n t
d e p a r t u r e i n s e a rc h o f an a l t e r n a t i v e a p p ro a ch to p r i c e
phenomena, i t s t r i k e s some w r i t e r s as a c i r c u i t o u s approach.
Thus th ey have a s s e r t e d t h a t th e e q u a tio n o f exchange
a p p ro a ch i s u n r e l a t e d t o more modern views o f the p r i c e -
d e t e r m i n a t i o n p r o c e s s : e . g . , as a r e l a t i o n betw een t h e
s u p p ly and demand f o r money ( f o r v a r io u s u s e s ) and t h e
volume of p r o d u c t i o n , o r as a r e l a t i o n betw een c o s t s and
p r o f i t o r m ark-up m a rg in s .
A S p e c i a l Role f o r Money
As f o r money i t s e l f , th e s p e c i a l l y - a s s i g n e d r o l e i t
h a s assumed in the q u a n t i t y t h e o r y — as a medium of exchange
o r means o f paym ent, p r i m a r i l y , only to be s p e n t upon
r e c e i p t ( i n e f f e c t ) , w ith only a minimum o f s t a b l e t r a n s
a c t i o n s b a la n c e s h e l d by members of the community— n o t only
a s s u r e s an a u to m a tic te n d e n c y t o f u l l employment b u t a l s o
h e l p s u n d e rp in th e a s su m p tio n s o f c o n s ta n t V and s te a d y
g ro w th o f T.
50
This m odel n e c e s s a r i l y e x c lu d e s any speck o f th e
" s p e c u l a t i v e " m o tiv e f o r h o ld in g money, t h a t i s , o f t h e
d e s i r e t o h o ld cash i n a n t i c i p a t i o n of f u t u r e changes i n
p r i c e s o r th e r a t e of i n t e r e s t , which would t e n d t o re d u c e
th e v e l o c i t y o f c i r c u l a t i o n . Y e t, i t i s t h i s s p e c u l a t i v e
m o tiv e , f a c i l i t a t e d by th e " s t o r e - o f - v a l u e " f u n c t i o n of
money, t h a t i s c a p a b le of c a u sin g " v o l a t i l e " f l u c t u a t i o n s
n o t o n ly in t h e v a lu e o f money b u t in th e l e v e l o f econom ic
a c t i v i t y as w e l l . 1
I t may be t r u e t h a t th e " t r a n s a c t i o n s " m o tiv e i s
p red o m in an t in o u r d e s i r e t o h o ld cash b a la n c e s (as
assumed in th e F i s h e r v e r s i o n of th e q u a n t i t y t h e o r y ) , b u t ,
as W eintraub h a s a s s e r t e d , t h i s so u rc e o f demand f o r money
may i t s e l f depend on t h e l e v e l o f p r i c e s , p a r t i c u l a r l y in
an "age of I n f l a t i o n " such as e x p e r ie n c e d s in c e th e 1 9 3 0 's :
in such an e n v iro n m e n t, th e r i s e i n P may i t s e l f become a
2
so u rc e of t r a n s a c t i o n s demand.
F u rth e rm o re i In h i s " r e - s t a t e m e n t " o f t h e q u a n t i t y
t h e o r y , M. Friedm an has a s s e r t e d t h a t t h i s th e o r y has
become, above a l l , a t h e o r y of t h e demand f o r money (and
n o t o f th e p r i c e l e v e l ) , in which m onetary a s s e t s a re
view ed as only one way o f h o ld in g w e a lth . A ccording t o
■ ’ ■Kurihara, op. c i t . , p p . 12-13.
^ W e in trau b , C l a s s i c a l K e y n esia n ism . . . , p . 21.
51
F riedm an, th e demand f o r money i t s e l f c o n s t i t u t e s a complex
f u n c t i o n o f th e g e n e r a l p r i c e l e v e l , th e r a t e of i n t e r e s t ,
t o t a l w e a l t h , t o t a l incom e, te c h n o lo g y , and t a s t e s . 1
S t a b i l i t y of v e l o c i t y . — As a l r e a d y i n d i c a t e d ,
p r e d i c t a b i l i t y o f th e e f f e c t s of AM i n th e t r a n s a c t i o n s
model o f th e q u a n t i t y t h e o r y c l e a r l y depends on th e
n u m e ric a l " s t a b i l i t y " of V o v e r the long r u n , t h a t i s , on
w h e th er V resum es i t s "norm al" l e v e l a f t e r each t r a n s i
t i o n a l d i s t u r b a n c e . I f V i s t r u l y s t a b l e , th en changes i n
M can be e x p e c te d t o e x e r t s tr o n g p r e s s u r e s on P o r T. But
i f n o t , th e n th e t r a c i n g o f m onetary e f f e c t s on P t r u l y
becomes more c o m p le x .2
In f a c t , how ever, th e assumed s t a b i l i t y o f V was
n o t alw ays In e v id e n c e . D ata s in c e W orld War I , and
e s p e c i a l l y s in c e 1930, i n d i c a t e t h a t v e l o c i t y has f l u c t u
a te d c o n s i d e r a b l y . F u rth e rm o re , i f V can vary so
n o t i c e a b l y , th e n i t I s r e a s o n a b le t o i n t e r p r e t th e b e h a v io r
of M as b e in g " a d a p t iv e " a s w e l l as " c a u s a l " and d e t e r
m in in g .
H i l t o n F rie d m a n , "The Q u a n tity Theory o f Money—
A R e s ta te m e n t," i n M ilto n Friedm an ( e d . ) , S tu d i e s in t h e
Q u a n tity Theory o f Money (C hicago: U n i v e r s i t y o f Chicago
P r e s s , 1 9 5 6 ), p p . 4-14.
2 por th e f o l lo w in g see H a r t, o p . c i t . . pp. 179*
180-81; W e in tra u b , C l a s s i c a l K ey n esian ism . . . , p. 83 .
52
L o ng -run v s . s h o r t - r u n . — The c o n c e n t r a t i o n on th e
lo n g - r u n v ie w p o in t by th e q u a n t i t y th e o r y h a s been
a t t r i b u t e d m ainly t o th e p e c u l i a r te n d e n c y o f g e n e r a l
econom ic t h e o r y , b e f o r e World War I , t o work m o stly w ith
t h i s tim e p e r s p e c t i v e r a t h e r t h a n w ith th e s h o r t - r u n or
" t r a n s i t i o n a l " o n e , a lth o u g h th e l a t t e r was by no means
t o t a l l y i g n o r e d . 1
C ast in t h i s C l a s s i c a l tim e m old, i t was a l s o
n a t u r a l f o r th e q u a n t i t y th e o r y t o assume p e r f e c t p r i c e
f l e x i b i l i t y and an a u to m a tic te n d e n c y tow ard f u l l
em ploym ent.
B u t, as F i s h e r h im s e lf r e a l i z e d , t h e lo n g -r u n
ap p ro a ch y i e l d e d r e s u l t s t h a t d i d n o t n e c e s s a r i l y fo llo w
i n th e c a se o f s h o r t - r u n o r c y c l i c a l changes dom inated by
d i s t u r b a n c e o f norm al r e l a t i o n s h i p s , such a s betw een M and
P, and betw een M and Mf , and t h e em ergence o f V, V ' , T and
P i n t o more a c t i v e r o l e s . As a c o n seq u e n ce , w hereas th e
b ro a d p a t t e r n of p r o p o r t i o n a l r e l a t i o n s h i p betw een " l a r g e "
changes i n M and P may be t r u l y d i s c e r n i b l e o v e r th e long
r u n , i t was in th e s h o r t ru n t h a t th e q u a n t i t y t h e o r y
p ro v e d l e s s a b le t o p r e d i c t o r e x p l a i n th e c h a r a c t e r
i s t i c a l l y " s m a ll e r " changes in M.2
1Chandler, op. c i t . , p. ^7.
2H a rt, op. c i t . , pp. 1 35-37 .
53
U s e fu l Framework f o r A n a ly s is
The e q u a t io n of exchange and th e q u a n t i t y th e o ry
s t i l l r e c e i v e s a r i ° us a t t e n t i o n in a wide range of i n t r o
d u c to r y and advanced t e x t b o o k s , n o t o nly in money and
b a n k in g but i n m acroeconom ics g e n e r a l l y . T h is i s a p p a r
e n t l y a t r i b u t e t o th e f a c t t h a t , as one w r i t e r p u t i t ,
t h e e q u a tio n o f exchange p ro v id e s a " l o g i c a l fram ework"
f o r a r r a n g in g t h e a n a l y s i s and e x p o s i t i o n of a h o s t o f
u n d e r l y i n g f a c t o r s c a p a b le o f u l t i m a t e l y a f f e c t i n g P v i a
such key v a r i a b l e s as M, V, and T, and i t a l s o s e r v e s to
s t i m u l a t e stu d y on why M, V, and T behave a s th e y do and
th e " f a c t o r s b e h in d " th e e q u a tio n of exchange.^"
As a co nsequen ce of such f u r t h e r s t u d y , b o th
t h e o r e t i c a l and e m p i r i c a l , th e more r e c e n t v e r s i o n s o f th e
q u a n t i t y th e o ry s u b s t a n t i a l l y abandoned th e s p e c i a l
a ssu m p tio n s o f c o n s ta n t V and T, p a r t i c u l a r l y f o r th e
u n d e rs ta n d in g o f s h o r t - r u n o r c y c l i c a l e v e n t s . Thus i t has
been a s s e r t e d t h a t P no lo n g e r depends s o l e l y on M, n o r
must changes i n P n e c e s s a r i l y o r i g i n a t e i n M, n o r m ust
changes i n M a lw a y s c au se p r o p o r t i o n a l changes i n P,
b e c a u se changes i n V o r T may c o u n te r a c t o r o f f s e t t h e
presum ed e f f e c t s of M on P. In d e e d , a c c o rd in g t o one
•^Chandler, op. c i t . , p . 25. See a l s o th e d i s
c u s s io n on t h i s in K u r i h a r a , op. c i t . , pp. 14-20.
54
w r i t e r , few a p r i o r i g e n e r a l i z a t i o n s can any lo n g e r be
made c o n c e rn in g th e s h o r t r u n .'1 '
M ajor S h o rtco m in g j
I
P ro b a b ly th e m ost s e r i o u s d e f e c t of th e e q u a tio n of;
exchange ap p ro ach i s i t s m ajor i m p l i c i t a ssu m p tio n t h a t
money su p p ly (M) and goods su p p ly (T) a r e n o t in any way
c o n n ec te d w ith each o t h e r , t h a t th ey a re in d e p e n d e n t
v a r i a b l e s , and t h a t th e volume i n use o f each i s g o v e rn e d
by s e p a r a t e s e t s o f " o u t s i d e " f o r c e s h a v in g n o th in g i n
common w ith e ac h o t h e r . I t assumes t h a t money i t s e l f
e n t e r s th e economic system only v i a th e exchange p r o c e s s
and a f t e r th e p r o d u c tio n of goods has ta k e n p l a c e . Only
i n t h i s c o n te x t i s i t c o n c e iv a b le t h a t V to o can be i n d e
p e n d e n t of ( o r u n r e l a t e d to ) th e goods s id e of th e e q u a tio n ;
of e x c h a n g e .2
I t rem ained f o r th e " in c o m e - e x p e n d itu r e " a p p ro a c h — ;
more o r l e s s co n tem p oraneously d e v elo p ed und er th e i n f l u
ence o f W ic k s e ll , Keynes and o t h e r s — t o r e l a t e money more
i n t e g r a l l y to b a s ic c i r c u l a r flo w s o f th e economic s y s te m ,
th ro u g h such key v a r i a b l e s as money income and demand,
-------- . . . . , „ ,, „ j
1C h a n d le r, op. c i t . . p p . 59, 2 2 -2 3 , 48-69. F o r a
d i s c u s s i o n o f l i m i t a t i o n s of t h e q u a n t i t y t h e o r y , see
G a r i s , op. c i t . . pp. 233 -4 2.
2M oulton, op. c i t . , pp. 1 1 -1 2 , 4 1 -4 4 , 209.
55
p r o d u c t i o n , co n su m p tio n , and I n v e s tm e n t.^ A lthou gh money
re m a in e d , i n t h i s new t h e o r y , v e ry much i n t h e p i c t u r e , i t
was r e g a r d e d more as ( a ) a p a s s e n g e r c a r r i e d a lo n g w ith t h e
key sp e n d in g flow s o f consum ption and in v e s tm e n t , o r as (b)
a s t o r e of v a lu e o r form of w e a lth . I f money was t o a f f e c t
p r i c e s , i t f i r s t had t o work i t s e f f e c t s th ro u g h a s e r i e s
of key v a r i a b l e s , s t a r t i n g w ith income and demand, and
i n c l u d i n g t h e r a t e o f i n t e r e s t .
In d e e d , the e q u a t io n o f exchange I t s e l f was
a d a p te d t o a n a rro w e r band of t r a n s a c t i o n s — a r i s i n g in
c o n n e c tio n w ith c u r r e n t p r o d u c tio n and income o n ly — in th e
g u is e o f th e " in c o m e - v e lo c ity " m o d el, in c o n t r a s t t o th e
o r i g i n a l " t r a n s a c t i o n s " model t h a t was a p p l i c a b l e t o a l l
t r a n s a c t i o n s , i n c l u d i n g mere e x c h a n g e. The k i n s h i p betw een
t h i s v e r s i o n of th e e q u a t io n o f exchange and t h e incom e-
e x p e n d itu r e th e o ry i s th u s more a p p a r e n t th a n i n t h e t r a n s
a c t i o n s m odel. I t a l s o c o n s t i t u t e d a more r e a l i s t i c
a p p ro x im a tio n t o econom ic a c t i v i t i e s more d i r e c t l y con
n e c te d w ith p r i c e - d e t e r m i n i n g p r o c e s s e s , such a s c u r r e n t
p r o d u c tio n and i n c o m e - c r e a t io n .
!The f o l lo w in g i s b ased m ain ly on i b i d . , p . 14;
C h a n d le r, op. c i t . , p p . 7 1 -7 3 J K u r i h a r a , o p . c i t . . pp.
2 2 -2 4 ; John H. W illia m s , "Com parison o f Q u a n tity Theory
and In c o m e -E x p e n d itu re T h e o ry ," In C h a rle s R. W h ittle s e y
( e d .) R eadin gs in Money and B anking (New York: W. W. N o rton
& C o., 1952)7 PP. l a i - o b .
5 6
Development of Income t h e o r y . — I n a more s i g n i f i c a n t
r e s p e c t , th e developm ent from q u a n t i t y t h e o r y to income
th e o ry p ro v ed more l o g i c a l . In t h e t r a n s i t i o n from
MVy = PyTy ( in c o m e - v e lo c ity m odel) t o I + C = Y can be
d i s c e r n e d th e r e l a t i o n s h i p of th e l e f t s i d e s w ith t h e
con cept o f " e x p e n d i t u r e s , '’ and t h e r i g h t s i d e w ith " o u tp u t,"
and th e t r a n s f o r m a t i o n of T i n t o c u r r e n t o u t p u t. I n o th e r
w ords, Income th e o r y advanced m a t t e r s by s p e l l i n g o u t th e
manner i n which m onetary changes " r e g i s t e r t h e i r e f f e c t s "
th ro u g h th e e x p e n d itu r e and income a s p e c t s o f C and I
( r a t h e r th a n M and V) and th ro u g h th e r a t e of i n t e r e s t . ^
I n o t h e r r e s p e c t s , how ever, income th e o ry c o n s t i
t u t e d a b a s i c d e p a r t u r e from th e q u a n t i t y th e o r y a p p ro a c h .
The new th e o ry no lo n g e r assumed t h a t t h e community h e ld
cash b a la n c e s o nly t o spend them; new b a la n c e s m igh t a ls o
be h e ld as s a v in g s d e p o s i t s . I t a l s o c o n s id e r e d two
Im p o rta n t q u e s t i o n s : ( a ) th e e f f e c t s of d e c i s i o n s on .....
w h eth er money s a v in g s would be h e ld as money b a la n c e s or
be i n v e s t e d , and (b) th e u n d e r ly in g f a c t o r s d e te rm in in g
t h i s d e c i s i o n . 2
■^Some w r i t e r s s t i l l p r e f e r t o d e s c r i b e th e i n f l a
t i o n p r o c e s s i n term s o f M V r a t h e r th a n C + I ; see G o ttf rie d
H a b e r l e r , I n f l a t i o n , I t s Causes and Cures ( r e v . e d . ;
W ash in g to n , D .C .: American E n t e r p r i s e A s s o c i a t i o n , 1 9 6 1 ),
pp. 3 - 1 0 , 1 6 -2 3 , 70-71.
2John L I n t n e r , "The Theory o f Money and P r i c e s , " In
Seymour E. H a r r i s ( e d . ) , The New Econom ics (New York:
A lf r e d A. K nopf, 1 9 ^ 8 ), p p . 5 16 -17.
57
F u r th e r m o r e , th e e a r l i e r q u a n t i t y th e o ry a ssu m p tio n
t h a t sp e n d in g ( o r " e f f e c t i v e demand") depended p r i m a r i l y
on th e s i z e of money ( t r a n s a c t i o n s ) b a la n c e s was r e p l a c e d
by th e c o n ce p t o f t r a n s a c t i o n s b a la n c e s th e m s e lv e s depend
in g on incom e, and of o t h e r money b a la n c e s p o s s i b l y accumu
l a t i n g i n l a r g e amounts b e f o r e th e y came t o e x e rc is e " any
e f f e c t s on c u r r e n t e f f e c t i v e dem and.1
Money As An E n a b lin g F a c t o r
I f th e " c a u s a l " predom inance of money, in th e
q u a n t i t y t h e o r y , h as been overshadow ed by th e more r e c e n t
a t t e n t i o n a cc o rd e d to o t h e r e q u a lly r e l e v a n t i n f l u e n c e s on
P , such as demand and c o s t s , what rem a in s o f m oney's r o l e
i n th e i n f l a t i o n p r o c e s s ? The p e r t i n e n t q u e s t io n would
now seem t o be: can i n f l a t i o n o c c u r or p ro c e e d v e ry f a r
w ith o u t th e " p e r m is s io n " o r " s u p p o rt" o f a p r i o r o r
accom panying i n c r e a s e i n money su p p ly ? T hat i s , i f
i n c r e a s e d M does n o t n e c e s s a r i l y c au se an i n c r e a s e d P, can
P r i s e s u b s t a n t i a l l y w ith o u t a p r e v io u s o r j o i n t r i s e i n
M? Does n o t money, a t l e a s t , s e rv e as a n e c e s s a r y
" e n a b lin g " o r " r a t i f y i n g " f a c t o r i n i n f l a t i o n of any s i z e ?
Does th e e q u a tio n o f exchange i t s e l f h e lp answ er
t h i s q u e s t io n ? A ccordin g t o th e e q u a tio n o f e x c h a n g e , P
1I b i d . , p. 535.
58
can r i s e w ith o u t a p e rm is s iv e r i s e i n M only as a conse
quence of (a ) an in c r e a s e i n V, a n d /o r (b) a r e d u c t io n or
la g i n a g g re g a te su p p ly o r T. How r e a l i s t i c a r e t h e s e two
c ase s?
Money in back g ro u n d , — To ta k e th e l a t t e r case
f i r s t : re d u c e d or la g g in g su p p ly m ight be p a r t i c u l a r l y
r e l e v a n t t o th e case of h y p e r - i n f l a t i o n , were i t n o t f o r
th e f a c t t h a t M and V a ls o g r e a t l y in c r e a s e d u r in g such
h e c t i c p r i c e s p i r a l s and c o n t r i b u t e a c t i v e l y t o th e i n f l a
t i o n p r o c e s s . The p o s s i b i l i t y of both c a se s (a) and (b)
o p e r a t in g i n com bin ation may a l s o be r e l e v a n t t o th e case
of h y p e r - i n f l a t io n , as in Germany a f t e r World War I.-*-
The p o s s i b i l i t y of i n c r e a s e d v e l o c i t y o c c u rin g
s i g n i f i c a n t l y was e x clu d ed by F i s h e r f o r th e lo ng ru n , and
in th e case o f s h o r t - r u n " t r a n s i t i o n s 1 1 or c y c l i c a l
upswings he b ased th e r i s e in V on th e r i s e in M and Mf .
As w i l l be seen below , t h i s . s h o r t - r u n case may be a p p l i
c a b le to th e e v e n ts o f 1955-1957, when in c r e a s e d V p la y e d
a more prom inent r o l e th a n in c r e a s e d M i n the r i s e o f P.
Over the lo n g ru n , how ever, the more "norm al" i n c r e a s e s in
V seem to have o c c u rre d w ith in a l i m i t e d range o f v a lu e s ,
i n d i c a t i n g t h a t V co uld n o t by i t s e l f ( i . e . , w ith o u t
1-See C o s ta n tin o B r e s c i a n i - T u r r o n i , The Economics o f
I n f l a t i o n (London: A lle n & Unwin, L t d . , 1937), PP. 155-223.
59
i n c r e a s e d M) e n a b le a " s p i r a l l i n g " o r "runaway"
i n f l a t i o n . 1
Some w r i t e r s have a s s i g n e d t o M th e p rim a ry r o l e o f
" e n a b lin g " o r " s u p p o r t i v e " cause of i n f l a t i o n . The most
u s u a l l y d i s c u s s e d c o n te x t i s h y p e r - i n f l a t i o n , where th e
i n c r e a s e s i n M p la y a c e n t r a l r o l e in p e r m i t t i n g th e
runaway s p i r a l o f i n c r e a s e d M and r i s i n g P. N e v e r t h e l e s s ,
even in more "norm al" p e r i o d s c o n d i t i o n s of money sup ply
and cash b a la n c e s o r l i q u i d i t y must be " f a v o r a b l e " f o r th e
o p e r a t i o n and c o n t i n u a t i o n o f th e more t y p i c a l c a s e s of
" e x c e s s demand" o r " w a g e -p ric e " i n f l a t i o n . 2
P o s t-w a r e x p e r i e n c e . — In t h i s c o n n e c tio n th e p o s t
war e x p e r ie n c e of t h e U n ite d S t a t e s , e x te n d in g th r o u g h th e
m u c h -d is c u s s e d p r i c e r i s e o f 1955-1957, e x e m p li f i e s th e
" e n a b lin g " r o l e of money— in th e d i r e c t form of i n c r e a s e d
su p p ly of M, and i n th e i n d i r e c t form o f i n c r e a s e d V.3
•^George L eland Bach, Economics (3 rd e d . ; Englewood
C l i f f s , N. J . : P r e n t i c e - H a l l , I n c . , i 960) , p. 161.
2I b i d . , p. 165; B arry N. S i e g e l , A ggregate
Economics and P u b lic P o lic y (Homewood, 1 1 1 .: R ic h a rd D.
I r w i n , I n c . , I 9 6 0 ) , p p . 2156, 263; H a b e r l e r , op. c i t . , p . 18.
^The f o llo w in g i s b a se d p r i m a r i l y on R ic h a rd T.
S e ld e n , " S t a te m e n t ," i n U .S ., C o n g ress, J o i n t Economic
Com m ittee, H e a r in g s , P a r t Study of Employment, G row th.
and P r ic e L e v e l s , 86th C ong.. 1 s t S e s s . . 1959.. p p . 671-729.
and " C o st-P u sh V ersus D em and-Pull I n f l a t i o n , " The J o u r n a l
o f P o l i t i c a l Economy, LXVII (F e b r u a r y , 195 5 ), pp. 1 -2 0 ;
Howard S. E l l i s , " L i m i t a t i o n s of M onetary P o lic y ," i n The
American A ssem bly, U n ite d S t a t e s M onetary P o lic y (New York:
Columbia U n i v e r s i t y , " 1958) , pp . 153-59; and Warren L.
The grow th o f money su p p ly d u r in g th e p e r i o d
1947-1957 was below t h e p r e -w a r and w a r-tim e r a t e s of
i n c r e a s e , r i s i n g some 25 p e r c e n t , from $108 b i l l i o n t o
n e a r l y $135 b i l l i o n . At the same tim e , th e g r o s s n a t i o n a l
p r o d u c t in c u r r e n t d o l l a r s n e a r l y d o u b led from $226 b i l l i o n
to $448 b i l l i o n . The d i f f e r e n c e in grow th r a t e s betw een
money and v a lu e of o u tp u t was a c c o u n te d f o r by t h e i n c r e a s e
in in c o m e - v e l o c i ty of c i r c u l a t i o n ( i . e . , GNP d i v id e d by M)
from a r a t e o f 2.09 t o 3 .3 3 . In d e e d , t h e p o s t- w a r r i s e in
v e l o c i t y r e v e r s e d th e s e c u l a r d e c l in e t h a t had s e t i n from
1880 t o 1945.
In th e p a s t , a t l e a s t s in c e 1911, boom p e r i o d s were
c h a r a c t e r i s t i c a l l y accom panied by s p u r t s i n v e l o c i t y as
h o l d e r s o f i d l e cash b a la n c e s d i v e s t e d th e m se lv e s and
econom ized on working b a l a n c e s . In a d d i t i o n , t h e i n c r e a s e d
v e l o c i t y had been a s s o c i a t e d w ith i n c r e a s e d money s u p p ly ,
e s p e c i a l l y d u r in g 1900-1930. P e c u l i a r t o th e p o s t- 1 9 4 0
e x p e r i e n c e , how ever, was the w a r-tim e l a g in v e l o c i t y —
s u p p r e s s e d by r a t i o n i n g and m a t e r i a l s c o n t r o l s — b e h in d th e
w a r-tim e i n c r e a s e in money; n e v e r t h e l e s s , i t was th e
l a t t e r which e x p la in e d much o f th e h ig h p o s t- w a r l i q u i d i t y
S m ith , "M onetary P o lic y and Debt M anagem ent," In U . S . ,
C o n g re ss, J o i n t Economic C om m ittee, S t a f f R eport on
Employment, G row th, and P ric e Levels"! 8 6 th Cong. , 1 s t Sess.,
T9S9; p p . 1 ! 37- ^ r p t $ , 359.---------------------
61
and th e su b s e q u e n t r i s e i n v e l o c i t y due t o th e d is h o a r d in g
o f p r i v a t e b a la n c e s .
The 1955-1957 e p i s o d e . — A s tr o n g segm ent o f o p in io n
h o ld s t h a t th e i n f l a t i o n e p is o d e o f 1955-1957 was e x p re s s e d
m a in ly th ro u g h h ig h e r v e l o c i t y . H ig h e r v e l o c i t y i n t u r n
r e f l e c t e d th e " e x c e s s l i q u i d i t y " o f th e n o n - f i n a n c i a l
p u b l i c ( p a r t i c u l a r l y i n h o ld in g s o f governm ent s e c u r i t i e s )
and th e i n c r e a s e d im p o rta n c e o f l i q u i d "money s u b s t i t u t e s "
( e . g . , tim e d e p o s i t s , s a v in g s and lo an s h a r e s , and s h o r t
term T re a s u ry s e c u r i t i e s ) r e l a t i v e to money in th e economy.
The s tr o n g demand f o r lo a n s and t h e t r e n d t o h i g h e r r a t e s
o f i n t e r e s t in d u ce d th e s u b s t a n t i a l e x p a n sio n of money
s u b s t i t u t e s as s o u rc e s o f l i q u i d i t y and enhanced th e
im p o rta n c e of l a r g e " n o n - f i n a n c i a l " c o r p o r a t io n s as
l e n d e r s .
Thus two im p o r ta n t a s p e c t s a re h i g h l i g h t e d . I n th e
f i r s t p l a c e , i n view of th e r e s t r i c t i v e m onetary p o l i c y and
r i s i n g i n t e r e s t r a t e s of t h i s p e r i o d , v e l o c i t y i n c r e a s e d
c o n s i d e r a b ly r e l a t i v e t o money s u p p ly . Whereas t h e l a t t e r
i n c r e a s e d o n ly $8 b i l l i o n from s e c o n d - q u a r t e r 195^ t o
t h i r d - q u a r t e r 1957* th e a p p ro x im a te m o netary e q u i v a l e n t of
th e r i s e i n v e l o c i t y was n e a r l y $22 b i l l i o n , i n d i c a t i n g
t h a t i n c r e a s e d V o p e ra te d as an e f f e c t i v e i n c r e a s e i n M.
I n th e second p l a c e , th e e x c e s s l i q u i d i t y and the r e s u l t i n g
i n c r e a s e d v e l o c i t y were th e m se lv e s b a se d l a r g e l y on th e
62
p r e v io u s c r e a t i o n o f e x c e s s iv e money su p p ly by w a r-tim e
" l a x i t y " in m o n etary and f i s c a l p o l i c y .
F i s h e r ' s i m p l i c a t i o n s . — F i n a l l y , i t seems t h a t
F i s h e r h i m s e l f , a t l e a s t i n s e l e c t e d p a s s a g e s , m ig h t have
re g a r d e d th e " c a u s a l " i n f l u e n c e o f money a s r e s i d i n g i n i t s
r o l e a s an " e n a b l e r " of p r i c e r i s e s . 1 Almost from the
s t a r t o f h i s book, i n h i s P r e f a c e , he p r o t e s t e d a g a i n s t th e
" im p ro p e r u se " made of th e q u a n t i t y th e o r y by " p ro m o te rs o f
unsound money"— in b e h a l f o f " i r re d e e m a b le p a p e r money" and
of n a t i o n a l f r e e c o in a g e o f s i l v e r — and p o i n te d s p e c i f i
c a l l y to th e f i r s t Bryan cam paign. Then, s p e c u l a t i n g a b o u t
th e f u t u r e , he c o u ld h a r d ly im a g in e a "worse econom ic
c a la m ity " th a n t h e p r o s p e c t i v e i n c r e a s e i n g o ld p r o d u c tio n
t h a t m ight " o u tr u n t r a d e " and r e s u l t in a " d e p r e c i a t i o n " o f
money.
More i m p o r t a n t l y , how ever, F i s h e r 's r e g a r d i n g o f M
and V (a s w e ll a s T) as th e "p ro x im a te " c a u s e s th ro u g h
w hich th e u n d e r l y i n g " a n te c e d e n t" c au se s managed t o a f f e c t
th e l e v e l o f P would seem t o im ply t h a t f o r him t h e i n s t i
t u t i o n s and a g e n c ie s of th e money supply p la y e d an
e s s e n t i a l l y " e n a b lin g " r o l e in t h e p r o c e s s of i n f l a t i o n .
W i s h e r , o p . c i t . , p p . v i i i , 14-15, 249-50.
63
Summary and C o n c lu sio n s
T h is c h a p t e r has shown t h a t th e c h i e f v i r t u e o f th e
F i s h e r i a n o r t r a n s a c t i o n s model o f th e e q u a tio n o f exchange
i s a t th e same tim e i t s m ain draw back. By p r o p e r l y rem in d -
. in g us o f money’ s r o le a s a means o f payment— and t h a t
money as such d o e s n o t c o n s t i t u t e w e a lth — i t went t o
e x tr e m e s , r e g a r d i n g money as e x c l u s i v e l y a means o f
exch an g e.
As a consequence i t n e g l e c t e d to n o te th e f u n c t i o n
o f money as a s t o r e of v a lu e and, h e n c e , th e d e r iv e d r e a l
in te r d e p e n d e n c e between goods m a r k e ts and money m a rk e ts v i a
changes i n th e i n t e r e s t r a t e . T h is t a s k was l e f t t o income
t h e o r y , d i s c u s s e d i n th e n e x t c h a p t e r .
In a s s e r t i n g t h a t P i s d e te rm in e d by M a l o n e , th e
q u a n t i t y th e o r y f u r t h e r s t r a i n e d o u r sense o f r e a l i t y .
F i s h e r had d e f i n e d th e v a lu e of money in r e l a t i o n t o th e
p r i c e l e v e l , w hich i s t h e same as r e l a t i n g M and goods
su p p ly . Y e t, a s M. Blaug has p o i n t e d o u t , n e i t h e r M n o r
goods can be l o g i c a l l y a s s e r t e d a s th e d e te r m in a n t o f t h i s
r e l a t i o n s h i p . 1
F i s h e r h im s e lf acknow ledged t h a t a l l th e
" a n t e c e d e n t " f a c t o r s I n f l u e n c i n g P work th ro u g h MV/T, and
^M. B la u g , Economic Theory in R e tr o s p e c t (Homewood,
I l l i n o i s : R ic h a rd D. I r w i n , I n c . , 1 9 6 2 ), p. 136T
64
t h a t only u n d e r s p e c i a l a s s u m p tio n s — a V g iv e n a s an i n s t i
t u t i o n a l datum , and a T d e te rm in e d by r e a l (n o n -m o n e ta ry )
f o r c e s — d i d M d i r e c t l y a f f e c t P. But h e re th e d i f f i c u l t y
i s th e id e a t h a t T i s supposed t o be d e te rm in e d s o l e l y by
r e a l f o r c e s , compounding th e above d i f f i c u l t y o f making
goods m a rk e ts and money m a rk e ts e n t i r e l y in d e p e n d e n t o f
e a c h o t h e r .
The q u a n t i t y t h e o r y u n d e r s ta n d a b ly g a in e d i t s
a p p e a l from th e f a c t t h a t h i s t o r y r e c u r r e n t l y d is p l a y e d
s t r o n g c o r r e l a t i o n s betw een l a r g e , r a p i d i n c r e a s e s i n M and
th e p r i c e l e v e l , and t h a t V had behaved re m a rk a b ly s t a b l e
o v e r lo ng p e r io d s o f tim e . On t h e o t h e r han d , F i s h e r was
a l s o s u f f i c i e n t l y r e a l i s t i c t o n o te ( a t l e n g t h ) t h a t h i s
e q u a tio n of exchange d id n o t a p p ly t o r e c u r r i n g c y c le s o r
" t r a n s i t i o n " p e r i o d s , which he re g a r d e d a s th e r u l e r a t h e r
t h a n t h e e x c e p ti o n , and as t e n d i n g to p e rm it P t o be
i n f l u e n c e d a l s o by V, T , and t h e i n t e r e s t r a t e l a g ; th e
l a t t e r , i n t u r n , a llo w e d T t o i n f l u e n c e V and M.
F u rth e rm o re , w h ile th e e q u a tio n o f exchange i s a
u s e f u l fram ew ork f o r a n a l y s i s w i t h in t h e c o n te x t o f a u to
m a t i c a l l y f l e x i b l e p r i c e s (and a te n d e n c y t o f u l l -
employment o u t p u t ) , i t i s even more u s e f u l as th e embryo o f
l a t e r , more s o p h i s t i c a t e d d e f i n i t i o n s o f i n f l a t i o n , as w i l l
be n o te d i n s u b s e q u e n t c h a p t e r s .
65
I n th e p r e s e n t c h a p t e r th e " c ru d e " r e l a t i o n M— P
was seen t o d e v e lo p i n t o MV/T — ^ P . I n coming c h a p t e r s t h i s
model w i l l be f u r t h e r m o d ifie d by t h e o r i e s p u r p o r t i n g to
e f f e c t s h a r p b r e a k s w ith th e e q u a tio n of ex ch a n g e, but
which i n e s s e n c e owe t h e i r v e ry e x i s t e n c e t o i t .
F i n a l l y , even i f M i s n o t n e c e s s a r i l y t h e cause o f
p r i c e r i s e s , i t re m a in s u n d o u b te d ly th e g r e a t " e n a b l e r " o f
i n f l a t i o n . I t t a k e s a s p e c i a l case in which a c o n s ta n t
money su p p ly w i l l p e rm it some I n f l a t i o n . 1 For exam ple, i f
b u s in e s s fir m s se e k to expand o u tp u t a t f u l l employment b u t
cannot o b t a i n new money from t h e b a n k s, t h e i r i n c r e a s e d
t r a n s a c t i o n s demand f o r money w i l l push up th e i n t e r e s t
r a t e . But t h i s w i l l te n d t o choke o f f th e e x t r a in v e s tm e n t
demand and m o d erate th e p r e s s u r e on P. How d e t e r r e n t w i l l
th e i n t e r e s t r a t e p ro v e t o be? T his w i l l depend on th e
amount o f s p e c u l a t i v e cash b a la n c e s o r i g i n a l l y h e ld by th e
p u b lic and which th e y may be ind u ced to a c t i v a t e by le n d in g
to i n v e s t o r s . The s m a lle r t h e cash b a la n c e s h e ld by th e
p u b lic a t th e s t a r t , th e g r e a t e r th e d e t e r r e n t e f f e c t s of
th e i n t e r e s t r a t e . The l a r g e r th e cash b a la n c e s , th e l e s s
d e t e r r e n t a re r i s i n g i n t e r e s t r a t e s , as e v id e n c e d d u r in g
th e 1955-1957 p r i c e r i s e s .
1A ckley, op. c i t . , p . 423; Jo a n R ob inso n, I n t r o
d u c tio n t o th e T heory of Employment (London: M acm illan and
Company, L t d . , 1937)» p. 76.
66
A g ain , i n th e case of excess-dem and i n f l a t i o n ,
d is c u s s e d i n th e n e x t c h a p t e r , i n c r e a s e d money su p p ly and
v e l o c i t y p ro v e t o be th e e s s e n t i a l s u p p o r tin g f a c t o r s . As
Day and B eza have p u t i t , i n f l a t i o n can alw ays be "b ro u g h t
t o an end" i f th e su p p ly of money i s l i m i t e d ; b u t , th e y
a l s o add, t h i s i s o nly a " s m a ll p a r t o f th e th e o ry of
i n f l a t i o n . " 1
*Day and B eza, op. c i t . , p. 285.
CHAPTER I I I
THE ROLE OP DEMAND
T h is c h a p te r d e a ls p r i m a r i l y w ith th e c a u s a l r e l a
t i o n s h i p s betw een th e a g g re g a te of m onetary demand and th e
p r i c e l e v e l . The main body o f econom ic a n a l y s i s co n ce rn e d
w ith t h i s r e l a t i o n s h i p , stemming from th e w r i t i n g s of Knut
W ic k s e ll and John Maynard Keynes and t h e i r f o l l o w e r s — and
from numerous o t h e r w r i t e r s n o t d i r e c t l y i d e n t i f i e d w ith
t h e s e two s c h o o ls of t h o u g h t — h as a l t e r n a t e l y been term ed
th e " in c o m e - e x p e n d ltu r e ," "Incom e," o r "demand" a p p ro ach t o
I n f l a t i o n a n a l y s i s . I n t h i s s t u d y , t h i s ap p ro a ch w i l l be
r e f e r r e d t o sim p ly as "Income t h e o r y . "
The main ty p e s of i n f l a t i o n t h e o r i e s d e r iv e d from
t h i s ap p ro ach a re p o p u l a r l y i d e n t i f i e d as "ex cess-d em an d "
or " d em a n d -p u ll" t h e o r i e s . A more r e c e n t v a r i a n t goes
u n d e r th e name of " d e m a n d -s h lft" th e o r y of i n f l a t i o n .
Whereas t h e q u a n t i t y th e o r y has t r a d i t i o n a l l y been
co n ce rn e d m ain ly w ith p r i c e s , t h i s h a s n o t alw ays been t h e
case i n income t h e o r y , p a r t i c u l a r l y I n th e K ey nesian
v e r s i o n s . N e v e r t h e l e s s , t h i s body o f d o c t r i n e d id i n c l u d e
e x p l i c i t t r e a t m e n t of changes i n th e p r i c e l e v e l w ith in th e
c o n te x t o f i t s t h e o r e t i c a l m o d els.
67
6b
T his c h a p t e r w i l l use m a in ly th e K eynesian and
p o s t-K e y n e s ia n v e r s i o n s of th e income th e o ry as th e c h ie f
p o i n t o f d e p a r t u r e f o r a d i s c u s s i o n of th e v a r i a b l e s t h a t
e n a b le demand t o c au se a r i s e i n p r i c e s .
The World of Income Theory
Income t h e o r y , i n th e K ey n esian and p o s t-K e y n e s ia n
v e r s i o n s , w hile o s t e n s i b l y p re o c c u p ie d w ith th e s u b j e c t of
em ploym ent, became e s s e n t i a l l y an a n a l y s i s of changes in
t h e l e v e l of a g g re g a te s p e n d in g , o u t p u t , and income as w ell.
I n t h i s t h e o r y , money and p r i c e s were t o be a s s ig n e d
s p e c i a l , new r o l e s — som etim es p a s s i v e , som etim es a c t i v e —
d e p e n d in g on th e l e v e l o f th e above p r i n c i p a l a g g r e g a t e s .
Components of A gg reg ate Demand
I n th e K ey n esian m o d el, th e g e n e r a l l e v e l o f
p r i c e s depends p a r t l y on th e r a t e of f a c t o r re m u n e ra tio n
and p a r t l y on th e s c a l e o f a g g re g a te p r o d u c tio n and
em ploym ent, w hich i n t u r n depend on th e l e v e l o f a g g re g a te
e x p e n d i t u r e s o r e f f e c t i v e demand, which i n t u r n depends on
th e p s y c h o l o g i c a l p r o p e n s i t i e s and o t h e r c o n s i d e r a t i o n s
u n d e r l y i n g each component of a g g r e g a te demand.
A ggregate m onetary demand a c t u a l l y c o n s i s t s of
t h r e e m ain s tre a m s of e x p e n d i t u r e s g e n e r a t e d s e p a r a t e l y by
i n d i v i d u a l s , b u s i n e s s f i r m s , an d governm ent.
69
Consumption demand d epend s p r i m a r i l y on th e l e v e l
of Income and th e p r o p e n s i ty t o consume ( o r s a v e ) , th e
l a t t e r b e in g a " s c h e d u le " o r " f u n c t i o n " t h a t r e l a t e s con
sum ption ( o r s a v in g ) t o d i s p o s a b l e income a t v a r i o u s l e v e l s
o f t o t a l n a t i o n a l incom e. The consum ption f u n c t i o n , in
t u r n , depends on c u sto m s, th e d i s t r i b u t i o n of incom e, th e
sy ste m of t a x a t i o n , and r e l a t e d f a c t o r s .
In v e s tm e n t demand i s presum ed t o depend on
p r o d u c e r s ' e s t i m a t e s o f th e p r o f i t r a t e s t h a t can be
e x p e c te d from p r o s p e c t i v e in v e s tm e n ts ( i . e . , th e " m a r g in a l
e f f i c i e n c y o f c a p i t a l " sc h e d u le ) i n r e l a t i o n t o t h e r a t e o f
i n t e r e s t on money f o r in v e s tm e n t p u r p o s e s .
The m a r g in a l e f f i c i e n c y o f c a p i t a l i t s e l f i s s a i d
to depend b a s i c a l l y on such dynam ic g row th f o r c e s as popu
l a t i o n , t e r r i t o r i a l e x p a n s io n , and t e c h n o l o g i c a l c h an g e, as
w e l l as on t h e s i z e o f th e e x i s t i n g s to c k of c a p i t a l
a s s e t s . On t h e o t h e r hand, th e r a t e o f I n t e r e s t depends on
(a ) t h e q u a n t i t y o f money, and (b ) th e s t a t e o f l i q u i d i t y
p r e f e r e n c e , o r th e d e s i r e of p e o p le t o h o ld a s s e t s i n th e
form of money f o r t r a n s a c t i o n s , p r e c a u t i o n a r y , and specu
l a t i v e m o tiv e s .
Because Keynes re g a rd e d th e demand f o r money f o r
t r a n s a c t i o n s and p r e c a u t i o n a r y m o tiv e s a s r e l a t i v e l y
s t a b l e , th e l i q u i d i t y p r e f e r e n c e m ain ly r e f l e c t e d th e
b e h a v io r o f s p e c u l a t i v e m o tiv e s , which were t o be re g a rd e d
70
as r e l a t i v e l y u n s t a b l e , owing t o th e p e c u l i a r s e n s i t i v i t y
of s p e c u l a t i v e h o ld in g s t o changes i n th e i n t e r e s t r a t e . 1
D i f f e r e n c e s from Q u a n tity Theory
What a re th e m ain d e p a r t u r e s and advances from t h e
q u a n t i t y th e o r y a c h ie v e d by income th e o r y ? F o r one t h i n g ,
t h e r e i s th e r o l e of money. W hereas F i s h e r p o s t u l a t e d a
d i r e c t and p r o p o r t i o n a l r e l a t i o n betw een M and P— becau se
M s e r v e d m ainly as a medium of exchange— i n th e w orld of
income th e o r y money p l a y s a more c o m p lic a te d r o l e . S econ d,
the r e l a t i o n betw een money su p p ly and e f f e c t i v e demand
r e c e i v e s a r e v e r s e e m p h a sis: w h ereas th e q u a n t i t y th e o r y
assumed demand was e q u i v a l e n t t o and d e p en d en t on M,
income th e o r y r e v e r s e s t h i s r e l a t i o n and d e -e m p h a siz e s t h e
dom inance o f M. T h i r d , income t h e o r y p l a c e s a m ajor
em ph asis on th e s h o r t r u n , p a r t i c u l a r l y on t h e d e te r m in a n ts
o f V and T, where th e l a t t e r s t a n d , r e s p e c t i v e l y , f o r
in c o m e - v e lo c ity and c u r r e n t o u t p u t.
The r o l e o f money. — With r e s p e c t to money, Keynes
p u t c h i e f em phasis on i t s f u n c t i o n as a s t o r e o f v a l u e ,
^ h e m ain s o u r c e s u sed f o r th e p r e c e d in g s e c t i o n
i n c l u d e : John Maynard K eynes, The G e n era l T heory of Employ
m en t. I n t e r e s t , and Money (New York: H a r c o u r t , Brace and
Company, 1 9 3 b )* PP« 171, 19 6-97, 294, c h a p t e r s 8 , 9, 11,
12; Dudley D i l l a r d , The Economics o f John Maynard Keynes
(London: Crosby Lockwood & Son L t d . , 195*0, c h a p t e r s 1, 3 ,
5 , 7 , 8; A lvin H. H ansen, M onetary Theory and F i s c a l P o lic y
(New York: M cGraw-Hill Book Company, 1 9 4 9 ), P . 96.
71
o r as a form o f h o ld in g w e a lth or h o a r d i n g , b e c a u se I t was
th e o n ly p e r f e c t l y l i q u i d a s s e t . I n t h i s c o n t e x t , th e r a t e
o f i n t e r e s t came t o be r e g a rd e d by Keynes n o t as a rew ard
f o r s a v in g b u t as a rew ard f o r p a r t i n g w ith l i q u i d i t y or
f o r th e n o n - h o a rd in g o f money (a s a payment f o r t h e u se o f
m oney), and i t s l e v e l m e re ly r e f l e c t e d t h e i n t e n s i t y of
p e o p l e 's d e s i r e to h o ard money ( i . e . , t h e i r l i q u i d i t y
p r e f e r e n c e ) f o r s p e c u l a t i v e p u r p o s e s . I n o t h e r w ords, th e
r a t e o f i n t e r e s t was a p u r e l y m onetary phenomenon.
The r a t e o f i n t e r e s t i s r e g a r d e d as a m onetary
phenomenon in th e se n se t h a t i t i s d e te rm in e d by th e demand
f o r and th e su p p ly o f money. The demand f o r money i s th u s
r e g a r d e d as a f u n c t i o n o f th e i n t e r e s t r a t e , and i t s r o l e
was t o be e x p la in e d i n r e l a t i o n t o t h e t h e o r y o f i n t e r e s t .
F i n a l l y , th e i n t e r e s t r a t e i t s e l f was v i t a l l y r e l a t e d t o
i n v e s t m e n t .
I n th e K ey n esia n view o f t h i n g s , th e a d d i t i o n of
t h e s e p e r s p e c t i v e s to money and i n t e r e s t , and th e r e l a t i o n
o f th e l a t t e r t o f l u c t u a t i o n s i n th e l e v e l o f s p e n d in g ,
h e lp e x p l a i n why th e economy may f a i l t o a d j u s t a u to m a t i
c a l l y t o f u l l employment l e v e l s . I n o t h e r w o rd s, i f money
income i s n o t alw ays r e s p e n t a f t e r I t s r e c e i p t (b u t I s
h o a r d e d ) , th e r e s u l t i n g d e c l i n e i n a g g r e g a te sp e n d in g and
r i s e i n r a t e o f i n t e r e s t (b o th due t o h o a rd in g ) re d u c e th e
l e v e l o f in v e s tm e n t, o u t p u t , and employm ent.
72
The p a t h s from money to p r i c e s .---As i n d i c a t e d i n
C h a p te r i i , t h e r e i s a s u p e r f i c i a l s i m i l a r i t y in th e income
and q u a n t i t y - t h e o r y a p p ro a c h e s : b o th r e g a r d th e l e v e l o f
a g g r e g a t e s p e n d in g as th e dom inant means o f i n f l u e n c i n g P.
But h e re th e re se m b la n c e e n d s. The p a th s o r m echanism s
th ro u g h which i n c r e a s e d e x p e n d i t u r e s a c t u a l l y r e s u l t in
i n c r e a s e d p r i c e s d i f f e r g r e a t l y i n t h e two t h e o r i e s .
In th e q u a n t i t y t h e o r y , i n c r e a s e s i n sp e n d in g a re
(a) n o r m a lly , o r i n th e lo n g r u n , im p e lle d o r m o tiv a te d
p u r e l y by i n c r e a s e s i n M, and (b) such i n c r e a s e d m on etary
demand i s supposed t o a f f e c t P d i r e c t l y . In income t h e o r y ,
h ow ever, i n c r e a s e s i n sp e n d in g a r e (a) n o t n o rm a lly
d i r e c t l y m o tiv a te d by i n c r e a s e s i n M b ut r a t h e r by a
d i f f e r e n t i a t e d s e t o f p r o p e n s i t i e s and c o n s i d e r a t i o n s n o t
d i r e c t l y r e l a t e d t o changes i n M, and (b) n e i t h e r do such
i n c r e a s e d e x p e n d i t u r e s a f f e c t P d i r e c t l y .
E n te r t h e r a t e o f I n t e r e s t . — A ccording t o th e
q u a n t i t y t h e o r y , i n c r e a s e s i n M a u t o m a t i c a l l y r e s u l t in
e n la r g e d e x p e n d i t u r e s , which th e n d i r e c t l y a f f e c t P. In
c o n t r a s t , th e income t h e o r y h o ld s t h e r e i s no d i r e c t p a th
from in c r e a s e d M t o i n c r e a s e d s p e n d in g , income and p r i c e s .
A r i s e in M may cause a r i s e i n s p e n d in g , b u t t h i s would
depend above a l l on th e i n i t i a l e f f e c t s o f i n c r e a s e d M on
th e i n t e r e s t r a t e , and t h e e f f e c t o f changes i n i n t e r e s t
r a t e on i n v e s tm e n t , c o n su m p tio n , and l i q u i d i t y p r e f e r e n c e .
73
I t would a l s o depend on th e e x i s t i n g l e v e l o f o u tp u t and
em ploym ent. F u rth e rm o r e , th e I n c r e a s e d q u a n t i t y of M
i
I t s e l f may be a consequence of i n c r e a s e d s p e n d in g , f o r
e x am p le, on in v e s tm e n t g o o d s.
F o r K eynes, f o r exam p le, an i n c r e a s e i n M would
f i r s t cau se a d rop i n i n t e r e s t r a t e , which t h e n would
in d u c e a r i s e in in v e s tm e n t and o u t p u t . Only a f t e r t h e
r i s i n g s c a l e o f o u tp u t began t o i n c u r r i s i n g c o s t s would
th e p r i c e l e v e l f i n a l l y b e g in t o r i s e . In t h i s c o n t e x t ,
t h e demand f o r M f o r t r a n s a c t i o n s p u rp o se s would be
i n c r e a s i n g as a consequence o f r i s i n g o u tp u t and p r i c e s :
t h e r i s e in P c a u se s a r i s i n g need f o r money f o r t r a n s
a c t i o n s , r a t h e r th a n t h e r e v e r s e , a s i n th e q u a n t i t y th e o r y .
F u rth e rm o re , a t l e s s th a n f u l l em ploym ent, i n c r e a s e d M and
e x p e n d i tu r e s would be accom panied by i n c r e a s e d o u tp u t and
employment w ith o u t n e c e s s a r i l y c a u s in g p r i c e s t o r i s e .
P r i c e s would b e g in to i n c h up only when f u l l employment was
a p p ro a c h e d , f o r r e a s o n s p r e s e n t e d below .
Em phasis on demand. — The q u a n t i t y t h e o r y , in con
c e n t r a t i n g on M as th e p re d o m in a n t i n f l u e n c e on P,
n e g l e c t e d t o e x p lo r e t h e u n d e r l y i n g d e te r m in a n ts of sp en d
i n g . In d e e d , I t assumed e x p e n d i tu r e s were an a u to m a tic
c o n c o m ita n t o f th e money s u p p ly . I n income t h e o r y ,
how ever, a g g r e g a te s p e n d in g i s no l o n g e r m e c h a n ic a lly
r e l a t e d t o th e q u a n t i t y o f Mj i n s t e a d , i t I s e x p la in e d by
74
p s y c h o l o g i c a l o r b e h a v i o r a l a t t i t u d e s as s t a t e d in
" s c h e d u le s " u n d e r l y i n g consum ption and in v e s tm e n t e x p e n d i
t u r e s . In o t h e r w ord s, econom ic m o tiv e s are s u b s t i t u t e d
f o r m e c h a n ic a l n e c e s s i t i e s . Thus th e e f f e c t o f an i n c r e a s e
i n t o t a l income on P w i l l d ep en d , among o t h e r t h i n g s , on
whose incomes ( o r what ty p e s o f incom es) in p a r t i c u l a r have
been i n c r e a s e d , and t h e i r l i k e l y e f f e c t s on t o t a l sp e n d in g .
Income t h e o r y p ro c e e d s t o p l a c e p rim a ry em phasis on
a g g re g a te e x p e n d i tu r e s o r e f f e c t i v e demand, n o t on money
p e r s e , which was r e l e g a t e d t o a se co n d a ry th o u g h s t i l l
n o te w o rth y r o l e . A cco rd ing to t h i s a p p ro a c h , t h e r e f o r e , i t
i s th e l e v e l and flow o f a g g r e g a te income and sp en d in g
w hich e x p la in th e q u a n t i t y o f M and i t s V, r a t h e r th a n th e
o p p o s i t e , as p o s t u l a t e d by th e q u a n t i t y t h e o r y . In d e e d ,
th e flo w s of Income and sp e n d in g become th e v e r y mechanisms
th ro u g h which I n c r e a s e d money su p p ly becomes " o p e r a t i v e "
a s a f o r c e f o r i n f la ti o n .^ *
■^-For th e p r e c e d in g s e c t i o n , t h e f o l lo w in g s o u r c e s
have been u se d : K eynes, op. c i t . , pp . 167, 174, 298, 300,
c h a p t e r s 13, 1 7 , 2 1; D i l l a r d , op. c i t .» c h a p t e r s 1, 8 , 9;
H an sen, op. c i t . , c h a p t e r s 6 , 9: B a rry N. S i e g e l , A g g reg ate
Economics and P u b l i c P o l i c y (Homewood, 1 1 1 .: R ic h a rd D.
I r w i n , I n c . , I 9 6 0 ) , pp. 2 3 4 -3 6 ; H a ro ld G. M o u lto n , Can
I n f l a t i o n Be C o n t r o l l e d ? (W ash in g to n , D .C .: Anderson Kramer
A s s o c i a t e s , 1 9 5 8 ), p . £2 9 .
75
T h e o rie s o f Demand I n f l a t i o n
How i s p r i c e d e te rm in e d in th e w orld o f income
t h e o r y ? K ey nesian t h e o r y h a s a p p li e d i t s a n a l y t i c a l t o o l s
t o two s e p a r a t e c a s e s o f p r i c e i n f l a t i o n based on demand as
t h e , more o r l e s s , c h i e f c a u s a l i n f l u e n c e .
The f i r s t , t r e a t e d by Keynes i n h i s The G e n e ra l
Theory o f Employment. I n t e r e s t , and Money, w i l l be r e f e r r e d
t o as " s e m i - i n f l a t i o n " : i t i s r e l e v a n t m ainly t o th e
l e s s - t h a n - f u l l - e m p l o y m e n t economy as i t a p p ro a c h e s f u l l -
employment s c a l e s o f o u tp u t.
The second c a s e , a n a ly z e d in h i s How t o Pay f o r t h e
W ar, w i l l be r e f e r r e d to a s "ex c e ss-d e m a n d " o r
" i n f l a t i o n a r y - g a p " i n f l a t i o n , and i s more r e l e v a n t t o w ar
tim e , p o s tw a r , and d e fe n se ( o r m o b i l i z a t i o n ) s i t u a t i o n s
c o m p risin g f u l l employment and e x c e ss demand in th e f a c e o f
s h o r t a g e s o f g o o d s.
O ther m odels o f demand i n f l a t i o n a re e s s e n t i a l l y
v a r i a t i o n s o f t h e s e two b a s ic c a s e s , and have been
g e n e r a l l y r e f e r r e d t o a s " d e m a n d -p u ll" i n f l a t i o n .
The Case o f " S e m i - I n f l a t i o n "
I t was n o t e d above t h a t , in incom e t h e o r y , th e
l e v e l o f P depends m ost im m e d ia te ly on th e l e v e l of
a g g r e g a t e o u tp u t ( t h a t i s , on t h e l e v e l o f em ploym ent- and
in c o m e - g e n e r a tin g a c t i v i t y ) w h ic h , i n t u r n , depends
76
p r i m a r i l y on th e l e v e l of a g g re g a te demand o r e x p e n d i t u r e s .
S p e c i f i c a l l y , r i s i n g demand and s p e n d in g — a s i n th e
case o f a b u s i n e s s upsw ing— would a t l e v e l s s u b s t a n t i a l l y
below f u l l employment be e x p e c te d t o be m atched by c o r r e s
ponding i n c r e a s e s i n o u t p u t , employment and incom e, w ith P
rem ain in g s t a b l e .
A p proaching f u l l em ploym ent. — I f , how ever, t o t a l
e x p e n d i tu r e s c o n tin u e to i n c r e a s e t o a p o i n t (somewhere
n e a r f u l l em ploym ent) a t w hich o u tp u t can no lo n g e r be
r e a d i l y i n c r e a s e d (owing t o l a b o r s h o r t a g e s , l i m i t e d
p r o d u c t i v e c a p a c i t y , e t c . ) , th e n p r i c e s may be e x p e c te d to
r i s e b ecau se o f s h o r t - r u n i n e l a s t i c i t y of su p p ly and
r i s i n g c o s t s .
K eynes, f o r exam ple, r e f e r r e d s p e c i f i c a l l y t o
i n c r e a s e d wage r a t e s a c c r u in g t o l a b o r a s a r e s u l t o f i t s
enhanced b a r g a i n in g p o s i t i o n , as employment r o s e and
unemployment d e c l i n e d . He a l s o p o in te d t o b o t t l e n e c k s and
s h o r t - r u n d im in is h in g r e t u r n s a s th e n e c e s s a r y b y -p ro d u c t
of r i s i n g s c a l e s o f o u t p u t. Once f u l l employment was
a t t a i n e d , any a d d i t i o n a l in c r e m e n ts i n e f f e c t i v e demand
would o n ly r e s u l t i n f u r t h e r p r i c e r i s e s unaccom panied by
any a d d i t i o n s t o o u tp u t and em ploym ent, t h a t i s , a s t a t e o f
" t r u e ” o r " a b s o l u t e " i n f l a t i o n . T h u s, f o r K eynes,
i n f l a t i o n sim ply r e p r e s e n t e d t h e " s p e c i a l c a se " i n which
o u tp u t " c e a s e d t o be r e s p o n s iv e " t o a d d i t i o n a l d o se s o f
77
m onetary demand, and m a r g in a l c o s t c u rv e s were s t e e p l y
r i s i n g u n d e r th e p r e s s u r e o f boom c o n d i t i o n s .
R is in g o u t p u t , r i s i n g w ages. — A lvin H. Hansen
v i s u a l i z e d s t e e p l y r i s i n g m a r g in a l c o s t c u rv e s o c c u r r i n g
a ls o because o f " in a d e q u a te f i x e d - c a p i t a l c a p a c i t y , "
a lth o u g h he b e l i e v e d t h a t c o s t c u rv e s were g e n e r a l l y much
f l a t t e r th a n Keynes had supposed ( i . e . , n o t so m arked ly
U -s h a p e d ), and t h a t th e y t h e r e f o r e te n d e d t o d e la y p r i c e
r i s e s d u rin g boom p e r i o d s . On th e o t h e r hand, Hansen
r e g a r d e d "wage i n f l a t i o n , " o r wage r a t e s o u tr u n n in g
advances i n p r o d u c t i v i t y , a s an im p o r ta n t p e r s i s t e n t
c o n t r i b u t o r to r i s i n g p r i c e s d u r in g th e u psw ing.
At g iv e n wage r a t e s , Hansen b e l i e v e d , o u tp u t and
employment would te n d t o i n c r e a s e a s a g g r e g a te money o u t
la y s were i n c r e a s e d , b u t t h a t a g iv e n volume o f a g g r e g a te
demand would p r o v id e more employment a t a low er wage r a t e
th a n a t a h i g h e r wage r a t e . For H ansen, t h e r e f o r e , n o t
only were r i s i n g p r i c e s " i n t i m a t e l y c o n n e c te d " w ith r i s i n g
o u tp u t and c o s t s , but th e l a t t e r w e re , in t u r n , " c l o s e l y
bound up" w ith r i s i n g l e v e l s o f " e f f l c i e n c y - w a g e s , " t h a t
i s , w ith th e r e l a t i o n betw een wage r a t e s and th e m a r g in a l
p r o d u c t i v i t y o f l a b o r a s d e n o te d by th e r a t i o W/E ( i . e . ,
w a g e s / e f f i c i e n c y ) .
E f f ic ie n c y - w a g e s and p r i c e s . — F o r exam p le,
s t a b i l i t y o f th e e f f i c ie n c y - w a g e s r a t i o would i n d i c a t e t h a t
7«
e very i n c r e a s e i n p r o d u c t i v i t y was b e in g m atched by o n ly a
c o rre s p o n d in g i n c r e a s e i n money wage r a t e s ; p r i c e s would
rem ain r e l a t i v e l y s t a b l e . But when money wage r a t e s r i s e
f a s t e r th a n th e i n c r e a s e i n p r o d u c t i v i t y , th e n e f f i c i e n c y -
wages would r i s e and so would p r i c e s r i s e c o rr e s p o n d in g ly .
In d e e d , Hansen c o n s id e r e d t h e e f f i c ie n c y - w a g e l e v e l as " th e
p i v o t " aroun d w hich th e e n t i r e p o s tw a r p r i c e s t r u c t u r e
o s c i l l a t e d and re v o lv e d . As a c o n se q u e n c e , he co n clu d ed
t h a t a " g e n e r a l i n f l a t i o n a r y movement" n e c e s s a r i l y in v o lv e d
wage i n f l a t i o n t o a l a r g e r o r s m a l l e r e x t e n t .
I n summary t h e n , r i s i n g demand le a d s t o r i s i n g
p r i c e s o n ly b e ca u se c o n d i t i o n s of s u p p ly — t h a t i s , th e
shape o f c o s t f u n c t i o n s — p r e v e n t h i g h e r s c a l e s of o u tp u t a t
e x i s t i n g o r p r e - i n f l a t i o n a r y p r i c e l e v e l s . *
The Case o f "Excess-Demand" I n f l a t i o n
"E xcess demand" i s th e more t e c h n i c a l te rm f o r th e
f a m i l i a r n o t io n o f " to o much money c h a s in g t o o few g o o d s ."
A ccording t o K eynes' tr e a tm e n t of e x c e s s demand I n f l a t i o n ,
^•The main s o u r c e s f o r th e above s e c t i o n a r e a s
f o l lo w s : K eynes, o p . c i t . , p . 23 9, c h a p t e r s 2 0 , 21; H ansen,
op. c i t . , c h a p t e r s b , 7, 8, and A Guide t o Keynes (New
York: M cGraw-Hill Book Company, i n c . , 1 95 3 ), pp. 183-203;
D i l l a r d , op. c i t . , c h a p te r s 9, 10; H ansen, M onetary Theory
. . . , o p . c i t . , pp. 101, 1 0 7 -9 . See a l s o th e d i s c u s s i o n
on €Ke f l a t n e s s o f a v e r a g e - c o s t c u rv e s i n Jo e S. B a in ,
I n d u s t r i a l O r g a n iz a tio n (New York: Joh n W iley & S o n s, 1959),
pp. 152-55* See a l s o S i e g e l , op. c i t . , pp. 2 3 6 -4 7 , f o r
f u r t h e r d i s c u s s i o n o f th e a g g re g a te su p p ly f u n c t i o n , and
th e r e l a t i o n of p r i c e s t o w ages, p r o d u c t i v i t y , and c o s t
c o n d i t i o n s .
79
i n h i s How t o Pay f o r th e War, th e main d i f f e r e n c e s from
th e case o f " s e m i - i n f l a t i o n " would be a s f o l lo w s :
1. The economy s t a r t s a t n e a r l y fu ll-e m p lo y m e n t
l e v e l s of o u t p u t.
2. The r e q u ir e m e n ts o f war n o t only p r e v e n t any
f u r t h e r i n c r e a s e s i n o u tp u t o f consum ption g o o d s, but may
even f o r c e a c e i l i n g on such o u t p u t.
3. A r i s i n g l e v e l o f money e a r n i n g s accom panies
th e i n c r e a s e d employment of c i v i l i a n s and armed se rv ice m e n
(" e v e n i f t h e r e were no i n c r e a s e s in t h e r a t e s o f money-
w a g es").
4. The outcome i s an " i n c r e a s e d q u a n t i t y o f money"
a v a i l a b l e t o be s p e n t on a r e s t r i c t e d amount o f g o o d s .^
In o t h e r w ords, an " e x c e s s of p u r c h a s in g power" f o r
consum ption p u r p o s e s — g e n e r a t e d by r i s i n g governm ent expend
i t u r e s f o r w ar— t h r e a t e n s to c au se a " p r o g r e s s i v e " or
" u n lim ite d " i n f l a t i o n a r y s p i r a l , u n l e s s i t i s "w ithdraw n"
from th e m ark et by o t h e r means. I t s h o u ld be added t h a t
e x c e s s demand can a l s o be g e n e r a t e d by I n c r e a s e d p r i v a t e
In v e s tm e n t e x p e n d i t u r e s , by a d e c l i n e I n l a b o r p r o d u c t
i v i t y w h ile money wages rem ain u n c h an g e d , and by a r e f u s a l
-*-See John Maynard K eynes, How t o Pay f o r th e War
(New York: H a r c o u r t , B race and Company, 1 9 4 0 ), p p . b -1 2 ,
5 7 -7 ^ ; H ansen, M onetary Theory . . . . o p . c i t . . p. 84;
D i l l a r d , op. c i t . , p , 242.
80
on th e p a r t o f l a b o r to f u l f i l l t h e e x i s t i n g amount o f work
f o r c u r r e n t r a t e s o f pay.
T h is ty p e o f i n f l a t i o n may be g e n e r a l i z e d as
f o l lo w s : th e t o t a l o f e f f e c t i v e demand f o r consumer and
in v e s tm e n t goods e x ce ed s th e t o t a l v a lu e o f o u tp u t a t f u l l
employment in term s o f e x i s t i n g p r i c e s . T hus, any g e n e r a l
r i s e in p r i c e s would i n d i c a t e t h a t a g g re g a te income and
demand h a v e , o r a re e x p e c te d to become e x c e s s iv e i n r e l a
t i o n to s u p p l y . 1
S h o r t a g e s , a b s o l u t e and r e l a t i v e . — I t sh o u ld be
n o te d t h a t e x c e s s demand has a n e c e s s a r y c o u n t e r p a r t i n th e
form of d e f i c i e n t su p p ly o r " s h o r t a g e s , " b e ca u se o u tp u t has
r e a c h e d a c e i l i n g o r must be c u r t a i l e d f o r s t r a t e g i c
r e a s o n s . 2
I n h i s a n a l y s i s of th e Korean war p e r i o d , A l b e r t G.
H a rt a s s e r t e d t h a t s h o r t a g e s and i n f l a t i o n a r e th e " n a t u r a l
outcome" o f m o b i l i z a t i o n . I n t h i s c o n t e x t , a c c o rd in g t o
H a r t , th e te rm " s h o r t a g e s " n o t o n ly c o v ers th e u s u a l n o tio n
o f a b s o l u t e l y re d u c e d s u p p l i e s b u t a l s o a p p l i e s to r e l a t i v e
■^A, C. L. Day and S t e r i e T. B eza, Money and Income
(New York: O xford U n i v e r s i t y P r e s s , I 9 6 0 ) , p . 295. A sim i-
l a r view I s found i n W illia m F e l i n e r and O th e r s , The Prob
lem o f R is in g P r i c e s ( P a r i s : O r g a n iz a tio n f o r E uropean
Economic C o - o p e r a t io n , 196I ) , p . 33.
^Day and B e za , op. c i t . , p . 295.
81
s h o r t a g e s g e n e ra te d a s a consequence o f I n c r e a s e d e a r n i n g s
n o t m atched by i n c r e a s e d consum er g o o d s. 1
The Swedish a p p ro a c h . — A more co m p lete d e f i n i t i o n
o f excess-dem an d i n f l a t i o n h a s been o f f e r e d by B ent H ansen,
who I n c l u d e s f a c t o r m a rk e ts i n h i s model i n a d d i t i o n t o
f i n a l - g o o d s m ark e ts. A ccording to H ansen, i n f l a t i o n a r y
m onetary p r e s s u r e s a r e said t o e x i s t so lo n g as t h e r e i s
e x c e s s demand in e i t h e r the g o o d s m a rk e ts or t h e f a c t o r
m a rk e ts ( o r in b o t h ) , and no e x c e s s s u p p ly in e i t h e r o f
them.
T h u s, absence o f e x c e ss demand i n th e goods m a rk e ts
need n o t p r e v e n t i n f l a t i o n a r y p r e s s u r e s from d e v e lo p in g in
th e f a c t o r m a rk e ts , w here th e demand f o r l a b o r ( a t e x i s t i n g
o u tp u t and wage l e v e l s ) may be i n e x c e ss o f th e l a b o r
su p p ly o f f e r e d . Here t h e r e s u l t would be a r i s e i n wages
b e fo r e t h e r i s e in p r i c e l e v e l , which would th e n f o llo w
from th e r i s e in c o s t s .
V ery l i k e l y , t h e more r e a l i s t i c c ase would be where
e x c e ss demand p r e v a i l s in b o th goods and l a b o r m a r k e ts . In
t h i s e v e n t , i f P r i s e s f a s t e r t h a n w ages, i t would i n d i c a t e
t h a t th e e x c e s s demand f o r go o d s i s g r e a t e r th a n th e e x c e s s
demand f o r la b o r ; c o n v e r s e l y , when th e wage l e v e l r i s e s
f a s t e r t h a n th e p r i c e l e v e l . F u r th e r m o r e , i f e x c e s s demand
A l b e r t G a i l o r d H a r t , D efense W ith o u t I n f l a t i o n
(New York: T w en tieth Century F u n d , 1 9 5 1 ), pp. 59-£>0.
82
has b ro u g h t o u tp u t l e v e l s t o a p o i n t where e x i s t i n g e q u ip
ment c a p a c i ty i s p r a c t i c a l l y f u l l y u t i l i z e d , w h ile the
l a b o r f o r c e i s n o t y e t f u l l y em ployed, th e n m ost p r e s s u r e s
on P w i l l be e x e r t e d from th e goods m a r k e ts . On t h e o t h e r
hand , i f la b o r becomes f u l l y o c c u p ie d b e f o r e equipm ent
c a p a c i ty d o e s, th e n wages w i l l be s u b j e c t e d t o t h e g r e a t e r
upward p r e s s u r e . ^
E l a b o r a t i o n s o f Excess-Demand I n f l a t i o n
The above d i s c u s s i o n of s e m i - i n f l a t i o n i n d i c a t e d
t h a t Keynes and A. H. Hansen had a s s ig n e d s i g n i f i c a n t r o l e s
t o c o s t s as a c o n t r i b u t o r t o r i s i n g p r i c e s . Now, i t h as
a l s o been n o te d by H a rt t h a t e x c e s s demand, t o o , may
t y p i c a l l y in d u c e o r s t i m u l a t e a " c o s t - p u s h " ty p e o f i n f l a
t i o n .
Demand and c o s t s . — The i n t e r r e l a t i o n s o f demand and
c o s t s w i l l be d is c u s s e d a g a in below and i n f o llo w in g
c h a p t e r s . Here i s n o te d H a r t ' s a s s e r t i o n t h a t , even i n th e
a b sen ce o f o v e r - a l l e x c e s s demand, c e r t a i n f o r c e s on th e
c o s t s i d e — such a s w ages, raw m a t e r i a l s p r i c e s , and
b u s i n e s s markups over d i r e c t c o s t s — would te n d t o push up
th e p r i c e of c i v i l i a n goods In th e f a c e o f i n c r e a s e d
m i l i t a r y p ro c u re m e n t.
l-Bent H ansen, A Study i n th e Theory of I n f l a t i o n
(London: George A lle n & Unwin L t d . , 1 9 5 l ) , pp. 4 - 8 , 18-20 .
See a l s o S i e g e l , op. c i t . , pp. 2 5 1 -5 4 , and th e d i s c u s s i o n s
i n J . E. Meade, The C o n tr o l of I n f l a t i o n (Cam bridge:
83
I n i t i a l l y , m i l i t a r y p ro cu rem en t c o n s p ic u o u s ly adds
i n f l a t i o n a r y p r e s s u r e s to th e raw m a t e r i a l s m a r k e ts , and
o f f e r s s u f f i c i e n t b o o s ts i n wage r a t e s t o a s s u r e an adequate
su p p ly of d e fe n s e w o rk e rs. F o llo w in g on t h e s e i n c r e a s e d
m a t e r i a l s and l a b o r c o s t s , p ro d u c e rs r a i s e t h e i r p r i c e s
a c c o rd in g t o an e s t a b l i s h e d markup o r m argin o v e r d i r e c t
c o s t s . The r e s u l t i n g r i s e i n P can th u s be a t t r i b u t e d
d i r e c t l y t o " c o s t - p u s h " f o r c e s r a t h e r th a n demand.
I n d e e d , a c c o rd in g t o H a r t , e x cess-d em and i n f l a t i o n s
c r e a t e d by d e fe n s e m o b i l i z a t i o n program s a re t y p i c a l l y tw o-
s i d e d : on th e i n i t i a t i n g s id e are t h e f o r c e s o f e x c e s s
demand ( o r " d e m a n d - p u ll" ) w hich a re " s e t up" by th e govern?-
m e n t 's b u d g e t, w h ile on th e r e s p o n s e s id e l u r k th e e q u a l ly
i n f l a t i o n a r y c o s t - p u s h f o r c e s p r e p a r e d t o ta k e f u l l ad v an -
“ I
ta g e o f th e e x c e s s demands made upon a v a i l a b l e s u p p l y .
" S e c t o r a l " e x c e s s demand. — Some w r i t e r s have
b ro ad en ed th e a p p l i c a b i l i t y o f e x cess-d em an d c a u s e s o f
i n f l a t i o n s t i l l f u r t h e r . Not only would t h i s ty p e o f i n f l a
t i o n com prise sym p to m atic s h o r t a g e s o f l a b o r a n d /o r s t r a i n s
upon p h y s i c a l c a p a c i t y , b u t - - s a y t h e s e e c o n o m is ts ~ s e ld o m
does e x c e s s demand f a l l e q u a l l y on a l l i n d u s t r i e s , o r on
Cambridge U n i v e r s i t y P r e s s , 1 9 5 8 ). PP- 1 1 -1 4 , and P a u l
D a v id so n , "Income and Employment M u l t i p l i e r s , and t h e P r ic e
L e v e l," The American Economic R eview , L II (S e p te m b e r, 1962),
pp. 738-55"!!
•^Hart, op. c i t . , pp. 6 5 -6 9 , 98.
84
a l l s e c t i o n s o f th e l a b o r m a r k e t, i n th e more norm al p e a c e
tim e s i t u a t i o n s .
On th e one h a n d , l a b o r may be unem ployed b e c a u se of
i t s im m o b ility , la c k o f s k i l l s , and r e l a t e d f r i c t i o n a l o r
s t r u c t u r a l r e a s o n s t h a t p r e v e n t i t from t a k i n g jo b s t h a t
a r e open. Y e t, th e p r e s s u r e o f demand may a l s o be th w a rte d
by th e l i m i t a t i o n s o f p r o d u c tiv e c a p a c i t y , so t h a t e x c e s s
demand may a r i s e b e cau se of t h i s r e a s o n a lo n e . Thus, th e
s t a t e o f e x c e s s demand— even i n th e f a c e o f unemploym ent—
may be o f v a r i o u s d e g r e e s , d e p en d in g on th e scope and nature
o f th e econom y's s t r u c t u r a l r i g i d i t i e s o r i n f l e x i b i l i t i e s
( i . e . , th e e x t e n t t o w hich r e s o u r c e s can be r e - a l l o c a t e d
from one s e c t o r o r a p p l i c a t i o n t o a n o t h e r ) .
F u r th e r m o r e , th e r a t e o f change of demand may a ls o
s i g n i f i c a n t l y d e te rm in e t h e i n f l u e n c e t h a t demand e x e r t s on
p r i c e s . F or i n s t a n c e , a sh arp i n c r e a s e i n demand t h a t
c o u ld r e a d i l y be a b s o rb e d w i t h i n , s a y , two y e a r s may impose
o b v io u s ly e x c e s s i v e p r e s s u r e s on t h e p r o d u c t i v e c a p a c i t y of
th e economy i f i t w e re , i n s t e a d , pack ed i n t o one y e a r : in
th e l a t t e r c a s e , t h e im p act on e x p e c t a t i o n s c o n c e rn in g
f u t u r e demand as w e l l a s b u s i n e s s c o n d i t i o n s in g e n e r a l
would g iv e r i s e t o i n f l a t i o n a r y p r e s s u r e s t h a t a re a b s e n t
i n th e f i r s t c a s e . I t a l s o e x p l a i n s why i n f l a t i o n a r y
«5
p r e s s u r e s may d e v e lo p w ith o u t " f u l l " employment and w ith o u t
e x ce ss demand in t h e economy as a w h o le .^
In t h i s c o n n e c ti o n , i t sh o u ld be added t h a t th e
degree o f e x c e s s demand w i l l a ls o be i n f l u e n c e d by th e
c o m p o s itio n of t o t a l demand: an i n c r e a s e d volume o f o u tp u t
can be more r e a d i l y s u p p l i e d in some i n d u s t r i e s or p r o d u c ts
th an in t h e case o f o t h e r s . In d e e d , t h i s a s p e c t o f e x c e s s -
demand i n f l a t i o n h a s been e l a b o r a t e l y e x p lo re d by C h a rle s
L. S c h u l t z e , as d e s c r i b e d i n the f o l lo w in g s e c t i o n .
The " d e m a n d - s h i f t " m odel. — The r a m i f i c a t i o n s o f
s e c t o r a l o r " p a r t i c u l a r " ty p e s o f ex ce ss-d e m a n d i n f l a t i o n ,
i n c o n t r a s t t o t h e o r i g i n a l (w a r-tim e or m o b i l i z a t i o n )
m odels o f " a g g r e g a te " o r o v e r - a l l e x c e s s demand, have been
more f u l l y d e v elo p ed by S c h u ltz e in what i s now known a s
th e " d e m a n d - s h if t" th e o ry o f i n f l a t i o n , a p p l i c a b l e m ain ly
to th e p e a c e - tim e economy o f th e 1950 's and l a t e r .
The d e m a n d -s h ift th e o r y p u r p o r t s t o e x p la in how a
g e n e r a l r i s e in P may o c c u r w ith o u t an e x c e s s i v e r i s e i n
th e o v e r - a l l l e v e l of demand (o r an autonomous upward push
of w a g e s ), a s i t u a t i o n a p p a r e n t l y l i k e t h a t o f th e 1955-543
c y c le . The c h i e f i n g r e d i e n t s of t h e d e m a n d - s h if t m odel
may be l i s t e d as f o l lo w s :
1. A r a p i d s h i f t o c c u rs i n th e c o m p o sitio n o f
demand— away from econom ic s e c t o r s whose demands a re
1P eliner and Others, op. c i t . , pp. 3^-43.
d6
f a l l i n g ( e . g . , a u to m o b ile s and r e s i d e n t i a l c o n s t r u c t i o n ) ,
and to w ard o t h e r s e c t o r s whose demands a r e r i s i n g r a p i d l y
( e . g . , c a p i t a l goods) and a r e t h e r e f o r e " e x c e s s i v e . 1 1
2. T h is d e m a n d - s h if t te n d s t o d r i v e up p r i c e s in
s e c t o r s f a v o r e d by t h e r i s i n g demands, b u t p r i c e s i n th e
sla ck -d e m a n d s e c t o r s e i t h e r rem ain s t a t i o n a r y ( i . e . ,
t o t a l l y r e s i s t a n t t o a p r i c e d e c l i n e ) o r drop only s l i g h t l y ,
so t h a t , on b a l a n c e , p r i c e r i s e s o u tw e ig h p r i c e d e c l i n e s ,
th e r e b y r a i s i n g th e a v e ra g e o f p r i c e s .
3 . T h is s e c t o r a l o r " p a r t i c u l a r " e x cess demand
s e r v e s to p u sh up t h e a v erag e p r i c e o f s p e c i a l i z e d i n t e r
m e d ia te m a t e r i a l s and components in heavy demand; i t a ls o
p u sh e s up t h e g e n e r a l l e v e l o f wage r a t e s as most
i n d u s t r i e s g r a n t wage i n c r e a s e s e q u a l o r alm ost e q u a l th o se
g r a n t e d by t h e r a p id l y - e x p a n d in g s e c t o r s . Thus, a r i s e in
c o s t s i s e x p e r ie n c e d even i n i n d u s t r i e s f a c e d by s a g g in g
demand (and p o s s i b l y unused c a p a c i ty and unem ploym ent, too),
w hich i n t e n s i f i e s t h e g e n e r a l r i s e i n P, because a t l e a s t
some o f t h e i r h ig h e r c o s t s a r e p a s s e d a lo n g in t h e i r prioes.
4. The r e s u l t i s a g e n e r a l r i s e i n p r i c e l e v e l ,
o r i g i n a t i n g i n th e e x c e s s demands e n jo y e d by p a r t i c u l a r
s e c t o r s o n l y , and s p r e a d in g t o th e r e s t o f th e economy v ia
th e c o s t m echanism , which i s c h a r a c t e r i z e d by i n f l e x i b i l i t y
of p r i c e s and wages i n th e downward d i r e c t i o n .
87
5. Over th e long r u n , a s u c c e s s io n o f such p e r i o d i c
s e c t o r a l booms, i n th e i n s t i t u t i o n a l c o n te x t o f downward
r i g i d i t i e s and th e c o s t - o r i e n t e d n a t u r e of p r i c e s and wages
— which " a c t l i k e a r a t c h e t " on th e p r i c e l e v e l - - i s d estin ed
to p u t " a new f l o o r " u n d e r each s u c c e s s i v e l y h ig h e r p r i c e
l e v e l a n d , t h e r e b y , f o s t e r a s e c u l a r upward d r i f t o r b i a s
in p r i c e s . The r i s e in p r i c e s i n m a rk e ts e n jo y in g e x c e s s
demand w i l l n o t be b a la n c e d by f a l l i n g p r i c e s i n s l a c k -
demand m a r k e ts .
T ra n s m is s io n o f I n f l a t i o n . — The d e m a n d - s h ift
t h e o r y , i t may be n o t e d , i s n o t u n l i k e th e m o b i l i z a t i o n
model s t u d i e d by H a rt i n th e sense t h a t f o r S c h u l t z e , to o ,
th e i n f l a t i o n a r y p r e s s u r e s g e n e r a t e d in one m ajo r s e c t o r
a re t r a n s m i t t e d th ro u g h o u t th e r e s t o f th e economy v i a th e
wage- and c o s t - p r i c e m echanism : on th e one h a n d , th e
p r i c e s o f one i n d u s t r y c o n s t i t u t e " t h e c o s t s o f a n o t h e r , "
w hile on t h e o t h e r hand a d h e re n c e t o markup p r i c i n g a s s u r e s
t h a t p r i c e - i n c r e a s e s w i l l f o llo w on th e h e e l s o f c o s t -
i n c r e a s e s . 1
" A g g re g ate" v e r s u s "N et" . — A c t u a l l y , th e demand-
s h i f t t h e o r y i s n o t as n o v e l as i t f i r s t seem s. Not o n ly
"I
C h a rle s L. S c h u l t z e , R ecent I n f l a t i o n in th e
U n ited S t a t e s , U .S ., C o n g re ss, J o i n t Economic C om m ittee,
Study P a p e r No. 1 (W ashington: U .S. Government P r i n t i n g
O f f i c e , 1 9 5 9 ), pp . 1 - 2 , 4, b -1 0 , 5 4 -5 9 , 143.
«a
did Bent Hansen acknowledge the p o s s i b i l i t y of s e c to r a l
"excess supply" (or slack demand) in the m idst of
"predominant" excess demand, but h is s p e c ia l d e f in it io n of
excess-demand i n f l a t i o n c a s ts a new lig h t on the meaning of
"aggregate" (in c o n tra s t to the p u rp o rte d ly opposite
n o tio n s " s e c to r a l" or " p a r t i c u l a r " ) . According to Hansen,
"predominant" or "e x ten siv e" excess monetary demand e x i s t s
so long as the " t o t a l market value" of excess demand in
"in d iv id u al" m arkets exceeds the value of the "excess
supply" in th o se in d iv id u a l markets which are s u ffe rin g
from sla ck demand.-1 - In o th e r words, the im p lic a tio n i s
th a t "excess demand" need not be "aggregate" or " o v e r- a ll"
so long as the "net" p re ssu re fo r p r ic e - in c r e a s e s in the
booming s e c to rs is stro n g enough to fo rce the g e n e ra l p ric e
le v e l upwards, d e s p ite the ex iste n c e of s la c k demand in
o th e r s e c to r s .
The main c o n trib u tio n of S c h u ltz e 's model may l i e
in i t s emphasis on an i n s t i t u t i o n a l environment of p ric e
and wage r i g i d i t i e s which assure th a t the p r ic e -in c re a s e s
g enerated in th e excess-demand s e c to rs a re tra n s m itte d —
as cost in c re a s e s — to th e slack-demand s e c to r s , t h a t i s ,
to th e economy as a whole.
-^B. Hansen, op. c i t . . p. 6.
b9
Some Common Denominators
By now i t can be seen th a t the cases of "semi-
i n f l a t i o n ’1 and "excess demand" in c o rp o ra te f e a tu r e s char
a c t e r i s t i c of the o th e r.
Why demand is " e x c e s s iv e " . —In the case of semi
i n f l a t i o n , demand ev e n tu a lly becomes "excessive" in the
sense th a t monetary demand exceeds the value of goods t h a t
can be supplied a t e x is tin g ( p r e - i n f l a t i o n ) p r ic e s ; indeed,
I t is only by "p e rm ittin g " the a v a ila b le and p ro sp e c tiv e
supply to be marketed at h ig h e r-th a n -e x is tin g p ric e s th a t
the scale of output can be expected to approach f u l l -
employment le v e ls .
On the o th e r hand, in the case of war-time excess
demand, aggregate demand o s te n s ib ly proves "excessive" in
r e l a t i o n to c u r ta ile d su p p lie s of consumer goods caused by
Increased government ex p en d itu res on war goods. Here, to o ,
what r e a l ly makes monetary demand "excessive" i s th e
r e l a t i v e s c a r c ity of goods a t e x is tin g p r i c e s , much the
same as in the case of s e m i- in fla tio n . The c h ie f d i f f e r
ence between the two models would seem to l i e in the
e x iste n c e of l e s s - t h a n - f u l employment a t the s t a r t of
s e m i- in fla tio n .
Demand versus supply. — The s i m i l a r i t y between semi-
i n f l a t i o n and excess-demand—re g a r d le s s of the s t a t e of
employment—may be viewed from another angle. In both
90
ty p e s o f i n f l a t i o n , th e l e v e l o f P b eh av es e s s e n t i a l l y as a
r e s u l t a n t of t h e b a la n c e betw een (a) a g g re g a te m onetary
demand, c o m p risin g incom es r e c e i v e d by th e f a c t o r s of
p ro d u c tio n , e n t e r i n g th e m a r g i n a l c o s t s , e s p e c i a l l y w ages,
and sy m b o liz ed by "Y," and (b) th e a g g r e g a te r e a l o u t p u t ,
as r e f l e c t e d i n th e s c a l e o f p r o d u c t i o n o r l e v e l of
c a p a c i ty i n v o l v e d , and sy m b o liz ed by !l0 . n l
In t h e term s of Income t h e o r y , th e s e r e l a t i o n s
betw een p r i c e l e v e l , demand, and o u tp u t may be s t a t e d as
a s im p le e q u a t i o n : P * Y /0 , which i s b a s i c a l l y s i m i l a r t o
th e " i n c o m e - v e lo c lty " m odel o f th e e q u a t io n o f ex change:
Py = M Vy/Ty. W ith th e s e e q u a t i o n s , i t i s e v i d e n t t h a t i f
Y (m onetary demand) b e g in s t o r i s e f a s t e r th a n 0— owing
e i t h e r t o (a) f u l l employment and s h o r t a g e s of consumer
g o o d s, o r (b) th e a c c e l e r a t e d i n c r e a s e o f f a c t o r incomes
and c o s t s e x c e e d in g th e r i s e in p r o d u c t i v i t y a s f u l l
employment i s a p p ro a c h e d — th e n P w i l l r i s e a c c o r d i n g l y .
S t a te d s u c c i n c t l y : P i s d e te rm in e d by th e r e l a t i o n betw een
a g g r e g a te demand and a g g r e g a te s u p p ly .^
■ ^A . H. H ansen, M onetary Th e ory . . . , op. c i t . ,
pp. 64 , 131-39; K eynes, The G e n e ra l Theory . . . , op. c i t .,
p p # 2 0 4 -9 5 .
^A. H. H ansen, I b i d . , p . 64, and A Guide t o K e y n e s.
op. c i t . , p . 163. See a l s o S i e g e l , op. c i t . , c h a p t e r 13,
f o r a d i s c u s s i o n o f th e r e l a t i o n betw een a g g re g a te demand
and s u p p ly f u n c t i o n s .
91
The Influence of Market S tru c tu re
The in f la t io n models o u tlin e d above r a is e some
important questions concerning the an a ly sis and i n t e r p r e t a
tio n of demand i n f l a t i o n .
F i r s t , th e re is the same b asic question asked in
connection with the q u an tity theory: in what sense can
expanded demand "cause" p ric e s to r is e ? S tated more
e la b o ra te ly : in view of the ro le played by costs in the
case of demand i n f l a t i o n , when can a given p ric e r i s e be
a t tr i b u te d to expanded demand r a th e r than to costs? Con
v e rs e ly , under which conditions w ill an expansion of demand
not cause p ric e s to ris e ?
Second, the above models of demand in f la t io n
in d ic a te th a t r i s i n g costs are a s t r a t e g i c causal f a c to r
working in tandem with demand to e f f e c t p ric e in c re a se s.
Although the ro le of r i s i n g costs (or "cost-push") w ill be
tr e a te d a t length in follow ing c h a p ters, th e question must
here be ra is e d : in what sense do co sts c o n s titu te a causal
f a c to r when operating in th e context of expanded-demand
in f la tio n ? In t h i s connection i t Is also proper to r a is e
a lo g ic a l question concerning the r e l a t i o n between costs
and demand: can "cost-push" I n f l a t i o n occur without the
"perm ission" of increased demand or purchasing power?
Some A sp ects o f P r ic e Theory
I t w i l l f i r s t be n e c e s s a r y t o r e f e r t o a t l e a s t
some a s p e c t s o f m icro -eco n o m ic p r i c e t h e o r y , w hich w i l l
a l s o be r e l e v a n t to l a t e r d i s c u s s i o n on c o s ts and admin
i s t e r e d p r i c e s . 1
P r i c e - t a k e r s v e rs u s p r i c e - m a k e r s . — P r i c e th e o r y
t e l l s us t h a t p r i c e s a re form ed in " m a r k e ts ," and t h a t i n
th e c o n te x t o f such m a rk e ts p r i c e s may be c l a s s i f i e d e i t h e r
as "g iv en " t o b u y ers and s e l l e r s (who c o n s t i t u t e th e
" p r i c e - t a k e r s " of p e r f e c t c o m p e t i t i o n ) , o r as " s e t " by th e
" p r ic e - m a k e r s " of im p e r f e c t c o m p e titio n and o l i g o p o l y . ^
I t may be t r u e t h a t th e p r a c t i c a l Im p o rta n ce o f th e
p e r f e c t - c o m p e t i t i o n model i s n o t v e ry g r e a t , owing t o i t s
m in o r r o l e i n o u r economy. F o r , as Jo a n R obinson h as p u t
i t , m a n u fa c tu re d goods a re sim p ly n o t s o l d on th e m arket
l i k e s t a p l e c o m m o d ities, w ith p r o d u c e r s " ta k i n g w hat th ey
f e t c h " ; on t h e c o n t r a r y , i t i s up to t h e p r o d u c e r t o
" d e c l a r e h i s p r i c e . . . and s e l l w hat w i l l g o . "3
1F o r a very r e l e v a n t a r t i c l e on th e i n te r d e p e n d e n c e
of (a ) m a rk e t s t r u c t u r e and c o s t - p r i c e r e l a t i o n s , and (b )
I n f l a t i o n a r y p r i c e t e n d e n c i e s , see John K enneth G a l b r a i t h ,
"M arket S t r u c t u r e and S t a b i l i z a t i o n P o l i c y , " The Review o f
Economics and S t a t i s t i c s . XXXIX (May, 1957), p p . 124-33.
^For a c o n v e n ie n t summary of t h e s e p o i n t s see T lb o r
S c i to v s k y , W elfare and C o m p e titio n (C hicago : R ic h a rd D.
I r w i n , I n c . , 1 9 5 1 ), pp . 14-26.
3J o a n R o b in so n , E x e r c is e s in Economic A n a ly s is
(London: M acm illan & Co. L t d . , 1 9 6 1 ), p. 1&2.
93
T h is i n s t i t u t i o n of p r i c e - s e t t i n g by p r o d u c e r s has
become known as " a d m i n i s t r a t i o n " o f p r i c e s , and th e p r i c e s
th u s s e t a re t h e r e f o r e c a l l e d " a d m i n i s t e r e d ." As we w i l l
s e e , how ever, a d m in is te r e d p r i c e s a l s o i n c lu d e wage r a t e s
d e te rm in e d by agreem ent betw een managements and u n io n s .
A ll o f th e s e wage r a t e s and many o f th e p r i c e s a ls o c o n s t i
t u t e c o s t e le m e n t s , f o r th e im m ediate em p loy ers and f o r th e
r e s t o f th e economy, and as such a re very l i k e l y t o c o n t r i
b u te t o p r i c e i n f l a t i o n b ased on th e upward t h r u s t s o f
i
c o s t S .
N e v e r t h e l e s s , a b r i e f d e s c r i p t i o n o f th e t r a d i
t i o n a l p e r f e c t - c o m p e t i t i o n m odel w i l l s e rv e to d r a m a tiz e
th e e s s e n t i a l l y m e c h a n ic a l n a t u r e o f ex cess-dem and as i t
would o p e r a te i n t h e c o n te x t o f p e r f e c t l y f l e x i b l e p r i c e s ,
r i s i n g and f a l l i n g p u r e l y u n d e r the im p a ct of "anonymous"
su pply -an d -d em an d f o r c e s i n o r d e r t o " c l e a r th e m ark e t" of
any e x c e s s e s .
A u to m atic p r i c e f l e x i b i l i t y . — When q u a n t i t i e s
demanded e x c e e d su p p ly a t e x i s t i n g p r i c e s , p e r f e c t l y
f l e x i b l e p r i c e s w i l l r i s e n o t b e cau se s e l l e r s d e c id e i t i s
p r o f i t a b l e t o " c h a rg e m ore"; r a t h e r i t i s th e im p e rs o n a l
mechanism o f t h e p e r f e c t m ark et t h a t a u t o m a t i c a l l y r a i s e s
I p r i t z M achlup, " S t a te m e n t," U . S ., C o n g re ss, J o i n t
Economic Com m ittee, H e a r in g s , P a r t 9A. Study o f Employm ent.
G row th, and P r i c e L e v e ls (W ashington: U.S. Government
P r i n t i n g O f f i c e , 1 9 $ 9 ), p . 2824.
94
p r ic e s to the le v e l where consumers would not want to
purchase any more than was su p p lied . As F r it z Machlup has
s ta te d i t , " S e lle r s d o n 't ask h ig h e r p r ic e s , they j u s t get
them." The same autom atic mechanism ap p lie s in the labor
m arket: when the demand f o r lab o r r i s e s , workers d o n 't ask
f o r higher wages— they simply get them as a r e s u l t of
co m p etitio n .^
I t may be tru e th a t a major share of our p ric e s and
wages do not " r is e " by them selves— as though p a s s iv e ly and
au to m atica lly r e f l e c t i n g the o p eratio n of market f o rc e s —
but are r a th e r " ra is e d " a c tiv e ly and consciously by
producers and s e l l e r s according to form al or inform al
p ric in g p o l i c i e s regarded as " a d m in is tra tio n ." Does i t
n e c e s s a r ily follow th a t the market demand of p e r f e c t compe
t i t i o n p lay s no r o le a t a l l in the p r i c e - s e t t i n g co n sid era
tio n s of "p ric e -m a k e rs"? I f market demand p la y s a r o l e ,
how may i t e n te r in to the p ric in g d e lib e r a tio n s of the
price-m akers?
S t r i c t l y c o s t- p l u s . — Adopting th e i l l u s t r a t i o n used
by Machlup, i t may be shown th a t sooner or l a t e r th e
im p erfectly com petitive price-m akers may take account (or
a t l e a s t become aware) of th e s ta te of market demand when
^ F r i t z M achlup, "A n o th er View of C o st-P u sh and
Dem and-Pull I n f l a t i o n , " The Review o f Economics and
S t a t i s t i c s , XLII (May, 19'bO," "p. 12 7". See a l s o G a l b r a i t h ,
p p . c i t *. p p . 126 -2 7.
95
they decide on the p ric e s to be s e t . 1 F i r s t , however, l e t
us assume the extreme case where p ric e s and wage r a t e s
throughout the economy are ad m in istered s t r i c t l y by some
rule-of-thum b " c o s t-p lu s " p o lic y , w ithout any account taken
of changes in market demand.
P ric e s and wages thus set may then e i t h e r (a) tu rn
out to be "to o h ig h ," r e l a t i v e to demand, so th a t producers’
s a le s f a l l o f f , in v e n to rie s p i l e up, inducing producers to
cut output and employment, or (b) p ric e s and wages may
prove to be "too low" r e l a t i v e to demand, so th a t s a le s are
stepped up, in v e n to rie s are ra p id ly d e p le te d , while
producers have to re q u e st customers to wait p a t i e n t l y fo r
o r d e r - d e liv e r ie s or simply r e j e c t some new o rd e rs as they
attem pt (w ith in c re a sin g d i f f i c u l t y ) to expand t h e i r output
and employment.
In e i t h e r c a se , our p erv erse p r ic e -a d m in is tra to r s
may refu se to re v is e o r a d ju s t t h e i r p r ic e s f o r goods and
lab o r s e r v ic e s , in t o t a l d is re g a rd of the s t a t e of market
demand, although th ey may have to r a i s e p r ic e s and wages
in response to any r i s e s in c o sts and c o s t- o f - liv in g .
^■To quote Joan Robinson on t h i s p o in t: " . . .
P ric e s cannot be fix e d by c o s ts alo n e, w ithout regard to
market co n d itio n s . . . For each firm (even when com peti
ti o n i s very im perfect) p ric e s are more or le s s narrowly
determ ined by market c o n d itio n s , and i t s b u sin ess i s not to
f ix p ric e s to cover c o sts but to fin d th in g s to produce a t
c o s ts which make the given p r ic e s p ro fitab le."(R o b in so n ,
op. c i t . , p . Ib3).
T hu s, i n t h e case o f an i n c r e a s e in demand, th e y w i l l be
s a t i s f i e d m ere ly t o a cc u m u late u n f i l l e d o r d e r s and u n f i l l e d
jo b v a c a n c i e s ; th e y w i l l not r a i s e p r i c e s ; and t h e r e w i l l
be no dem an d -p u ll on p r i c e s . ^
R e l a t i o n s Between Demand and C o sts
The " s t r i c t l y c o s t - p l u s " p r i c i n g model d e s c r i b e d
above has been p u r p o s e ly overdraw n i n o r d e r to show more
c l e a r l y — once i t s a ssu m p tio n s a r e r e l a x e d — how d e m a n d -p u ll
f o r c e s a re in r e a l i t y l i k e l y t o e n t e r t h e c o n s i d e r a t i o n s o f
p r ic e - m a k e r s n o t w i th s ta n d i n g th e e x i s t e n c e of a d m i n i s t e r e d
p r i c e and wage p o l i c y .
More r e a l i s t i c c a s e s . — Many m a rk e ts in w hich p r i c e s
a r e a d m in is te r e d may i n r e a l i t y c o n s i s t o f (a) some
w ould-be b u y e rs who, i n p e r i o d s of r i s i n g demand, would
w i l l i n g l y o f f e r h i g h e r p r i c e s i n o r d e r t o r e c e i v e p r e f e r r e d
t r e a t m e n t , a s w e ll a s (b) some s e l l e r s who would a g re e t o
a c c e p t h i g h e r p r i c e s even th o u g h th ey ex ceed th e l i s t
p r i c e s . I n t h i s e v e n t the p r i c e i n c r e a s e s s e t by s e l l e r s
would be i n re s p o n se t o d e m a n d -p u ll f o r c e s ( r a t h e r th an t o
c o s t s e x c l u s i v e l y ) i n somewhat th e same manner a s su g g e ste d
by p e r f e c t l y c o m p e ti t iv e , m a r k e t - c l e a r i n g p r i c e s , and
d e s p i t e t h e c o - e x i s t e n c e of c o s t - p l u s p r i c i n g p o l i c i e s . 2
■^Machlup, "A n o th er View . . . , " op. c i t . , pp.
127-28. See a ls o G a l b r a i t h , op. c i t . , p . 127.
2M achlup, "A n o th er View . . . , " op. c i t . . p . 12 8 .
97
A ccording t o Machlup i t i s n o t easy t o d e te rm in e to
what e x t e n t th e p r i c e s s e t i n our economy a r e a c t u a l l y
c h a r a c t e r i z e d by ( a ) th e m a r k e t - c l e a r i n g t e n d e n c i e s o f
p e r f e c t c o m p e titio n even in th e f a c e o f c o s t - p l u s p r i c i n g
p o l i c i e s , o r by (b ) c o s t - p l u s c o n s i d e r a t i o n s e x c l u s i v e l y ,
i n w hich s e l l e r s do n o t alw ay s have r e g a r d f o r th e
e x i s t e n c e o f e x c e s s demand o r d e m a n d -p u ll.
N e v e r t h e l e s s , Machlup a d d s, i t i s f r u i t f u l t o
c o n c e iv e th e p o s s i b i l i t y t h a t , u n d e r c e r t a i n c o n d i t i o n s ,
expanded demand may n o t p ro v e " e f f e c t i v e " ( i . e . , won’t
cause a d e m a n d -p u ll-u p of p r i c e s ) , and t h a t an e n s u in g
c o s t - p u s h would be r e q u i r e d t o e f f e c t th e p r i c e r i s e . ^
B e cau se, by v i s u a l i z i n g such a c a s e , we a re a l s o a b le t o
d i s t i n g u i s h two d i f f e r e n t t y p e s of c o s t - p u s h i n f l a t i o n :
1) A c o s t - p u s h o f wages and p r i c e s t h a t i s
a g g r e s s iv e or au to n o m o u s, th e r e b y c r e a t i n g an e x c e s s supply
( o f p r o d u c tiv e c a p a c i t y o r o f la b o r ) o.f a " d i s e q u i l i b r a t -
ing" ty p e t h a t w i l l have t o be a b so rb e d or l i q u i d a t e d by an
i n c r e a s e i n e f f e c t i v e demand ( f i n a n c e d by an e x p a n s io n of
money and c r e d i t o r i n c r e a s e d v e l o c i t y ) s u f f i c i e n t t o
p e r m it o r " r a t i f y " t h e i n c r e a s e in p r i c e s .
2) A c o s t - p u s h of wages and p r i c e s t h a t " a b s o rb s "
a p r e v i o u s l y e x i s t i n g e x c e s s demand and t h e r e b y s e r v e s to
^•This case may be much more r e a l i s t i c th a n Machlup
a l l o w s , a c c o rd in g t o G a l b r a i t h , op. c i t . , p p . 127-30 .
98
" e q u i l i b r a t e " th e im b a lan c e c r e a t e d by th e e x c e s s demand.
Such in d u c e d c o s t i n c r e a s e s Machlup d e s c r i b e s as
" r e s p o n s i v e " o r " c o m p e titiv e " i f i t i s c o n c e iv a b le t h a t
th ey would a l s o have o c c u r re d i n th e ab sen ce o f a d m in is
t e r e d p r i c e - and w a g e - s e t t i n g pow ers o f management and
u n io n . 1 T h is r e s p o n s iv e ty p e o f c o s t- p u s h may be u s e f u l l y
d i s t i n g u i s h e d from th e more p o p u l a r c o n c e p t o f " a g g r e s s iv e "
c o s t - p u s h , which w i l l be t r e a t e d a t le n g t h in t h e n e x t two
c h a p t e r s .
W ith p e r m is s io n of demand. — At t h i s p o i n t i t i s
n e c e s s a r y t o c o n s id e r an im p o r ta n t q u e s t io n o f l o g i c d i s
cussed by M achlup, b e c a u se i t b r i n g s home th e b a s i c i n t e r
r e l a t e d n e s s of c o s t - p u s h and d e m a n d -p u ll f o r c e s i n c o n c r e te
i n f l a t i o n s i t u a t i o n s . I t h as a lr e a d y been n o te d t h a t I n a
w orld o f a d m i n i s t e r e d p r i c e s t h e r e i s a sense i n which
d e m a n d -p u ll can n o t cause i n f l a t i o n b e ca u se i t r e q u i r e s a
c o s t- p u s h to r e a l i z e o r f u l f i l l i t . I t i s now im p o rta n t t o
e x p la in i n what se n se a c o s t- p u s h i n f l a t i o n i s n o t p o s s i b l e
w lth p u t th e " p e r m is s io n " of expanded p u r c h a s in g power o r
demand; f o r o th e rw is e a c o s t - p u s h would m ere ly r e s u l t in
red u ced s a l e s and o u t p u t , and i n i n c r e a s e d unem ploym ent,
and n o t i n i n f l a t i o n . 2
^M achlup, "A n o th er View . . . ," op. c i t . , pp.
127-28, and " S t a te m e n t ," op. c i t . , p . 28241
2M achlup, "A n o th e r View . . . ," op. c i t . , pp.
126-27.
99
F i r s t , i t may be a rg u e d t h a t in o u r economy m ost
wages and p r i c e s in v o lv e "paym ents t o be made by somebody
who has th e money or can g e t t h e money and i s p r e p a r e d t o
spend it."-*- The a rg u m e n t, b a se d on th e r u l e s of i n d u c t i v e
l o g i c , c o n tin u e s as f o l lo w s : on th e one s i d e e x i s t (a) th e
wage- and p r i c e - (o r c o s t - ) r a i s i n g powers o f u n io n s and
management; on th e o t h e r s id e s ta n d (b) th e p u r c h a s i n g -
power f a c i l i t i e s of th e m on etary and f i s c a l sy s te m s. I f i t
i s t r u e t h a t (a) and (b) w orking t o g e t h e r cause s u c c e s s iv e
p r i c e r i s e s , t h a t (a) w ith o u t (b ) cannot do s o , b u t t h a t
(b) w ith o u t (a ) can, th e n (b) and n o t (a) sh o u ld be deemed
th e " c a u se " o f th e p r i c e r i s e s .
A n e c e s s a r y c o n d i t i o n . — In o t h e r w o rd s, th e con
c l u s i o n i s t h a t a c o n t i n u i n g r i s e i n p r i c e s i s n o t p o s s i b l e
w ith o u t th e a d d i t i o n a l p u r c h a s in g power e x te n d e d by th e
m o netary and f i s c a l s y s te m s ; th e r e s u l t i n g i n c r e a s e in
e f f e c t i v e demand i s a n e c e s s a r y c o n d itio n f o r th e
o c c u rre n c e o f h i g h e r p r i c e s ; o th e r w is e o v e r - z e a l o u s p r i c e -
and w a g e - a d m i n i s t r a t i o n would o n ly r e s u l t i n re d u c e d s a l e s
and o u tp u t and em ploym ent, and n o t in h i g h e r p r i c e s . I t
sh o u ld be added t h a t a n o th e r a l t e r n a t i v e r e s u l t , n o t
m en tio n ed by M achlup, would be re d u c e d p r o f i t m a rg in s .
^Machlup, "Statem ent," op. c i t . , pp. 126-27-
100
C l a s s i f i c a t i o n s o f Demand I n f l a t i o n
These p r e l i m i n a r y c o n s i d e r a t i o n s p r e p a r e u s f o r th e
p r o p e r a p p r e c i a t i o n o f M a c h lu p 's c l a s s i f i c a t i o n o f demand-
e x p a n sio n I n t o two b ro a d t y p e s :
1. " Autonomous" d e m a n d -e x p a n sio n s. —These
e x p a n s io n s o f demand a r e "n o t lin k e d t o p r e v io u s o r t o
e x p e c te d c o s t i n c r e a s e s " but would o c cu r even i f no c o s t
i n c r e a s e s were e x p e r ie n c e d o r a n t i c i p a t e d ; f o r ex am p le, a
governm ent d e f i c i t o r a boom i n p r i v a t e in v e s tm e n t o r con
sum ption sp e n d in g m ig h t se rv e a s an autonomous demand.
2. " D e r i v a t i v e " d e m a n d -e x p a n slo n s. — These may
th e m s e lv e s be s u b - c l a s s i f i e d a lo n g two l i n e s :
a) "In d u ce d " e x p a n s io n s , i n t h e se n se t h a t
th e y come a s a " d i r e c t co n seq u e n ce " o f a c o s t i n c r e a s e ;
l a r g e r - t h a n - n o r m a l d is b u r s e m e n ts w i l l be made e i t h e r by
p r o d u c e r s — who have t o borrow o r t a p r e s e r v e s i n o r d e r t o
f i n a n c e h i g h e r wage r a t e s — o r by w a g e -e a rn e rs who r e c e i v e
h i g h e r wages a n d , s a y , i n c r e a s e t h e i r p u r c h a s e s on i n s t a l l
ment c r e d i t . Such "in d u c e d " d em an d -ex p an sio n s may, a l t e r
n a t i v e l y , be term ed " c o s t - i n d u c e d . "
b) " S u p p o r tiv e " o r "com pen satory" e x p a n s io n s
o f demand, which r e p r e s e n t t h e im p le m e n ta tio n of m on etary
o r f i s c a l p o l i c y d e s ig n e d t o a v e r t o r re d u c e th e unem ploy
ment a t t r i b u t a b l e ( a c t u a l l y o r p o t e n t i a l l y ) to th e wage
( c o s t ) o r p r i c e I n c r e a s e s . F o r exam p le, e a s i e r c r e d i t or
101
In creased government ex p en d itu res may be a p p lied in an
attem pt to m aintain employment and e f f e c t iv e demand.'1 '
With the a id of the above d e f in it io n s i t is
p o ssib le to regard both the s e m i- in fla tio n of Keynes and
the excess-demand of Hart as p rim a rily autonomous demand-
expansions, with the l a t t e r probably involving a stro n g e r
degree of co st-in d u ced expansion of demand, owing to the
la rg e r amounts of government spending (fo r war or defense)
and the v e r y - f u l l le v e l of employment.
Even more im portant: while the normal d i s t i n c t i o n
between "demand-pull" and "cost-push" may be u s e fu l f o r the
purpose of b u ild in g a n a l y t i c a l models, i t may not be u s e fu l
f o r the more p r a c t i c a l ta s k of id e n tify in g the a c tu a l
causes a t work in concrete cases where both models may be
working in com bination. As Machlup has put i t , these con
ce p ts simply may not be " o p e ra tio n a l" : they may not lend
them selves to r e l i a b l e s t a t i s t i c a l t e s t s . 2
F in a ll y , i t i s now p o ssib le to conclude th a t th e
expansion of monetary demand i s a necessary co n d itio n not
only fo r "demand-pull" i n f l a t i o n but also f o r "cost-push"
i n f l a t i o n . On th e one hand, one may id e n tif y demand-pull
■^Machlup, "Another View . . . ," op. c i t . , pp.
129-30. The term " d e riv a tiv e " has been suggested by Dennis
H. Robertson, Growth, Wages, Money (Cambridge: Cambridge
U n iv e rsity P re s s , 1 9 b l), pp. 29-3b.
^Machlup, "Another View . . . ," op. c i t . , p. 128.
102
i n f l a t i o n s o n ly in s i t u a t i o n s where expanded demand i s
c l e a r l y th e i n i t i a t i n g f a c t o r , and any e n s u in g c o s t -
i n c r e a s e s would b e lo n g to th e in d u c e d v a r i e t y . On t h e
o t h e r hand , demand I n f l a t i o n s o f th e in d u ced o r s u p p o r tiv e
c a t e g o r i e s would be l i k e l y t o f o llo w in a p a r t i c i p a t o r y
m anner in th e wake o f p r i c e r i s e s s t a r t e d by c o s t - p u s h
f o r c e s . 1
Summary and C o n c lu sio n s
T h is c h a p t e r h a s a tte m p te d to show how income
th e o r y r e l a t e s p r i c e i n f l a t i o n t o e x c e s s iv e i n c r e a s e s in
m onetary demand as t h e p red o m in an t i n f l u e n c e , but w ith
s i g n i f i c a n t c o n t r i b u t i o n s a l s o made by c o s t s and r e l a t e d
su p p ly c o n d i t i o n s .
W hile money, i n income t h e o r y , re m a in s s u b s t a n t i
a l l y a means o f payment (as i n t h e q u a n t i t y t h e o r y ) , i t i s
red u c ed t o an in s t r u m e n t o f t h e a c t i v e f o r c e s o f r e a l
demand e x e r c i s e d by co nsu m ers, p ro d u c e rs and g overn m en t.
Any i n c r e a s e s i n money su pply and v e l o c i t y , t h e r e f o r e ,
become o p e r a t i v e m a in ly by e n t e r i n g and f lo w in g th r o u g h th e
c h a n n e ls o f t h e in c o m e - e x p e n d itu r e mechanism.
F u r th e r m o r e , money i s now a l s o p r o p e r l y r e g a r d e d a s
a s t o r e - o f - v a l u e o r w e a lth t o be h e ld i n am ounts t h a t v a ry
a c c o rd in g t o changes i n th e r a t e o f i n t e r e s t and t h e p r i c e
l e v e l . In b o th o f th e above c o n t e x t s , money I t s e l f I s
S -I b i d . , p. 129
103
a f f e c t e d by th e l e v e l of Ty ( o r o u tp u t of f i n a l g o o d s, i n
th e in c o m e - v e lo c ity model o f t h e e q u a t io n of e x c h a n g e ) , by
Vy ( o r in c o m e - v e l o c i ty , now seen t o be i n f lu e n c e d by th e
r a t e o f i n t e r e s t , l i q u i d i t y p r e f e r e n c e , and t h e p r o p e n s i t y
t o consum e), and th e p r i c e l e v e l . /■
may be summarized i n sim p le form a s f o llo w s : w hereas th e
q u a n t i t y th e o ry p o s t u l a t e d th e d i r e c t c a u s a l r e l a t i o n
M— £~P, th e income th e o ry s e e s th e p r i c e - d e t e r m i n a t i o n
mechanism as flo w in g in th e f o l lo w in g m anner:
In t h i s scheme t h e i n t e r v e n i n g a g e n ts D, W, and 0 s t a n d ,
r e s p e c t i v e l y , f o r a g g re g a te demand (c o m p ris in g c o n su m p tio n ,
in v e s tm e n t, and governm ent s p e n d i n g ) , money wage r a t e s , and
a g g r e g a te r e a l o u t p u t .
Income t h e o r y I n s e r t s demand a s th e f i r s t im p o r ta n t
f i l t e r i n g c h a n n e l o f i n c r e a s e d money su p p ly . But demand
i t s e l f i s i n f l u e n c e d by t h e f o r c e s (n o t shown abov e) o f th e
p r o p e n s i ty to consum e, th e m a r g in a l e f f i c i e n c y o f c a p i t a l ,
and th e l i q u i d i t y p r e f e r e n c e .
on P depends on (a ) th e amount of expanded demand t h a t may
be a b so rb e d by i n c r e a s e d W r a t h e r th a n I n c r e a s e d 0 , and (b)
th e e l a s t i c i t y o f su p p ly 0 a t o r n e a r f u l l em ploym ent.
The t h e o r e t i c a l ad v an c es y i e l d e d by Income t h e o r y
P
N ex t, th e e x t e n t o f i n f l u e n c e e x e r c i s e d by demand
104
In t h i s f a s h i o n does income t h e o r y g iv e due
c o g n iz an c e t o what Keynes c a l l e d th e " c o m p l e x i t i e s and
i n t e r d e p e n d e n c i e s o f th e r e a l w o r l d . I t sh o u ld be n o t e d ,
how ever, t h a t th e d e m a n d -in f lu e n c in g f u n c t i o n s o f con
su m p tio n , i n v e s tm e n t , and l i q u l d i t y - p r e f e r e n c e a r e them
s e l v e s d ep en d e n t on th e e l a s t i c i t i e s of W (and o t h e r f a c t o r
c o s t s ) and 0 w ith r e s p e c t t o changes i n D. As A. H. Hansen
p u t i t , th e i n t e r r e l a t i o n s p o r t r a y e d in income t h e o r y a re
" h ig h ly com plex," more so th a n even Keynes had p o s t u l a t e d . 2
N e v e r t h e l e s s , income th e o r y u n d o u b te d ly b r i n g s u s f r u i t
f u l l y a lo n g th e ro a d from t h e q u a n t i t y t h e o r y .
However, t h e em ergence o f demand a s a c h a n n e lin g
i n s t i t u t i o n f o r i n c r e a s e d money su p p ly and v e l o c i t y i s
accom panied by th e em ergence o f c o s t s ( i n th e form o f wage
and p r i c e i n c r e a s e s ) a s a p a r t n e r in th e a c t . On th e one
h a n d , i n e l a s t i c i t y o f su p p ly l i e s a t th e h e a r t o f b o th
" s e m i - i n f l a t i o n " and " e x c e s s -d e m a n d ." On th e o t h e r hand,
t h e p re v a le n c e of c o s t - p l u s p r i c i n g p o l i c i e s a t tim e s
c o n v e r t s t h e r o l e o f expanded demand i n t o t h a t o f an
e n a b lin g o r p e r m is s iv e a g e n t o f i n f l a t i o n from t h a t of an
autono m ously p red o m in an t one.
^Keynes, The G e n e ra l Theory . . . , op. c i t . , p . 29&
^A. H. H ansen, A Guide t o K eynes, p . 187-
105
F i n a l l y , t h i s c h a p te r has a rg u e d t h a t demand
e x p a n s io n — s u p p o r te d by th e m onetary and f i s c a l a u t h o r i t i e s
— a l s o c o n s t i t u t e s a n e c e s s a r y c o n d i t i o n f o r any c o n ti n u i n g
r i s e in th e p r i c e l e v e l , i n c l u d i n g t h e c o s t - p u s h t y p e .
Having exam ined th e c o n d i t i o n s u n d e r which expanded
demand can by i t s e l f cause i n f l a t i o n , and u n d er w hich
c o n d i t i o n s i t n eeds th e a s s i s t a n c e o f c o s t- p u s h t o do so ,
th e n e x t s t e p i s to examine t h e c o n d i t i o n s u n d e r which
r i s i n g c o s t s — p a r t i c u l a r l y wages and p r o f i t s — can by them
s e l v e s r e s u l t in p r i c e i n c r e a s e s , in c o n t r a s t t o th o s e
c o n d i t i o n s i n which t h e y need th e h e lp of expanded demand
t o do so.
CHAPTER IV
THE ROLE OF WAGES
In t h e two p r e c e d in g c h a p t e r s , p r i c e i n f l a t i o n was
c o n c e iv e d as e m a n atin g from th e demand s id e of th e economy;
t h a t i s , p r i c e r i s e s were r e g a r d e d as in d u ce d by e x c e s s iv e
money supp ly o r e x c e s s i v e m on etary demand.
In t h i s c h a p t e r and t h e n e x t , p r i c e i n f l a t i o n w i l l
be t r e a t e d a s a consequence o f su p p ly or c o s t c o n d i t i o n s ,
in p a r t i c u l a r of e x c e s s i v e w a g e - in c r e a s e s and of " t a r g e t "
p r o f i t m arg in s soug ht by p r i c e - s e t t e r s .
Both o f th e s e o s t e n s i b l e c a u se s o f i n f l a t i o n have
f o r some tim e been d i s c u s s e d u n d e r th e g e n e r a l h e a d in g of
" c o s t- p u s h " t h e o r i e s as w e ll a s th e s p e c i f i c h e a d in g s o f
"w age-push" and " a d m i n i s t e r e d p r i c e s , " r e s p e c t i v e l y .
J u s t i f i c a t i o n o f t h e s e t h e o r i e s l i e s i n t h e f a c t
t h a t , on th e one h a n d , wages c o n s t i t u t e by v a lu e th e
l a r g e s t s i n g l e f a c t o r - c o s t i n th e economy, and t h e r e f o r e
te n d t o be a m ajo r d e te r m i n a n t o f changes i n c o s t o f
p r o d u c t i o n , 1 w h i l e , on th e o t h e r han d , p r o f i t m a rg in s may
iH a ro ld G. M oulton , Can I n f l a t i o n Be C o n t r o l l e d ?
(W ashington, D .C .: A nderson Kramer A s s o c i a t e s , 195^)*
PP. 159-63.
106
107
be more o r l e s s p r o t e c t e d from a d v e rs e c h an ges In m arket
c o n d it i o n s by th e c o s t - p l u s p r i c i n g a b i l i t y o f f ir m s in
o l i g o p o l i s t i c m a rk e ts .
In th e p r e c e d in g c h a p t e r , on d e m a n d -p u ll i n f l a t i o n ,
i t was s t a t e d t h a t h i g h e r c o s t s ( e . g . , wages and p r o f i t s )
and p r i c e s may be " in d u c e d " by e x c e s s i v e m o n etary demand,
o r may be a t t r i b u t e d t o an i n c r e a s e in th e d e r iv e d demand
f o r f a c t o r s o f p r o d u c t i o n . A c t u a l l y , as w i l l be seen
b elo w , h i g h e r c o s t s and p r i c e s may a ls o o c c u r
" a u to n o m o u sly ," " a g g r e s s i v e l y , " o r " s p o n ta n e o u s ly " even i n
th e absence o f e x c e s s m onetary demand in t h e p ro d u c t
m a r k e t .
F or i n s t a n c e , i f a s t r o n g l a b o r u n io n su c c e e d s i n
o b t a i n i n g w a g e - in c r e a s e s i n s p i t e of unemployment i n th e
g iv e n i n d u s t r y , t h i s would s i g n i f y a " s p o n ta n e o u s " i n c r e a s e
i n f a c t o r p r i c e s . S i m i l a r l y , p ro d u c e r s and s e l l e r s i n th e
" a d m i n i s t e r e d - p r i c e " s e c t o r s o f t h e economy may be a b le t o
r a i s e p r i c e s ( i n o r d e r t o m a in ta in p r o f i t m a rg in s i n t h e
fa c e o f a c t u a l o r im pending r i s e s i n wages and o t h e r c o s t s )
because of th e "m arket power" endowed t o them by t h e i r
h i g h ly d i f f e r e n t i a t e d p r o d u c ts (and the r e l a t i v e l y
I n e l a s t i c demand a s s o c i a t e d w ith such p r o d u c t d i f f e r e n t i a
tion).
The l a t t e r p r i c i n g power o f firm s w i l l be t r e a t e d
i n d e t a i l i n th e n e x t c h a p t e r . B ut i t may be n o te d a t t h i s
108
p o in t t h a t w ages, t o o , a r e an ,fa d m in is te r e d " p r i c e i n t h e
sense i n d i c a t e d h e r e , b e c a u se th e y may r e f l e c t th e b a r g a i n
in g or m a rk e t power o f s t r o n g u n io n s . In any e v e n t , t h e
f i r s t t a s k o f th e p r e s e n t c h a p te r i s t o e s t a b l i s h th e
c o n d i t i o n s which in d u ce o r e n a b le a w a g e - ln c r e a s e . T h is
w i l l be fo llo w e d by a d i s c u s s i o n o f t h e c o n d i t i o n s u n d e r
which w a g e - in c r e a s e s can cause a r i s e In u n i t c o s t s , w hich
In t u r n may in d u ce firm s t o r a i s e t h e i r p r i c e s . A f t e r a
d i s c u s s i o n o f t h i s l i n k (betw een w a g e -b o o sts and h i g h e r
c o s ts ) i t w i l l be p o s s i b l e ( i n th e n e x t c h a p t e r ) t o d i s c u s s
th e n e x t im p o r ta n t l i n k , p r i c i n g p o l i c y , w hich t i e s h i g h e r
c o s ts t o h i g h e r p r i c e s .
The W ag e -D eterm in atlo n P ro c ess
As i n d i c a t e d a b o v e, t h i s c h a p t e r w i l l d i s c u s s (1)
th e u n d e r l y i n g w a g e -d e te rm in in g f a c t o r s and ( 2 ) th e m anner
i n which wages can i n c r e a s e " e x c e s s i v e l y , " t h a t i s ,
s u f f i c i e n t l y t o f o r c e a r i s e i n u n i t t o t a l c o s t s . However,
s in c e t h i s r e p r e s e n t s on ly t h e c o s t - r a i s i n g s i d e of w age-
i n c r e a s e s , t h i s c h a p t e r w i l l a l s o have t o d e a l w ith ( 3 ) th e
d e m a n d -ra is in g s i d e of w a g e - i n c r e a s e s . D is c u s s io n s o f
"w age-push" i n f l a t i o n have te n d e d t o n e g l e c t o r s l i g h t th e
f a c t t h a t wages n o t o n ly c o n s t i t u t e c o s t s , b u t (as a
109
f a c t o r c o s t ) a l s o n e c e s s a r i l y c o n s t i t u t e income and
e f f e c t i v e demand.^-
I n d e e d , i t i s o n ly s t r e s s i n g th e o b v io u s t o say
t h a t a wage i n c r e a s e h a s a t w o - f o l d e f f e c t : a r i s e i n u n i t
t o t a l c o s t s (assum ing no o f f s e t t i n g l a y - o f f s , r i s e i n
p r o d u c t i v i t y , o r re d u c e d p r o f i t s ) and a d i r e c t i n c r e a s e i n
p u r c h a s in g power o f w a g e - e a r n e r s . F u rth e r m o r e , i n e v e ry
w a g e - in c r e a s e i t i s th e i n c o m e - r a is i n g e f f e c t w hich i s
c e r t a i n , w hereas th e c o s t - r a i s i n g e f f e c t depends on th e
ab sen c e o f o f f s e t s su c h as i n c r e a s e d p r o d u c t i v i t y , l a y - o f f s
o f some w o r k e r s , or re d u c e d p r o f i t s . Of c o u r s e , a
se co n d a ry q u e s t i o n o c c u r s : w i l l th e i n c r e a s e d wages
(incom e) become " e f f e c t i v e " demand and form an a c t u a l
i n c r e a s e i n e x p e n d i t u r e s ? T h is l a t t e r a s p e c t w i l l be d i s
c u sse d below i n th e s e c t i o n on " w a g e - p u l l . 1 1
In o t h e r w o rd s, i f wages a re i n c r e a s e d e x c e s s i v e l y —
th e r e b y c a u s in g c o s t s to r i s e and in d u c in g p r i c e s t o be
r a i s e d by f i r m s - - t h e r e s u l t i n g I n f l a t i o n w i l l n o t be f u l l y
e x p la in e d by r e f e r e n c e only t o "w age-push" p r e s s u r e s ;
O u t s t a n d i n g e x c e p ti o n s i n c l u d e F ra n k ly n D. Holzman,
" I n f l a t i o n : C o st-P u sh and Demand P u l l , " The American E eco
nomic Review, L (M arch, i 960) , p p . 2 0 -4 2 ; M o ulton, op. c i t ..
pp. 78- 80; S id n ey W e in tra u b , C l a s s i c a l K e y n e sia n ism . Mone
t a r y T h eo ry , and th e P r i c e L ev e l ( P h i l a d e l p h i a : C h ilto n
Companyj 1 9 6 1 ). A lv in H. Hansen a l s o a s s e r t s t h a t John
Maynard Keynes r e c o g n iz e d t h a t " t h e i n c r e a s e In wages would
c au se a f u r t h e r s h i f t i n th e demand c u r v e s , w ith i n f l a t i o n
a ry c o n se q u e n c e s" ; see h i s M onetary Theory and F i s c a l
P o l i c y (New Y ork: M cGraw-Hill Book Company, 1949)» P. 107.
110
a c c o u n t must a l s o be t a k e n of th e 1 1 d em an d -p u ll" p r e s s u r e s
t h a t have been s im u lta n e o u s ly g e n e r a te d by th e wage-
i n c r e a s e . 1 T h is l a t t e r a s p e c t was r e f e r r e d t o ( i n C h a p te r
i i i ) as " in d u c e d " demand e x p a n s io n .
I n t h i s s tu d y , t h e d e m a n d -in c re a s in g a s p e c t o f wage-
i n c r e a s e s w i l l be r e f e r r e d t o as w a g e -p u ll ( in l i n e w ith
th e g e n e r a l term " d e m a n d -p u ll" ) and w i l l be d is c u s s e d in
th e l a t t e r p a r t of t h i s c h a p t e r . A c t u a l l y , th e i n c r e a s e d
income g e n e r a t e d by w a g e - p u ll can a f f e c t a g g re g a te e x p e n d i
t u r e s and o u tp u t i n two ways: (a ) d i r e c t l y , th ro u g h th e
m a r g in a l p r o p e n s i t y t o consume o f th e w a g e - e a m e r s
r e c e i v i n g th e h i g h e r w a g es, and (b ) i n d i r e c t l y . by in d u c in g
changes i n i n v e s tm e n t , e x p o r t s , and governm ent e x p e n d itu r e s .
B oth o f th e s e a s p e c t s o f w a g e - p u ll w i l l be d is c u s s e d below P
The "Dilemma M odel"
The manner in which w a g e - in c r e a s e s cause c o s t s and
p r i c e s t o r i s e — o f t e n d i s c u s s e d u n d e r t h e h e a d in g of th e
" w a g e - p r ic e " i s s u e — h a s g e n e r a l l y been d e s c r i b e d and
a n a ly z e d i n te rm s of a "dilemma m odel" o f p r i c e i n f l a t i o n
■^Noteworthy i s t h e e x p l i c i t acknowledgment of
d e m a n d -p u ll a s p e c t s o f w a g e - in c r e a s e s i n t h e model o f wage-
push i n f l a t i o n d e v e lo p e d by Holzman, op. c i t .
2See t h e d e t a i l e d a n a l y s i s in Holzman, op. c i t . .
which u s e s th e term " c o s t - p u l l " f o r th e term " w a g e -p u ll"
u sed h e r e .
I l l
t h a t co m p rise s t h r e e s t a g e s viewed a s s e q u e n t i a l and I n t e r
r e l a t e d ( o r m u tu a lly d e te r m in in g ) a t th e same tim e . The
th r e e s t a g e s may be summarized as f o l lo w s :
1) W a g e -D e te rm in a tio n . — I n th e I n i t i a l p h a s e , th e
s tr o n g l a b o r u n io n s in o u r economy manage t o o b t a i n wage-
r a t e s t h a t r i s e f a s t e r th a n p r o d u c t i v i t y o r th e a v e ra g e
o u tp u t p e r u n i t o f l a b o r i n p u t . T h is argum ent a p p l i e s b o th
to th e high-em ploym ent (boom) p h a s e s of th e c y c le and to
r e c e s s i o n p e r i o d s . 1
2) C o st- and P r i c e - D e t e r m i n a t l o n . — The " e x c e s s iv e "
w a g e -in c re a s e s o b ta in e d i n th e f i r s t s ta g e have t h e immed
i a t e e f f e c t s o f (a) i n c r e a s i n g u n i t l a b o r c o s t s (ULC) and
u n i t t o t a l c o s t s (UTC) w hich , i n t u r n , (b) e n c o u rag e firm s
to i n c r e a s e p r o d u c t p r i c e s .
3) M o n e ta r y - F is c a l P o l i c y . — As a consequ ence o f th e
above p r e s s u r e s f o r h i g h e r p ro d u c t p r i c e s , t h e m o n e ta ry -
f i s c a l a u t h o r i t i e s a re f a c e d w ith a "dilem m a": (a) sh o u ld
they " j u s t i f y " o r " r a t i f y " th e h i g h e r p r i c e l e v e l by
i n c r e a s i n g th e money s u p p ly ( v i a an "easy-m oney" or
" e l a s t i c " c r e d i t p o l i c y ) , th e re b y s e t t i n g th e s t a g e f o r a
second round of i n c r e a s e s in u n i t l a b o r c o s t s and p r i c e s ;
(b) o r sh o u ld th e y a tte m p t to th w a r t th e i n c i p i e n t i n f l a
t i o n by l i m i t i n g th e money s u p p ly , a f t e r w hich employment
^ e e Abba P. L e r n e r , Review o f The F a i l u r e o f th e
"New Econom ics" by Henry H a z l i t t , The Review o f Economics'
and S t a t i s t i c s » XLII (May, I 9 6 0 ) , p . 235.
112
may b e g in t o d e c l i n e b e c a u se p ro d u c e rs and consum ers w i l l
have been d e p r iv e d o f th e m onetary means (expanded p u r c h a s
in g power) n eed ed t o buy up th e f a c t o r - s e r v l c e s and goods
o f f e r e d a t t h e h ig h e r p r i c e s . Hence th e r e s u l t i n g dilemma:
i n f l a t i o n o r unem ploym ent. 1
I t s h o u ld be n o te d t h a t t h i s l a s t sta g e o f th e
dilemma m odel— in w hich governm ent a u t h o r i t i e s a r e g iv e n
th e r e s p o n s i b i l i t y f o r a f f e c t i n g th e flo w o f m onetary
income and demand (in d u c e d by upward c o s t a d ju s tm e n ts ) and,
h e n c e , the l e v e l of p r i c e s and unem ploym ent— i s a c t u a l l y
con cern ed w ith th e demand s id e o f w a g e -c o st i n c r e a s e s ,
whose p o t e n t i a l i n f l a t i o n a r y p r e s s u r e has been i d e n t i f i e d
above as " w a g e - p u l l ."
Two m a jo r v a r i a n t s . — The dilemma model o u t l i n e d
above i s a c t u a l l y one o f two m a jo r v a r i a n t s . Some w r i t e r s
have ta k e n a n o th e r m ain r o u te t o th e dilemma ( t h i r d ) s ta g e ,
one t h a t s t a r t s e i t h e r w ith (a) th e assu m p tio n of a go v ern
ment g u a r a n te e o f ( o r commitment to ) f u l l employment " a t
any c o s t , " o r (b) a t l e a s t an i n i t i a l l y h ig h l e v e l of
em ploym ent.
F u rth e rm o re , i n t h i s se co n d main v a r i a n t o f th e
dilem ma m odel, one su b -g ro u p o f w r i t e r s e n v is io n s an
1U n le ss o th e r w is e s p e c i f i e d , th e main s o u rc e used
f o r t h e p r e c e d in g and t h e f o l lo w in g d i s c u s s i o n o f th e
"dilem ma m odel" i s th e d e t a i l e d , b o o k - le n g th a n a l y s i s by
W illiam G. Bowen, The W age-P rice I s s u e ( P r i n c e t o n : P rin ceto n
U n i v e r s i t y P r e s s , I 9 6 0 ) .
113
I n h e r e n t i n c o m p a t i b i l i t y betw een g o v e rn m e n t's f u l l -
employment commitment and p r i c e s t a b i l i t y ( q u i te a p a r t from
th e e x i s t e n c e o f p o w e rfu l l a b o r u n io n s ) because o f th e
ten d e n cy o f our economy— w ith i t s t e c h n o l o g i c a l and i n s t i
t u t i o n a l " r i g i d i t i e s " and " i m m o b i l i t i e s " — t o g e n e r a t e
b o t t l e n e c k s and r i s i n g c o s t s and p r i c e s as a g g r e g a te o u tp u t
moves to w a rd fu ll-e m p lo y m e n t l e v e l s .
On the o t h e r hand , a n o th e r su b -g ro u p of e c o n o m is ts ,
w hile s t a r t i n g w ith th e same a ssu m p tio n o f f u l l em ploym ent,
a ls o in v o k e s th e p a r t i c i p a t i o n o f l a b o r u n io n s a s p a r t of
th e dilemma m echanism . However, in t h i s v e r s i o n of the
dilemma m o d el, th e w a g e - in c r e a s e s a c h ie v e d by u n io n s a re
a t t r i b u t e d more t o e x i s t i n g fu ll-e m p lo y m e n t program s th a n
t o th e b a r g a i n i n g s t r e n g t h of u n io n s p e r s e . 1
I n t e r - r e l a t e d s t a g e s . — I t s h o u ld be n o t e d , how ever,
t h a t th e e x i s t e n c e o f t h e s e two m ajo r v a r i a n t s o f th e
d ile m m a -d e c is io n m erely r e f l e c t s th e u n d e r ly in g i n t e r
r e l a t i o n s h i p s and i n t e r a c t i o n s o f t h e t h r e e s t a g e s t h a t
com prise t h e b a s i c m odel: wage m ovem ents, p r i c i n g
p o l i c i e s , and th e m o n e t a r y - f i s c a l e n v iro n m e n t. In th e
p r e s e n t c h a p t e r , t h e f i r s t v a r i a n t o f th e model ( d e s c r i b e d
ab o v e)— i n which i n f l a t i o n a r y p r e s s u r e s a re presum ed t o
1A good exam ple i s M ilto n F rie d m a n , "Some Comments
on th e S i g n i f i c a n c e of Labor Unions f o r Economic P o l i c y , "
The Im p act of th e U n io n , e d . David McCord W right (New York:
K e lle y & M illm an , 1956)", pp. 204-3*1.
114
em anate from e x c e s s i v e w a g e - i n c r e a s e s — w i l l se rv e as th e
fram ework o f d i s c u s s i o n .
The W ag e -D eterm in atio n S tag e
Of c e n t r a l im p o rtan c e in th e dilemma m odel i s th e
i n i t i a l o r w a g e - d e te r m in a tio n s t a g e . In t h i s s ta g e i t i s
a s s e r t e d t h a t wages i n c r e a s e f a s t e r th a n p r o d u c t i v i t y (o r
o u tp u t p e r m an-hour) which n e c e s s a r i l y le a d s to an I n c r e a s e
i n u n i t l a b o r c o s t s (ULC). The f i r s t Im p o rta n t q u e s t io n s
t h a t a r i s e a r e : In what ways can wages r i s e f a s t e r t h a n
p r o d u c t i v i t y ? Under which c o n d i t i o n s i s I t p o s s i b l e f o r
wage r a t e s to be r a i s e d s u f f i c i e n t l y to cau se an I n c r e a s e
i n ULC?1
Role o f p r o d u c t i v i t y . — As a f i r s t a p p ro x im a tio n , i t
must be a s s e r t e d ( n e g a t i v e l y ) t h a t wage a d ju s tm e n ts o r
in c re m e n ts a r e n o t n e c e s s a r i l y l i n k e d t o In c re m e n ts in
p r o d u c t i v i t y ; f o r exam ple, i t i s p o s s i b l e f o r wage-
i n c r e a s e s to ex ceed p r o d u c t i v i t y - i n c r e a s e s . In t h i s
c o n n e c ti o n , s t u d i e s on t h e r e l a t i o n s h i p betw een th e wage-
d e te r m i n a ti o n p r o c e s s and t h e r a t e o f grow th In p r o d u c t
i v i t y i n d i c a t e t h a t t h e r e i s g e n e r a l l y l i t t l e o r no l i k e l i
hood t h a t u n io n s and management w i l l a g re e t o a c c e p t
1U n le ss o th e r w is e s p e c i f i e d , t h i s s e c t i o n I s b a se d
m ain ly on Bowen, op. c i t . , pp . 6 3 -9 1 * F o r t h e p u rp o se o f
t h i s c h a p t e r , and u n l e s s o th e r w is e I n d i c a t e d , t h e te rm
"wages" r e f e r s o n ly t o paym ents made f o r d i r e c t l a b o r ( e . g . ,
a v e ra g e h o u r ly e a r n i n g s ) and t h e i r " f r i n g e b e n e f i t s , " but
e x c lu d e s s a l a r i e s .
115
p r o d u c t i v i t y - c h a n g e s a s a b in d in g g uide to wage
a d ju s tm e n ts .
The u n d e r ly in g re a s o n i s t h a t b o th p a r t i e s g e n e r
a l l y want t o o b t a i n th e b e s t p o s s i b l e w a g e -b a rg a in f o r
t h e m s e lv e s , and a r e n o t d is p o s e d t o be r e s t r i c t e d e x c l u
s i v e l y by a p r o d u c t i v i t y fo rm u la . S p e c i f i c a l l y , u n io n s a re
r e l u c t a n t t o a c c e p t th e " p r o d u c t i v i t y p r i n c i p l e " o f wage
d e te r m i n a ti o n b e cau se i t im p lie s th e a c c e p ta n c e of th e
e x i s t i n g income d i s t r i b u t i o n as beyond a l t e r a t i o n , and t h i s
th e y a re a p p a r e n t l y n o t y e t w i l l i n g t o do. As f o r
p r o d u c e r s , th e y te n d t o f e e l t h a t , b ecau se i n c r e a s e s in
p r o d u c t i v i t y a re n o t s o l e l y a t t r i b u t a b l e t o th e l a b o r in p u t
i t s e l f , t h e i r w o rk ers have no i n h e r e n t r i g h t t o th e g a in s
from such p r o d u c t i v i t y g ro w th , a lth o u g h th e y may u l t i m a t e l y
r e c e i v e b e n e f i t s from su ch g a i n s .
T h is i s n o t t o e x c lu d e t h e p o s s i b i l i t y t h a t
p r o d u c t i v i t y - i n c r e a s e s w i l l e x e r t some I n d i r e c t e f f e c t s on
th e w a g e - d e te r m in a tio n p r o c e s s , t h a t i s , th r o u g h th e
changes i t in d u c e s i n o t h e r w a g e -d e te rm in in g f a c t o r s , such
a s th e demand f o r l a b o r , p r o f i t s , and th e c o s t - o f - l i v i n g
in d e x .
Demand f o r l a b o r . — F o r exam ple, th e f i r m ' s demand
f o r l a b o r — an im p o r ta n t d e te r m in a n t of w ages—may be more
o r l e s s i n f l u e n c e d by an i n c r e a s e in o u tp u t p e r m an-hour,
depend ing f i r s t o f a l l on th e so u rc e o f i n c r e a s e d
116
p r o d u c t i v i t y . T h at i s , an i n c r e a s e i n p r o d u c t i v i t y due t o
(a) a s h o r t - r u n ( c y c l i c a l ) r i s e in volume of o u tp u t o r
s c a l e o f o p e r a t i o n s (w ith a g iv e n s to c k o f equipm ent) may
have a d i f f e r e n t im pact on t h e f i r m 's demand f o r l a b o r ,
compared w ith (b) an upward s h i f t i n t h e f i r m ' s e n t i r e
a v e r a g e - p r o d u c t i v i t y curve a s a co n seq u e n ce , s a y , o f new
o r im proved eq u ip m en t.
In th e fo rm e r c a s e , f o r exam p le, a r i s e i n demand
f o r p r o d u c ts may r e s u l t in i n c r e a s e d p r o d u c tio n and o u tp u t
p e r m an-hour b e cau se of econom ies o f s c a l e w ith th e e x i s t
in g s to c k of e q u ip m en t; h e n c e , as long as l a b o r ’ s m a r g in a l
n e t p r o d u c t i v i t y e x ceed s i t s a v erag e n e t p r o d u c t i v i t y , th e
i n c r e a s e d volume o f o u tp u t may a ls o be e x p e c te d t o s tim u
l a t e th e f i r m 's demand f o r l a b o r . However, such i n c r e a s e s
in. p r o d u c t i v i t y v e ry o f t e n may m erely r e f l e c t a p r i o r
i n c r e a s e i n t h e demand f o r l a b o r , and n eed n o t n e c e s s a r i l y
cause a su b seq u e n t r ig h tw a r d s h i f t in t h e f i r m ' s demand
curve f o r la b o r .
In th e l a t t e r c a s e , how ever, th e I n c r e a s e d " l a b o r "
p r o d u c t i v i t y ( p e r m an-hour) may r e f l e c t a t e c h n o l o g i c a l
improvement i n c o r p o r a t i n g a whole complex of f a c t o r s o t h e r
t h a n (o r i n a d d i t i o n t o ) l a b o r , and t h e r e f o r e c o u ld n o t be
a t t r i b u t a b l e s o l e l y t o th e l a b o r in p u t i t s e l f . As a
c o n se q u e n c e , i n c r e a s e d o u tp u t p e r m an-hour co u ld p ro c e e d
w ith o u t any i n c r e a s e in th e demand f o r l a b o r . In o t h e r
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w ords, th e demand f o r l a b o r ( i n such c a s e s ) w i l l depend
c o n s id e r a b ly on how much o f th e upward s h i f t i n t h e p ro d u c
t i v i t y curve may be a t t r i b u t e d to l a b o r i t s e l f .
P r o d u c t s d e m a n d - e l a s t i c i t y . — In b o th of th e s e
c a s e s , t o th e e x t e n t t h a t th e demand f o r la b o r i s e s s e n
t i a l l y a " d e riv e d " demand, th e u l t i m a t e e f f e c t o f p ro d u c
t i v i t y grow th on th e demand f o r la b o r w i l l a l s o depend on
th e e l a s t i c i t y o f demand f o r th e f i r m ’ s p r o d u c t . G e n e ra lly ,
th e more e l a s t i c th e demand f o r th e p ro d u c t ( i n th e r e l e
v a n t r e g i o n o f o u t p u t ) , th e l a r g e r w i l l be th e i n c r e a s e i n
demand f o r la b o r a s s o c i a t e d w ith a g iv e n i n c r e a s e in th e
p r o d u c t i v i t y o f l a b o r .
At the same t im e , th e demand f o r th e f i r m ’ s p ro d u c t
w i l l depend on t h e accom panying changes i n th e r e l a t i v e
p r i c e s o f p r o d u c ts t h a t a r e c o m p e titiv e o r com plem entary to
the g iv e n p r o d u c t . F u rth e r m o r e , demand f o r th e p ro d u c t
w i l l a l s o depend on th e e x t e n t t o which th e community
w ishes t o ta k e th e i n c r e a s e d p r o d u c t i v i t y (and low er
p r i c e s ) i n th e form o f i n c r e a s e d l e i s u r e r a t h e r th a n i n
i n c r e a s e d p u r c h a s e s o f r e a l p r o d u c t s .
F irm ’ s a b i l i t y - t o - p a y . — L a s t b u t n o t l e a s t ,
i n c r e a s e s in p r o d u c t i v i t y n o t only e x e r t employment ( i . e . ,
l a b o r - d i s p l a c i n g ) e f f e c t s , b u t a l s o p rodu ce income ( i . e . ,
p r o f i t ) e f f e c t s . T hus, w h ile l a b o r d is p la c e m e n t may, on
the one h an d , r e t a r d t h e demand f o r l a b o r , i t may a l s o
118
r e p l e n i s h th e v e ry so u rc e from which f u t u r e w a g e - in c r e a s e s
may be f i n a n c e d . The r e s u l t i n g p r o f i t a b i l i t y , o r " a b i l i t y -
t o - p a y " - - a n o t h e r s i g n i f i c a n t wage d e te r m i n a n t — w i l l te n d t o
be i n c r e a s e d to th e e x te n t t h a t p r o d u c t i v i t y - i n c r e a s e s a re
n o t f u l l y o f f s e t by e q u i v a l e n t i n c r e a s e s in wages.-1 - I f
l a b o r I s r e t i c e n t i n i t s demand f o r i n c r e a s e s , t h i s w i l l
te n d t o s u p p o r t r e d u c t i o n s i n s e l l i n g p r i c e s , w hich in t u r n
w i l l e x e r t downward p r e s s u r e on the c o s t - o f- l i v i n g in d e x ,
which a l s o p l a y s a r o l e In t h e w a g e - d e te r m in a tio n p r o c e s s .
O th e r s i g n i f i c a n t d e t e r m i n a n t s . — In r e a l i t y , t h e r e
a r e , in a d d i t i o n t o p r o d u c t i v i t y , a num ber of o t h e r s i g
n i f i c a n t f a c t o r s t h a t i n f l u e n c e th e s i z e of th e wage
a d ju s tm e n t a rr a n g e d between w o rk e rs and e m p lo y e rs. F or th e
p u rp o s e s o f t h i s s t u d y , i t w i l l s u f f i c e t o d e s c r i b e them i n
b ro ad s t r o k e s , a f t e r which i t w i l l be p o s s i b l e (a ) t o see
more c l e a r l y how p r o d u c t i v i t y p e r se I s r e l a t e d t o t h e s e
o th e r w a g e -d e te rm in in g f a c t o r s , and (b) t o r e a l i z e t o what
e x t e n t th e w a g e -d e te rm in in g p r o c e s s b a s i c a l l y em braces a
group o r c o m b in a tio n of i n t e r a c t i n g f a c t o r s r a t h e r th a n a
s i n g l e , dom inant f a c t o r .
The d i s c u s s i o n of wage d e te r m in a n ts ( o r s t i m u l i t o
wage demands) w i l l f i r s t be fra m e d in t h e c o n te x t of th e
i n d i v i d u a l f ir m - - w h ic h may e s t a b l i s h wage r a t e s e i t h e r on a
u n i l a t e r a l b a s i s o r v i a c o l l e c t i v e b a r g a i n i n g — and th e n
ISee a l s o Holzman, op. c l t . , p . 3^.
119
w i l l be fram ed i n term s o f th e g e n e r a l wage l e v e l , c o m p ris
in g th e o v e r - a l l a v e r a g e . ( i n d e x ) o f i n d i v i d u a l wage
d e c i s i o n s .
The "Economic" D e te rm in a n ts o f Wages
The f i r s t grou p o f i m p o r t a n t w a g e -d e te rm in in g (o r
w a g e - i n s t i g a t i n g ) f a c t o r s may be c l a s s e d as " e c o n o m ic .” In
a d d i t i o n t o ( 1) in c re m e n ts i n p r o d u c t i v i t y , t h e s e f a c t o r s
in c lu d e th e f o llo w in g :
2) The s i z e of th e " e x c e s s demand f o r l a b o r , "
d e f i n e d somewhat l o o s e l y as th e d i f f e r e n c e betw een th e
q u a n t i t y o f l a b o r t h a t em plo yers would l i k e t o h i r e and th e
q u a n t i t y o f l a b o r a v a i l a b l e a t a g iv e n wage.
3) The f i r m ' s " a b i l i t y - t o - p a y " o r " p r o f i t a b i l i t y , "
w hich may be a l t e r n a t i v e l y c o n c e iv e d as r e f l e c t i n g th e
f i r m ' s "econom ic r e n t , " th e m arg in o f a c t u a l r e t u r n s above
some " f a i r " r a t e o f r e t u r n , th e h i s t o r i c r a t e o f p r o f i t s ,
o r th e e x p e c te d r a t e o f p r o f i t s .
*J) The " c o s t - o f - l i v i n g " as m easured sim p ly by an
in d e x o f r e t a i l p r i c e s , such as th e consum er p r i c e in d e x of
th e U. S. Bureau o f Labor S t a t i s t i c s .
5) The i n s t i t u t i o n c a l l e d "wage c o m p a ris o n s,"
u s u a l l y i n v o lv i n g co m p a riso n s o f r a t e s of w a g e - in c r e a s e
r a t h e r t h a n a b s o l u t e wages.
120
I t w i l l be u s e f u l , f o r the developm ent of t h i s and
l a t e r c h a p t e r s , t o d e s c r i b e th e s e "econo m ic” wage-
d e te rm in in g f a c t o r s . 1
E x ce ss demand f o r l a b o r . — W ith r e s p e c t t o th e
e x c e s s demand f o r l a b o r , t h e r e a p p e a rs t o be s u b s t a n t i a l
agreem en t t h a t demand and su p p ly c o n d it i o n s i n th e l a b o r
m a rk e t c o n s t i t u t e a s i g n i f i c a n t d e te rm in a n t o f wage move
m e n ts. 2 Even i n th e case o f fir m s whose wages a re s e t by
th e u n i l a t e r a l a c t i o n o f em ployers (w ith o u t d i r e c t p a r t i c i
p a t i o n of a u n i o n ) , t h e r e seems to be l i t t l e dou bt c o n c e rn
in g th e d i r e c t i o n o f im pact e x e r t e d by l o c a l la b o r - m a r k e t
p r e s s u r e s , a lth o u g h th e s p e c i f i c r e a c t i o n s o f i n d i v i d u a l
f ir m s t o l a b o r s c a r c i t y may be h ig h ly d i v e r s e .
The l a t t e r r e a c t i o n w i l l depend on (a) th e amount
o f p r e s s u r e on th e f i r m t o make some k in d o f wage a d j u s t
ment due t o t h e p r e s s u r e e x e r t e d by l a b o r s c a r c i t y on t h e
f i r m ' s o p e r a t i o n s ( i t s e l f r e l a t e d t o th e f i r m ' s demand f o r
l a b o r ) , and on (b) t h e u se by firm s o f non- wage ty p e s o f
a d ju s tm e n ts t o th e l a b o r s h o r ta g e i n s t e a d o f w a g e -In c re a se s.
1The m ain s o u rc e f o r t h i s d i s c u s s i o n , u n l e s s o t h e r
wise i n d i c a t e d , i s Bowen, op. c i t . , p p . 9 2-1 41, 146, 183.
2C la rk K e rr b e l i e v e s th e l e v e l of employment i s th e
m ost im p o r ta n t s i n g l e w a g e - d e te r m in a n t. See h i s p a p e r ,
"The Im p a c ts o f U nions on th e L evel o f W ages," i n The
Am erican A ssem bly, Wages, P r i c e s . P r o f i t s and P r o d u c t i v i t y
(New York: Colum bia U n i v e r s i t y , 1959)» P* 106.
121
Non-wage forms o f a d ju s tm e n t , in t u r n , depend on th e f i r m 's
r e a d i n e s s t o a c c e p t l a b o r of low er q u a l i t y , on th e f i r m 's
r e p u t a t i o n as " a good p la c e t o w ork," on th e f i r m 's a b i l i t y
t o o f f s e t th e l a b o r s h o r ta g e by i n c r e a s i n g th e w ork-week,
and, l a s t l y , t h e c o m p a ra tiv e d e s i r a b i l i t y o f i n c r e a s i n g th e
base wage r a t e s by th e f i r m . The l a t t e r , i n t u r n , depends
on th e e x t e n t o f w a g e - o r ie n te d m o b i l i t y o f la b o r i n th e
f i r m 's l o c a l i t y . In any e v e n t , r e s o r t t o non-wage form s of
a d ju s tm e n ts w i l l n o rm a lly a l s o in v o lv e some i n c r e a s e in
u n i t l a b o r c o s t s , p a r t i c u l a r l y because t h e d i l u t i o n of
la b o r q u a l i t y i s f a r from c o s t l e s s .
Role o f c o l l e c t i v e b a r g a i n i n g . — I n th e case of
f irm s whose wages a re s e t by th e m ach in ery o f c o l l e c t i v e
b a r g a i n i n g , t h e r e i s g e n e r a l agreem ent on t h r e e m ain th e o
r e t i c a l p o i n t s : ( 1 ) demand and su p p ly c o n d it i o n s i n th e
la b o r m ark et a re an im p o r ta n t d e te r m in a n t of th e b a r g a i n in g
power o f b o th u n io n and management; ( 2 ) th e g r e a t e r th e
demand f o r l a b o r r e l a t i v e t o th e s u p p ly , t h e g r e a t e r th e
r e l a t i v e b a r g a i n in g power of th e u n io n ; and ( 3 ) t h e g r e a t e r
th e u n i o n 's r e l a t i v e b a r g a i n in g pow er, th e l a r g e r w i l l be
th e w a g e -in c r e a s e a g re e d upon.
While t h e s e t h r e e g e n e r a l i z a t i o n s may be h e l p f u l i n
e x p l a i n i n g th e d i r e c t i o n o f Im pact ( o f la b o r - m a r k e t c o n d i
t i o n s ) on wages, th e key (and s t i l l h o t l y d e b a te d ) q u e s t io n
i s : t o what e x t e n t a r e u n io n wage p o l i c i e s a c t u a l l y
122
i n f l u e n c e d by th e p o t e n t i a l e f f e c t s o f wage ag re em e n ts on
employment o p p o r t u n i t i e s ( i . e . , on " p o t e n t i a l "
unem ploym ent)? In o t h e r w o rd s, in th e a b sen c e o f a p e r
f e c t l y c o m p e titiv e l a b o r m a r k e t, w i l l p o t e n t i a l unem ploy
ment i n f l u e n c e ( t h a t i s , d e t e r ) un ion wage demands i n th e
same way i t would p resum ably i n f l u e n c e n o n -u n io n iz e d l a b o r 's
wages? I n t h e l i g h t o f some s t u d i e s on t h i s q u e s t i o n , i t
would a p p e a r t h a t p o t e n t i a l unemployment i s l e s s l i k e l y to
d e t e r u n io n wage demands th e g r e a t e r th e demand f o r l a b o r
r e l a t i v e t o th e su p p ly ; nor w i l l i t d e t e r as s i g n i f i c a n t l y
as an i n c r e a s e d amount o f a c t u a l or " r e a l i z e d " unemployment.
E m p lo y e r's r e s i s t a n c e . — T his b r i n g s up th e r e l a t e d
q u e s t i o n : t o what e x t e n t do la b o r - m a r k e t c o n d it i o n s a f f e c t
th e e m p lo y e r 's r e s i s t a n c e to u n io n wage demands?
B ecause th e m ain impediment t o t h e g r a n t i n g of
h i g h e r wage r a t e s by management may be i t s i n c e n t i v e to
r e s i s t , i t i s r e a s o n a b l e t o e x p e c t t h a t t h e g r e a t e r th e
f i r m ' s e x c e ss demand f o r l a b o r , th e l e s s l i k e l y w i l l i t
r e s i s t making wage c o n c e s s io n s : f o r one t h i n g , th e fir m
w i l l w ish t o a s s u r e i t s e l f an a d e q u a te l a b o r s u p p ly ; a g a i n ,
th e o p p o r t u n i t y c o s t o f a l a b o r sto p p a g e ( i n th e form o f
fo re g o n e p r o f i t s ) may be to o g r e a t ; f i n a l l y , th e p r o d u c e r
may be a b le t o p a s s h i s h ig h e r c o s t s fo rw a rd ( i n th e form
of h i g h e r p r i c e s ) o r backward ( i n low er c o s t s ) .
123
As a c o n s e q u e n c e , i t may be a rg u e d , an i n c r e a s e d
demand f o r l a b o r w i l l t e n d to i n c r e a s e u n io n b a r g a in in g
s t r e n g t h and demands a t th e same tim e t h a t i t weakens t h e
e m p lo y e r's w i l l t o r e s i s t .
F i r m 's p r o f i t p o s i t i o n . - - I n c o n n e c tio n w ith t h e
i n f l u e n c e o f p r o s p e c t i v e p r o f i t a b i l i t y on w a g e - i n c r e a s e s ,
a c c o rd in g to Bowen, th e s i g n i f i c a n t f a c t i s t h a t e s t i m a t e s
of e x p e c te d p r o f i t s a c t u a l l y com p rise two e le m e n ts : ( 1 ) a
b a s ic o r " u n a d ju s te d " e s t i m a t e o f f u t u r e p r o f i t s c a l c u l a t e d
on th e a ssu m p tio n t h a t t h e r e w i l l n o t have t o be any new
w a g e - i n c r e a s e , and ( 2 ) a "wage a d ju s tm e n t" t h a t r e p r e s e n t s
the amount by w hich t h e b a s i c - p r o f i t e s t i m a t e w i l l be
r e v i s e d as a r e s u l t of a w a g e -in c re a s e t h a t has to be co n
s i d e r e d . In e f f e c t , t h e "wage a d ju s tm e n t" r e p r e s e n t s t h e
f i r m 's o p p o r t u n it y c o s t ( i n term s of f o re g o n e p r o f i t s ) o f
a g re e in g t o th e p r o s p e c t i v e w a g e - in c r e a s e .
The b a s i c u n a d ju s te d ( o r o v e r - a l l ) p r o f i t e s t i m a t e
w i l l g e n e r a l l y be i n f lu e n c e d m o s tly by p a s t and c u r r e n t
p r o f i t l e v e l s , a s w e ll a s by t r e n d s in s a l e s , p r o d u c t i v i t y ,
and c o s t - r e d u c i n g i n n o v a t i o n s . The wage a d ju s tm e n t, on th e
o t h e r h a n d , w i l l ten d t o r e f l e c t m ain ly th e e a s e w ith
which t h e f ir m can p a s s a lo n g th e h i g h e r wages in th e form
of h i g h e r p r i c e s .
In g e n e r a l , i t I s r e a s o n a b le t o e x p e c t t h a t t h e
s i z e o f the wage a d ju s tm e n t w i l l v a ry d i r e c t l y w ith t h e
124
f i r m 's p r o s p e c t i v e p r o f i t s , and i n v e r s e l y w ith th e o p p o r
t u n i t y c o s t of th e h y p o t h e t i c a l w a g e - in c r e a s e ( t h a t i s ,
i n v e r s e l y w ith th e c o s t o f r e f u s i n g t o a g re e t o t h e wage
b o o s t ) .
C o s t - o f - l i v i n g i n d e x . — W ith r e s p e c t t o th e c o s t - o f -
l i v i n g in d e x , th e m ost im p o r ta n t p o i n t s t o n o t e a re t h a t
( 1 ) i t i s more m e a su ra b le t h a n th e o t h e r w a g e -d e te rm in in g
f a c t o r s , and ( 2 ) i t i s n o t b e l i e v e d c a p a b le of i m p e l li n g an
i n f l a t i o n a r y s p i r a l , t h a t i s , i t can only r e i n f o r c e an
e x i s t i n g p r i c e r i s e .
T h is l a t t e r p o i n t i s n o t m eant t o u n d e r e s t i m a t e th e
im p o rtan c e o f r i s i n g consum er p r i c e s a s a s o u r c e of l a b o r
d i s s a t i s f a c t i o n and s t r o n g upward p r e s s u r e s on th e wage
l e v e l , e s p e c i a l l y i f w o rk ers a re o r g a n iz e d . I n d e e d , th e
w id e sp re a d a d o p tio n o f e s c a l a t o r c la u s e s i n wage c o n t r a c t s
b e sp ea k s i t s s i g n i f i c a n c e f o r th e w a g e - d e te rm in a tio n
p r o c e s s .
W age-com parisons and key b a r g a i n s . — A f i n a l e c o
nomic d e te r m in a n t o f wage a d ju s tm e n ts i s o f t e n r e f e r r e d t o
as "wage c o m p a r is o n s ." T h is f a c t o r has a s p e c i a l
Im p o rtan ce i n th e w a g e - s e t t i n g p r o c e s s b e ca u se o f i t s two
f o l d n a t u r e : ( 1 ) i t n o t o n ly o p e r a t e s t o d e te rm in e th e
m agnitude o f s p e c i f i c wage b a r g a i n s , b u t (2) I t a l s o
s e rv e s a s an Im p o r ta n t mechanism f o r t h e t r a n s m i s s i o n of
p a r t i c u l a r w a g e - in c r e a s e s from one o r more f i r m s o r
125
I n d u s t r i e s to o t h e r s e c t o r s o f th e economy. Thus th e
mechanism of wage com parisons o p e r a t e s t o tr a n s f o r m t h e
w a g e - in c r e a s e s o f s p e c i f i c "key" b a r g a in s i n t o a g e n e r a l
p a t t e r n o f w a g e - in c r e a s e s f o r t h e economy a s a w h o le .^
A lthough th e s i g n i f i c a n c e o f wage co m p arisons has
been d i s c u s s e d m ain ly i n th e c o n te x t o f c o l l e c t i v e b a r g a i n
in g , t h i s mechanism (som etim es r e f e r r e d t o as " c o e r c iv e
com p arison ") h as a ls o been o p e r a t i v e in c a s e s of u n i l a t e r a l
w a g e - s e t t i n g by f ir m s n o t c o n fro n te d by l a b o r u n io n s . Wage-
e a r n e r s a re t y p i c a l l y i n t e r e s t e d i n how t h e i r own wage ra te s
compare w ith th e wage r a t e s of o t h e r s . S t u d i e s i n d i c a t e
t h a t em plo yers have been w i l l i n g t o i n c r e a s e t h e i r wage
r a t e s so t h a t em ployees w i l l n o t have t o make " i n v i d i o u s
com parison s" w ith o th e r em plo yers p a y in g c o m p a ra tiv e ly
h i g h e r wages.
F u rth e rm o re , in an i n d u s t r y whose wages f o llo w th e
le a d o f wages s e t by "key" co m p anies, th e i n d i v i d u a l f i r m
w i l l t e n d n o t t o f e a r d i r e c t c o m p e titio n from w i t h in th e
i n d u s t r y i f i t g r a n t s a w a g e - in c re a s e n e c e s s i t a t i n g a
p r i c e r i s e . I n d e e d , a c c o rd in g t o a r e c e n t stu d y by W illiam
F e l l n e r and o t h e r e c o n o m is ts ( r e f e r r e d t o h e r e a f t e r a s t h e
^■According t o S id n e y W ein tra u b : " I n p r a c t i c e wage
i n c r e a s e s in im p o r ta n t I n d u s t r i e s te n d t o be t r a n s m i t t e d
soon enough to o t h e r s e c t o r s o f t h e econom y." See h i s A
G e n e ra l Theory o f th e P r i c e L e v e l, O u tp u t, Income P is tr lT -
b u t i o n , and Economic Growth ( P h i l a d e l p h i a : C h ilto n Company.
1 9 5 9 ), P. 63.
126
"OEEC s t u d y " ) , e x c e s s i v e w a g e - in c r e a s e s a re more l i k e l y to
s p re a d in o l i g o p o l i s t i c i n d u s t r i e s th a n i n i n d u s t r i e s where
p r i c e c o m p e titio n i s more i n t e n s e , w h ile th e y w i l l be l e s s
l i k e l y t o o c c u r in i n d u s t r i e s s u b j e c t t o s t r o n g f o r e i g n
c o m p e titio n . ^
The u n i o n 's c o n t r i b u t i o n . — The a p p e a ra n c e o f th e
u n io n on th e sc en e f i n d s t h i s co m p arison mechanism e x e r t i n g
an a d d i t i o n a l p r e s s u r e on wage d e c i s i o n s th ro u g h th e
" p o l i t i c a l " n a t u r e o f th e u n io n and th e c o m p e titio n among
u n ion l e a d e r s t o p e rfo rm w e ll i n te rm s o f c o m p a rativ e
w a g e - in c r e a s e s .
The e x t e n t t o which such added u n io n p r e s s u r e s w i l l
a c t u a l l y su c c e e d i n o b t a i n i n g h ig h e r wages depends n o t o n ly
on th e u n i o n ’ s a b i l i t y t o c lo s e down p l a n t o p e r a t i o n s and
cause l o s s o f rev e n u e t o th e f i r m , b u t a ls o depend s on th e
f i r m ’ s p r o s p e c t i v e p r o f i t s a n d / o r i t s a b i l i t y t o p a s s a lo n g
h ig h e r wages i n h i g h e r p r i c e s .
In t h i s c o n n e c ti o n , t h e OEEC stu d y p o i n t s t o th e
i n f l a t i o n a r y im pact c a u se d by " c o n tin u e d a tte m p ts " of
i n d i v i d u a l u n io n s t o u p s e t th e e x i s t i n g wage s t r u c t u r e
( a f f e c t i n g d i f f e r e n t i n d u s t r i e s , r e g i o n s , or t y p e s o f
l a b o r ) by f o r c i n g wages to " l e a p - f r o g " each o t h e r i n a
^■William F e l l n e r and O t h e r s , The Problem o f R is in g
P r i c e s ( P a r i s : O r g a n iz a tio n f o r E uropean Economic Co
o p e r a t i o n , 1961) , p . 5 1 .
127
"wage-wage" s p i r a l . In d e e d , a c c o rd in g t o th e OEEC s tu d y ,
" l e a p - f r o g g i n g ” has been one of th e m a jo r r e a s o n s f o r
e x c e s s iv e w a g e - in c r e a s e s In r e c e n t y e a r s . 3 -
In t h e o r y , t h e w ag e-com pariso n mechanism may be
s a i d t o o p e r a t e In an ’’in d e p e n d e n t" f a s h i o n i f th e g e n e r a l
p a t t e r n o f w a g e - in c r e a s e s can be a t t r i b u t e d t o (a) th e
" c o e r c i v e " power e x e r c i s e d by union l e a d e r s h i p i n key f i r m s
o r i n d u s t r i e s — whose w a g e - in c r e a s e s have s p re a d t o th e r e s t
o f th e economy— r a t h e r th a n t o (b) t h e p o s s i b i l i t y t h a t a l l
f ir m s a re " i n th e same b o a t , " t h a t i s , s u b j e c t t o th e same
wage p r e s s u r e s ( e . g . , th e c o s t - o f - l i v i n g in d e x ) and r e s
ponding in a u n ifo rm way b e ca u se of s i m i l a r a b i l i t y - t o - p a y .
In r e a l i t y , ho w ev er, i t would be a d i f f i c u l t t a s k
t o d i s t i n g u i s h th e e x t e n t t o which " c o e r c i v e " pow ers r a t h e r
th a n u n ifo rm ( o r common) p r e s s u r e s were o p e r a t i n g ,
e s p e c i a l l y , f o r e x am p le, i f d a t a i n d i c a t e t h a t f ir m s had
been s u b j e c t t o very s tr o n g and s i m i l a r exogenous wage
p r e s s u r e s such as th e c o s t - o f - l i v i n g . The OEEC s tu d y , on
th e o t h e r h a n d , w h ile acknow ledging t h e d i f f i c u l t y of
a s c e r t a i n i n g th e d e te r m i n a n ts o f key w a g e - b a r g a in s ,
b e l i e v e s t h e r e h as been a g e n e r a l te n d e n c y f o r th e key
b a r g a i n t o be s e t in i n d u s t r i e s whose p ro d u ct-d em an d i s
m ost a c t i v e and th e r i s e in p r o d u c t i v i t y and p r o f i t s th e
h i g h e s t . ^
^I b i d . , p. 5**.
2l b i d .
12 b
The " I n s t i t u t i o n a l ” D e te rm in a n ts of Wages
E q u a lly Im p o rta n t w ith th e econom ic d e te r m in a n ts of
wage a d ju s tm e n ts a re s e v e r a l " i n s t i t u t i o n a l " f a c t o r s t h a t
a l s o e x e r t c o n s i d e r a b l e im pact on th e w a g e - s e t t i n g p r o c e s s .
1) F i r s t , o f c o u r s , i s th e l a b o r union i t s e l f ,
w hich i n s t i t u t i o n h a s p ro b ab ly r e c e i v e d th e most a t t e n t i o n
in d i s c u s s i o n s o f th e w a g e -p ric e i s s u e , a lth o u g h t h i s
s p e c i a l (and o f t e n d ra m a tic and p o le m ic a l) i n t e r e s t may
have te n d e d t o e x a g g e ra te th e a c t u a l s i g n i f i c a n c e o f th e
u n io n In th e w a g e - d e te r m in a tio n p r o c e s s .
O th e r i n s t i t u t i o n a l a t t r i b u t e s o f th e c o l l e c t i v e
b a r g a i n in g p r o c e s s , w hich have (u n d e s e rv e d ly ) r e c e i v e d much
l e s s a t t e n t i o n than th e union p e r s e , in c lu d e t h e f o llo w
ing :
2) The n a tu r e o f r e l a t i o n s betw een th e l a b o r u n io n
and th e em p lo y er.
3) The scope o f c o l l e c t i v e b a r g a i n i n g , o r t h e extent
o f m u lti- e m p lo y e r o r in d u s t r y - w i d e b a r g a i n in g .
4) The le n g th o r d u r a t i o n o f c o n t r a c t s s ig n e d by
u n io n and management.
5) The " h a b i t u a l " o r " e x p e c te d " n a tu r e o f wage-
i n c r e a s e s .
6 ) The " p u b lic " n a tu r e o f c o l l e c t i v e b a r g a i n i n g . 1
iU n le s s o th e rw is e s p e c i f i e d , t h i s d i s c u s s i o n i s
b ased p r i m a r i l y on Bowen, op. c i t . , p p . l4 2 - b 6 , ld 7 -2 0 6 ,
213.
129
Im p act o f th e u n io n . — Of th e m a jo r i n s t i t u t i o n a l
d e te r m i n a n ts o f w ages, t h e most u s u a l l y m en tio n ed i s th e
la b o r u n io n , a lth o u g h n o t alw ay s w ith e q u a l e m p h a s is .^ As
a m a t t e r o f p e r s p e c t i v e , how ever, a number o f p o i n t s must
be n o t e d .
F i r s t , n o t a l l wages i n th e economy a r e s e t by
d i r e c t p a r t i c i p a t i o n o f a u n io n ; i n d e e d , l e s s th a n h a l f o f
a l l w a g e -e a r n e r s have t h e i r wages s e t by c o l l e c t i v e b a r
g a i n i n g . Nor i s th e u n io n th e o n ly a g e n t In v o lv e d in
c o l l e c t i v e b a r g a i n i n g . Then, th e u n io n does n o t o p e r a t e
in d e p e n d e n tly o f i t s e n v iro n m e n t; t h e l a t t e r may a l s o
g e n e r a t e s t r o n g p r e s s u r e s f o r w a g e - i n c r e a s e s , p r e s s u r e s
t h a t may ta k e t h e i r t o l l even i n t h e a b se n c e of u n i o n s , and
which th e u n io n may m e re ly be m e d ia tin g .
Even w ith r e s p e c t t o t h e i r own aim s o r o b j e c t i v e s ,
u n io n s r e g a r d w a g e - in c r e a s e s a s o n ly one o f s e v e r a l . T h is
does n o t mean t h a t u n io n s a r e n o t alw ay s p r e p a r e d t o p u rs u e
Gompers' b e h e s t t o o b t a i n "m o re , 1 1 o r " a l l th e y can g e t . "
R a th e r i t means t h a t t h e y w i l l be a b le t o m axim ize wage
demands o n ly so lo ng a s th e y do n o t i n c u r o f f s e t t i n g
p e n a l t i e s such as p o t e n t i a l unemployment o r heavy s t r i k e
l o s s e s . A t h i r d p o s s i b l e p e n a l t y - - f e a r o f e n su in g
^For a u s e f u l summary o f t h e v a r i o u s " t y p e s " of
u n io n s and th e im pact o f each on w ages, see C la rk K e r r , o p .
c i t . . p p . 92— 94.
130
I n f l a t i o n — seems a l e s s p o w e rfu l d e t e r r e n t , p a r t i c u l a r l y
becau se u n io n members may be a b le t o g a in more in h i g h e r
wages th a n th e y lo s e i n r i s i n g consum er p r i c e s .
F irm ’ s m arket p ow er. — G e n e r a ll y , th e " in d e p e n d e n t"
or d i f f e r e n t i a l a b i l i t y o f a u n io n t o o b t a i n w a g e - r a i s e s —
t h a t i s , th e power o f w ork ers to o b t a i n h i g h e r wages w ith
a u n io n th a n w ith o u t a u n io n — w i l l te n d t o be s t r o n g e r th e
more s h e l t e r e d i s t h e f i r m ’ s c o m p e titiv e p o s i t i o n i n t h e
p ro d u c t m a rk e t, th e more im p o rta n t a r e n o n - p r i c e form s o f
c o m p e ti t io n , and th e more f a v o r a b l e a re employment and
p r o f i t t r e n d s .
Thus u n io n s may f i n d i t more a d v a n ta g e o u s t o
b a r g a in w ith f ir m s in o l i g o p o l i s t i c m a rk e ts th a n in
p e r f e c t l y c o m p e titiv e m a r k e ts , where h i g h e r wages and
p r i c e s m ight sim ply f o r c e a f ir m r i g h t o u t of b u s i n e s s .
C oncerning th e e f f e c t o f b u s i n e s s c o n d i t i o n s , e c o n o m is ts
seem a g re e d t h a t u n io n s a re r e l a t i v e l y more i n f l u e n t i a l i n
p u t t i n g a f l o o r u n d e r w ages, by f i g h t i n g wage c u t s i n
r e c e s s i o n s , th a n in p u s h in g wages up i n p e r i o d s o f g e n e r a l
e x c e s s demand.
I n d i r e c t im p a c ts o f th e u n i o n . — A p art from t h e
above d i r e c t im p a c ts e x e r t e d by t h e u n io n on th e wages o f
i t s own members, t h e r e a r e s i g n i f i c a n t i n d i r e c t e f f e c t s
e x e r t e d on th e wages of n o n -u n io n members i n o t h e r f i r m s ,
m ain ly v i a two r o u t e s : ( 1 ) " a n t i c i p a t o r y " w a g e - in c r e a s e s
131
g r a n t e d by n o n -u n io n f ir m s in o r d e r t o f o r e s t a l l th e p o s s i
b i l i t y of em ployees se e k in g r e p r e s e n t a t i o n by a non-company
u n io n ; and ( 2 ) th e mechanism o f " c o e r c iv e " wage co m parison s
m en tio n ed a b o v e , w hich may be o p e r a t i v e even among f i r m s
t h a t have no f e a r o f u n i o n i z a t i o n .
The u n io n in p e r s p e c t i v e . — Two b r i e f comments, of
a m e th o d o lo g ic a l n a t u r e , a r i s e in c o n n e c tio n w ith t h e b a s ic
problem o f a p p r a i s i n g th e a c t u a l im pact o f th e u n io n p e r se
on t h e w a g e - s e t t i n g p r o c e s s .
F i r s t , b ecau se th e u n io n i s but one o f s e v e r a l
f a c t o r s t h a t a f f e c t w ages, i t i s v ery d i f f i c u l t t o
a s c e r t a i n how much o f any wage r a i s e may be a t t r i b u t e d t o
e a c h of t h e r e l e v a n t wage d e t e r m i n a n t s , i n c l u d i n g th e
amount o f in d e p e n d e n t i n f l u e n c e e x e r t e d by th e u n io n p e r
s e . The problem i s p a r t i c u l a r l y tro u b le so m e b e ca u se
s e v e r a l o f t h e o t h e r s i g n i f i c a n t w a g e -d e te rm in in g f a c t o r s
a l s o c h a r a c t e r i s t i c a l l y p a r t i c i p a t e w h erever u n io n s a r e
o p e r a t i v e . F or exam p le, s e c t o r s of th e economy i n w hich
u n io n s a r e dom inant a r e a l s o c h a r a c t e r i z e d by h i g h ly
p r o f i t a b l e f ir m s and o l i g o p o l i s t i c m arket s t r u c t u r e s .
S ec o n d , s in c e f o r t h i s stu d y what i s p r i m a r i l y
r e l e v a n t i s th e u n i o n 's im pact on th e i n f l a t i o n p r o c e s s
p e r. s e , i t i s th e u n i o n 's e f f e c t on a b s o l u t e chan g es in
money w a g e s ~ r a t h e r th a n on wage s t r u c t u r e o r on l a b o r ' s
s h a re in t h e n a t i o n a l income— t h a t i s o f c h i e f i n t e r e s t
132
f o r t h i s p u rp o s e . F or exam ple, u n io n s may a f f e c t th e wage
s t r u c t u r e w ith o u t n e c e s s a r i l y a f f e c t i n g any a b s o l u t e
changes i n th e o v e r - a l l wage l e v e l . S i m i l a r l y , changes in
l a b o r f s sh a re o f th e n a t i o n a l income do n o t p e r se i n d i c a t e
t h e u n io n * s im pact on th e a b s o l u t e money-wage l e v e l .
Union-management r e l a t i o n s . — The r e m a in in g , l e s s
d r a m a tic i n s t i t u t i o n a l w a g e -d e te rm in a n ts m en tio n ed above
a r e no l e s s s i g n i f i c a n t f o r an u n d e r s ta n d in g o f t h e f u l l
im pact o f u n io n s on t h e i n f l a t i o n p r o c e s s .
F or exam ple, th e n a t u r e of t h e r e l a t i o n s h i p between
u n ion and management w i l l d e te rm in e w h e th er th e f i r m w i l l
p r e f e r t o (a) a tte m p t t o e m b a rra s s o r d i s c r e d i t t h e u n i o n 's
l e a d e r s h i p , even a t th e c o s t o f a long and c o s t l y s t r i k e ,
r a t h e r th a n (b) se ek t o g r a n t g e n e ro u s w a g e -b o o sts i n
o r d e r to enhance t h e p r e s t i g e o f u n io n l e a d e r s t h a t i t
f a v o r s . S i m i l a r l y , t h i s r e l a t i o n s h i p w i l l i n f l u e n c e th e
e x te n t t o which non-wage c o n c e s s io n s (su c h as u n io n
s e c u r i t y c l a u s e s ) w i l l be a c c e p te d a s t h e p r i c e f o r
re d u c e d wage demands.
One j o u r n a l i s t has gone so f a r a s t o s u g g e s t t h a t
b e n e a th th e a p p a r e n t s u r f a c e f r i c t i o n s betw een u n io n s and
management t h e r e l u r k s an a c t i v e community of i n t e r e s t —
a type o f " c o r p o r a t e s y n d ic a lis m " o r "unacknow ledged
p a r t n e r s h i p " — c o l l a b o r a t i n g f o r m u tu al b e n e f i t a t th e
133
e x p en se of th e p u b l i c , i n th e form o f j o i n t l y - a d m i n i s t e r e d
p r i c e s and w ages. 1
nS e l l e r s T i n f l a t i o n '.1— In c o n t r a s t to t h i s view i s
Abba P. L e rn e r* s c o n ce p t of " s e l l e r s 1 i n f l a t i o n , ” in w hich
w a g e -e a rn e rs and " p r o f i t - t a k e r s " a r e r e g a r d e d a s a n ta g o
n i s t s ( o r c o n te n d e r s ) f o r a l a r g e r s h a r e of th e in c o m e - p ie ,
r a t h e r th a n a s mere c o n s p i r a t o r s a g a i n s t th e consum er.
A ccordin g t o L e r n e r , s e l l e r s * i n f l a t i o n w i l l crop up when
e v e r w a g e -e a r n e rs and p r o d u c e r s " t o g e t h e r " ( i . e . , sim u l
t a n e o u s l y ) a tt e m p t t o o b t a i n i n c r e a s e d s h a r e s o f income
t h a t add up t o more th a n 100 p e r c e n t o f th e f i r m ' s s e l l i n g
p r i c e . I f b o th p a r t i e s p e r s i s t in t h e i r p o s i t i o n s , t h e i r
demands cannot be s a t i s f i e d u n le s s p r o d u c t p r i c e s a ls o r i s e .
Once p r i c e s r i s e , b o th p a r t i e s f i n d th e m s e lv e s no b e t t e r
o f f t h a n b e fo re and t h e r e f o r e resume t h e i r t u g - o f - w a r o v e r
in c o m e -s h a re s in an a tte m p t t o a c h ie v e th e im p o s s ib le .
T hus, c o n c lu d e s L e r n e r, "we have th e c o n tin u in g p r o c e s s o f
s e l l e r s ' i n f l a t i o n ." 2
^■For e x am p le, see B e rn ard D. N o s s i t e r , "The H idden
A f f a i r Between B ig B u s in e s s and Big L a b o r ," H a r p e r 's
M agazine, CCXIX ( J u l y , 1959)* PP« 3 2 -3 9 , which a p p e a rs t o
oe c a s e d on th e " a d m i n i s t e r e d - p r i c e " t h e o r i e s o f e c o n o m is ts
G a r d in e r C. Means and John M. B l a i r .
^Abba P. L e r n e r, " I n f l a t i o n a r y D e p re s s io n and t h e
R e g u la tio n o f A d m in is te re d P r i c e s , " i n U .S ., C o n g ress,
J o i n t Economic Com m ittee, Compendium, The R e l a t i o n s h i p o f
P r i c e s t o Economic S t a b i l i t y and Growth (W ashington: U .S.
Government P r i n t i n g O f f i c e , 1 9 5 8 ), p p . 257-68.
134
I n d u s t r y - w i d e a g re e m e n ts . — -One o f th e more w id e ly
d is c u s s e d i n s t i t u t i o n a l a s p e c t s i s t h e scope o f c o l l e c t i v e
b a r g a i n i n g , o r the e x t e n t of m u lti- e m p lo y e r o r i n d u s t r y
wide a g re e m e n ts . One group o f e c o n o m is ts b e l i e v e s t h a t
in d u s t r y - w i d e b a r g a in s a re more i n f l a t i o n a r y b e ca u se th e y
make i t e a s i e r f o r a l l firm s t o p a s s a lo n g h i g h e r p r i c e s
t h a n f o r i s o l a t e d f i r m s , one a t a tim e . O t h e r s , how ever,
a rg u e t h a t i n d i v i d u a l l y - s t r u c k f ir m s a r e more l o a t h e t o
r e s i s t a s t r i k e w h ile c o m p e ti t o r s a r e s t i l l o p e r a t i n g ,
w ith o u t a s t r i k e on t h e i r h a n d s ; a form o f " p a t t e r n b a r
g a in in g " can th u s u n f o l d in w hich i n d i v i d u a l f i r m s o f f e r
wage b o o s ts t h a t compare f a v o r a b l y w ith in d u s tr y - w id e
a g re e m e n ts . Thus i t i s not y e t c e r t a i n w h eth er i n d u s t r y
wide wage n e g o t i a t i o n s n e c e s s a r i l y y i e l d more i n f l a t i o n a r y
r e s u l t s t h a n th e m ost l i k e l y a l t e r n a t i v e o f p a t t e r n b a r
g a in i n g .
L o n g e r-te rm c o n t r a c t s . — A nother n o te w o rth y i n s t i
t u t i o n a l d evelo pm ent i s th e t r e n d to w a rd l o n g e r - te r m c o n
t r a c t s . The im pact o f such c o n t r a c t s on th e lo n g - r u n move
m ents of w ages and p r i c e s has a p p a r e n t l y n o t b een f u l l y
e x p lo r e d , a lth o u g h t h e r e i s a te n d e n c y t o b e l i e v e such
c o n t r a c t s s e r v e t o s t a b i l i z e wage r a t e s , t h a t i s , smooth
o u t th e c y c l i c a l p e a k s and t r o u g h s o f wage movements. T his
a s p e c t , h o w e v er, may be o f f s e t by a n o th e r (o f g r e a t e r
t h e o r e t i c a l s i g n i f i c a n c e ) , n a m e ly , th e a c t u a l economic
135
env iro n m en t t h a t c h a r a c t e r i z e s th e p e r i o d in w hich th e
lo n g e r c o n t r a c t s a r e s ig n e d .
I f t h e e nv ironm en t i s c h a r a c t e r i z e d by w id e s p r e a d ,
i n t e n s i v e , and c o n tin u e d e x c e s s demand, a s d u rin g th e e a r l y
p o st-W o rld War I I y e a r s , i t may be r e a s o n a b le t o assume
t h a t lo n g - ru n c o n t r a c t s w i l l e x e r t a s t a b i l i z i n g i n f lu e n c e
on w ages, p a r t i c u l a r l y b e ca u se u n io n s may i n a d v e r t e n t l y
"u n d erco m p en sate" t h e i r wage demands a t th e s t a r t of such
an e x u b e r a n t p e r i o d . On th e o t h e r han d, t h i s a s p e c t may be
more th a n o f f s e t by t h e e x t e n s i v e u se o f e s c a l a t o r c l a u s e s ,
by a t t e m p t s to r e n e g o t i a t e c o n t r a c t s in o r d e r t o a d j u s t
r a t e s u p w ard s, by s t r i k i n g f o r some non-wage i s s u e t h a t may
r e s u l t i n h i g h e r c o s t s , o r by " l a y i n g down on th e j o b , "
which a l s o s e r v e s t o red u c e e f f i c i e n c y .
However, i f th e c o n t r a c t s a r e s ig n e d p r i o r t o a
r e c e s s i o n , or a p e r i o d o f l e s s p ro no unced demand, th e n th e y
may w e ll t e n d to im p a rt an upward b i a s t o th e e n s u in g wage
l e v e l , b e ca u se r a t e s had been s e t i n th e p r e c e d in g boom.
To th e e x t e n t t h a t th e econom ic env iro n m en t c o n tin u e s t o be
o n ly m o d e ra te ly e x p a n s iv e , i t i s r e a s o n a b l e t o a rg u e t h a t
lo n g - r u n c o n t r a c t s t e n d to e x e r t a t l e a s t a s l i g h t upward
b i a s t o th e wage t r e n d . T h is i s p a r t i c u l a r l y a p t i n th e
c a s e of lo n g - ru n a g re e m e n ts t h a t e x c lu d e "w a g e-re o p en in g "
c l a u s e s : t h e s e t e n d t o be so u g h t by u n io n s a t c y c l i c a l
p h a s e s t h a t e n co u rag e r a t h e r th a n dampen th e upward
136
movement o f wage r a t e s . F u r th e r m o re , i n a r e c e s s i o n th e
u n io n may p r e f e r t o c o n tin u e w ith o u t a c o n t r a c t r a t h e r than!
s ig n a new one i n th e l e s s - f a v o r a b l e econom ic e n v iro n m e n t. ;
I n any c a s e , i t a p p ea rs t h a t th e econom ic en v iro n m en t p la y s ;
an im p o r ta n t r o l e even i n lo n g -te rm c o n t r a c t s . j
The " h a b i t u a l " w a g e - i n c r e a s e . — More a p p a re n t th a n
m e a su ra b le i s th e ten d e n cy of w a g e - e a r n e r s t o e x p e c t su b
s t a n t i a l w a g e - r a is e s e a c h y e a r as a " h a b i t u a l 1 1 o r "norm al"
o c c u r r e n c e . The o r i g i n s o f t h i s i n s t i t u t i o n a re n o t so
h a rd t o t r a c e , in view o f th e s t r o n g upw ard su rg e o f wages
d u rin g and a f t e r World War I I , th e a t t r a c t i o n f o r wage-
e a r n e r s of t h e p e r i o d i c pay i n c r e a s e e n jo y e d by s a l a r i e d
p e r s o n n e l , and th e i n t r o d u c t i o n of t h e a n n u a l "Im provem ent
f a c t o r " as a fo rm a l embodiment of t h i s e x p e c t a t i o n of
p e r i o d i c wage I n c r e m e n ts .
The r e l e v a n t q u e s t i o n h e re I s : what i s th e a c t u a l
s t r e n g t h o r g r i p of th e " h a b i t " on th e wage n e g o t i a t o r s ?
I f th e h a b i t i s s tr o n g enough t o r e s i s t th e e f f e c t s of mild;
r e c e s s i o n s o r tem p orary d e c l i n e s In p r o d u c t i v i t y , th e n i t
would c o n s t i t u t e an a d d i t i o n a l s o u rc e o f upward p r e s s u r e
on th e wage l e v e l .
The r e c e n t OEEC stu d y by F e l i n e r and o t h e r s m ain - ;
t a i n s t h a t t h i s i n s t i t u t i o n a l h a b i t has been p a r t i c u l a r l y '
im p o rta n t i n th e U n ite d S t a t e s o f th e 1 9 5 0 's b e c a u se I t i s |
compounded w ith a d e s i r e (" c o n s c io u s o r u n c o n s c io u s " ) t o
137
f u r t h e r i n c r e a s e th e s h a r e o f n a t i o n a l income g o in g t o
la b o r f o llo w in g th e s u c c e s s f u l g a in s a c h ie v e d i n t h i s
r e s p e c t d u rin g th e 19^0 *5 .1
The p u b l i c i n t e r e s t . — The f i n a l i n s t i t u t i o n a l d e t e r
m in a n t i s th e i n c r e a s i n g l y " p u b l i c n a t u r e " of t h e c o l l e c
t i v e b a r g a i n in g p r o c e s s , t h a t i s , th e i n c r e a s i n g a t t e n t i o n
b e in g g iv e n by th e p u b l i c and g o v e rn m e n ta l a u t h o r i t i e s t o
th e r e s u l t s o f key wage n e g o t i a t i o n s .
N orm ally t h e r e a re two broad c h a n n e ls t h r o u g h
w hich th e " p u b l i c i n t e r e s t " can a f f e c t wage n e g o t i a t i o n s :
( 1 ) th ro u g h fo rm a l g o v e rn m e n ta l m ea su re s o r t h r e a t s t h a t
d i r e c t l y a f f e c t o r i n f l u e n c e t h e w a g e - s e t t in g p a r t i e s , and
( 2 ) th ro u g h t h e m o ti v a ti o n of u nio ns an d management t o
v o l u n t a r i l y r e s t r a i n t h e i r wage b a r g a i n s a c c o rd in g t o th e
e x p re s s e d co n cern o f t h e p u b l i c .
As t o the fo rm e r a p p ro a c h , t h e r e seems t o be l i t t l e
doubt t h a t d i r e c t governm ent i n t e r v e n t i o n ( v ia wage
c o n t r o l s o r s e i z u r e o f p l a n t s ) would have p o t e n t i a l im p acts
on wage n e g o t i a t i o n s . On th e o th e r h a n d , the r e c o r d does
n o t e n co u rag e e x p e c t a t i o n s t h a t wage b a r g a in s w i l l i n
"norm al" t i m e s — s a y , in th e absence o f b a la n c e -o f -p a y m e n ts
d e f i c i t s — be " r e s t r a i n e d " v o l u n t a r i l y by unions an d manage
ment out of d e f e r e n c e t o p u b l i c s e n t im e n t .
^William F e lln e r and O thers, o p . c i t . , pp . 52-53 .
138
T h is i s p a r t i c u l a r l y u n d e r s t a n d a b le when th e p u b l i c
h a r b o r s o t h e r l e a n in g s ( s a y , a p r e f e r e n c e f o r " l a b o r p e a c e "
o r a n t i p a t h y t o " b ig b u s i n e s s " ) which c o u ld m i l i t a t e
a g a i n s t n o n - i n f l a t i o n a r y wage a g re e m e n ts . At t h e same
t im e , em ployers th e m se lv e s may a c t u a l l y la c k a r e a l
i n c e n t i v e t o r e s i s t union demands: t h e y may p r e f e r t o
a v o id a p ro lo n g e d s t r i k e ; th e y may f e a r i t would be to o
d i f f i c u l t t o p e rs u a d e th e p u b l i c t h a t wage demands a re
" u n r e a s o n a b l e " ; o r th e y may f e e l c o n f id e n t t h a t governm ent
i s more r e c e p t i v e t o c r e e p in g i n f l a t i o n t h a n t o c r e e p in g
unemployment. As A rth u r F. Burns has p o i n te d o u t , i t may
be t h a t governm ent i s n o t y e t p re p a re d to check r e c e s s i o n
and unemployment: w itn e s s t h e e x i s t e n c e o f t h e Employment
Act b u t th e a b se n c e of a P r i c e - S t a b i l i t y A ct, a la c k p r o
b a b ly e x p la in e d by th e p r e v a l e n t s t a t e o f p u b l i c o p in io n .
One may add th e c ase where g o v e rn m e n t, asked t o a c t a g a i n s t
" i n f l a t i o n o r unem ploym ent"— as p o s t u l a t e d by t h e dilemma
m odel— f i n d s t h a t th e f e a r o f r e s u l t i n g unemployment r e t a r d s
any s tr o n g a c t i o n s t o check i n f l a t i o n .
Summary C o n s id e r a tio n s
The w a g e -d e te rm in a tio n p r o c e s s a s o u t l i n e d above
r e v e a l s th e f o llo w in g e s s e n t i a l u n d e r l y i n g and i n t e r r e l a t e d
A r t h u r F. B u rn s, P r o s p e r i t y W ithout I n f l a t i o n
(New York: Fordham U n i v e r s i t y P r e s s , 1 9 5 7 ), pp . 41-42.
a s p e c t s in v o lv e d in th e g r a n t i n g o f w a g e - in c r e a s e s : (1 ) On
th e one h a n d , t h e f ir m p o s s e s s e s a m u l t i - s o u r c e p o t e n t i a l
a b i l i t y - t o - p a y h i g h e r wages. (2) On th e o t h e r han d , t h e
f irm f a c e s an a r r a y of p r e s s u r e s (su c h as e x c e s s demand f o r
l a b o r , c o s t - o f - l i v i n g , o r wage com p arison s) t o g r a n t w age-
i n c r e a s e s somewhere w i t h i n o r aro u n d i t s ” a b i l i t y - t o - p a y . "
Each o f th e wage p r e s s u r e s w i l l r e q u i r e some amount of
w a g e -in c re a s e i n o r d e r t o s a t i s f y i t , d ep en d in g on th e
f i r m 's re s p o n s e p a t t e r n to wage demands, w hich i n t u r n
depends both on (a) th e f i r m 's o v e r - a l l o b j e c t i v e s and
m o t i v a t i o n s , and (b) t h e r e l a t i v e p r o f i t a b i l i t y ( o r c o s t )
t o th e f ir m i n a c q u ie s c in g t o th e wage p r e s s u r e s , in
r e s i s t i n g them , o r in s u p p o r t i n g them out o f n o n - p e c u n ia r y
m o tiv e s . (3) F i n a l l y , t h e en u m e rated d i r e c t and i n d i r e c t
d e te r m in a n ts o f wage demands and b a r g a in s g e n e r a l l y do n o t
o p e r a te in d e p e n d e n tly ( i . e . , s i n g l e - h a n d e d l y ) b u t i n t e r a c t
i n a v a r i e t y o f c o m b in a tio n s .
S p e c ia l u n io n p r e s s u r e s .- - T h e above c o n s i d e r a t i o n s
ap p ly g e n e r a l l y t o w a g e - in c r e a s e s g r a n te d by i n d i v i d u a l
f ir m s u n d e r b o th c o n d it i o n s o f (a ) u n i l a t e r a l w a g e - s e t t i n g
by th e e m p lo y e r, and (b) c o l l e c t i v e b a r g a i n i n g . However,
i n a d d i t i o n to e x p l o i t i n g such p r e s s u r e s as c o s t - o f - l i v i n g
a d ju s tm e n ts and wage c o m p a ris o n s , th e unio n c o n f e r s tw o
s p e c i a l s o u rc e s o f p r e s s u r e s : (1) t h e need t o m atch th e
s i z e o f w a g e - in c r e a s e s won by " r i v a l " u n io n s o r u n io n
140
l e a d e r s , and (2 ) th e ten d en cy t o ta k e i n t o a c c o u n t th e
e m p lo y e r's g e n e r a l econom ic p o s i t i o n , such a s th e s i z e of
p r o d u c t i v i t y - I n c r e a s e s o r " e x c e s s " p r o f i t s , r e g a r d l e s s o f
p r e s s u r e s l i k e c o s t - o f - l i v i n g and wage c o m p a riso n s.
F u rth e rm o r e , a lo n g w ith t h e s e new s o u r c e s o f p r e s s u r e , th e
u n io n c a r r i e s th e t h r e a t of an o rg a n iz e d s t r i k e (and
com plete p l a n t shutdow n) which i s a b s e n t i n th e case o f
u n i l a t e r a l w a g e - s e t t i n g .
T hus, i n a s s e s s i n g th e f i r m ' s p r o b a b le r e s p o n s e to
union p r e s s u r e s , th e most s i g n i f i c a n t new im pact e x e r t e d
by th e u n io n i s t o i n c r e a s e th e c o s t o f r e s i s t a n c e by th e
f i r m , o r ( c o n v e r s e ly ) t o i n c r e a s e th e r e l a t i v e p r o f i t
a b i l i t y o f i t s a c q u ie s c in g t o t h e u n i o n 's wage demands.
The G e n e ra l Wage L evel
How does th e p r e c e d in g d i s c u s s i o n , fram ed i n term s
o f f a c t o r s d e te r m in in g w a g e - in c r e a s e s in th e case o f i n d i
v i d u a l f i r m s , e n a b le us t o u n d e r s t a n d th e mechanism w hich
g e n e r a t e s i n c r e a s e s i n th e g e n e r a l ( o v e r - a l l ) wage l e v e l ,
in term s o f which th e w a g e -p ric e i s s u e i s u s u a l l y d isc u sse d ?
D e te rm in a n ts o f th e Wage L evel
G e n e r a l l y , movements i n th e o v e r - a l l in d ex o f wages
may be r e g a r d e d as b e in g d ep en d e n t on two p a i r s o f m a jo r
f a c t o r s : th e f i r s t p a i r of f a c t o r s may be term ed th e
l 4 l
" a p p ro x im a te " d e te r m in a n ts o f the wage l e v e l , c o m p risin g
(1) th e same w a g e -d e te rm in a n ts t h a t a re o p e r a t i v e in t h e
c a se o f th e i n d i v i d u a l f i r m , and (2) th e d i s t r i b u t i o n o r
d i s p e r s i o n o f t h e s e f a c t o r s i n th e economy a t l a r g e . The
second p a i r may be r e f e r r e d t o as " a n t e c e d e n t " o r u n d e r
l y i n g f a c t o r s , w hich se rv e t o i n f l u e n c e th e w orkings o f th e
a p p ro x im ate d e te r m i n a n ts . These co m p rise: (3 ) th e r e
a c t i o n s o f f ir m s t o wage p r e s s u r e s , a s r e f l e c t e d in t h e i r
p r i c e , o u t p u t , and employment d e c i s i o n s ; (4) t h e r e a c t i o n s
of th e governm ent and th e m o n e t a r y - f i s c a l a u t h o r i t i e s t o
th e r e s u l t i n g changes in p r i c e s and unem ploym ent; and (5)
c e r t a i n o t h e r f a c t o r s , such as l a b o r m o b i l i t y and e l a s t i
c i t i e s o f demand.^-
S e c to r e d n a t u r e of t h e economy. — T here i s r e a s o n t o
b e l i e v e t h a t th e r e g u l a r d e te r m in a n ts o f i n d i v i d u a l wage
d e c i s i o n s — such as p r o d u c t i v i t y , e x c e s s demand f o r l a b o r ,
th e c o s t - o f - l i v i n g , and a b i l i t y - t o - p a y — would i n a
"homogeneous" economy ( c o n s i s t i n g o f a " s i n g l e firm " and a
" s i n g l e u n io n " ) n e c e s s a r i l y a f f e c t t h e g e n e r a l ind ex o f
wages i n a s im u lta n e o u s f a s h i o n , t h a t i s , a t th e same tim e
t h a t th ey a f f e c t i n d i v i d u a l wage d e c i s i o n s . I n r e a l i t y ,
how ever, t h e v a r i e t y of w a g e - s e t t i n g p ro c e d u r e s and t h e i r
d i s t r i b u t i o n a l p a t t e r n among th e d i f f e r e n t f i r m s of our
■'■This d i s c u s s i o n i s b ased m ainly on Bowen, op. c i t .,
pp . 210-1M.
142
c h a r a c t e r i s t i c a l l y s e c t o r e d economy must be e x p e c te d t o
e x e r c i s e some d i f f e r e n t i a l im p a c ts on th e wage l e v e l .
Thus, i n a s e c t o r e d economy, an i n c r e a s e i n th e
wage index i s more l i k e l y to be i n i t i a t e d i n s p e c i f i c o r
"key” s e c t o r s ( i . e . , f ir m s o r i n d u s t r i e s ) and th e n be t r a n s
m i t t e d to o t h e r s e c t o r s o f th e economy; i t s m agnitude w i l l
t h e r e f o r e depend on th e e x t e n t of t r a n s m i s s i o n o r c h a in
r e a c t i o n a s w e l l as on th e s i z e of th e I n i t i a l wage b o o s t s .
W age-T ransm ission Mechanisms
As a f i r s t a p p r o x im a tio n , i t can be s a i d t h a t t h e
e f f e c t i v e n e s s o f wage com parisons and t h e t r a n s m i s s i o n o f
w a g e - in c r e a s e s may be i n f l u e n c e d by such f a c t o r s as (1) th e
p re v a le n c e o f u n io n o r g a n i z a t i o n s , (2) th e n a t u r e o f p o l i
t i c a l r i v a l r y among u n io n s and t h e i r l e a d e r s , (3) th e
d e g re e o f a l e r t n e s s o f union l e a d e r s t o w a g e - in c r e a s e s won
i n o t h e r p l a c e s , (4) t h e d e g re e of a d h eren c e by w orkers
and em p loy ers to " h i s t o r i c a l " d i f f e r e n t i a l s i n wage r a t e s ,
(5) t h e e x te n t o f s c a r c i t y o r s h o r t a g e s i n l a b o r s u p p ly ,
and (6) th e g e n e r a l l e v e l of p r o f i t a b i l i t y in th e econom y.1
From th e above a r r a y o f i n f l u e n c e s i t a p p e a rs t h a t
wage com parison s te n d t o ru n i n " l i m i t e d o r b i t s , " t h a t i s ,
U n l e s s o th e r w is e s p e c i f i e d , t h i s d i s c u s s i o n i s
b a se d m ainly on Bowen, op. c i t . , pp. 2 0 7 -2 8 ; see a l s o
F r i t z M achlup, "A n o th er View o f C o st-P u sh and D em and-Pull
I n f l a t i o n , " The Review o f Economics and S t a t i s t i c s . XLII
(May, I 9 6 0 ) , pp . 133-35.
1*43
t h e w a g e - tr a n s m is s io n mechanism te n d s t o i n f l u e n c e m o stly
t h e wages of f ir m s t h a t (a ) compete f o r la b o r w ith th e fiiros
r e s p o n s i b l e f o r i n i t i a t i n g t h e key w a g e - i n c r e a s e s , and (b)
t r a d i t i o n a l l y have t h e i r w a g e - s c a le s compared w ith th o s e of
t h e " p a t t e r n - s e t t i n g " f i r m s .
Wages and p r o d u c t i v i t y g a i n s . — The s i g n i f i c a n c e o f
t h e p a t t e r n of t r a n s m i s s i o n i s b ro u g h t home by a c o n s i d e r a
t i o n of t h e p o s s i b l e e f f e c t s o f d i f f e r e n t i a l l y d i s t r i b u t e d
r a t e s o f p r o d u c t i v i t y on th e g e n e r a l l e v e l of wages and
p r i c e s . F o r i n s t a n c e , i t i s a p p a r e n t l y a c c e p te d d o c t r i n e
t h a t th e consumer p r i c e l e v e l can be h e ld s t a b l e i f t h e
a v erag e o f a l l w a g e - in c r e a s e s does n o t exceed th e a v e ra g e
grow th o f p r o d u c t i v i t y in t h e economy as a w h o le , t h a t i s ,
i f wage r a t e s a re a llo w ed t o i n c r e a s e only by t h e same
p e r c e n t a g e as th e a v erag e i n c r e a s e i n p r o d u c t i v i t y of a l l
f i r m s . 1 T h is r u l e , how ever, has o f t e n been m i s i n t e r p r e t e d
t o mean t h a t wages in i n d i v i d u a l f i r m s or i n d u s t r i e s can
r i s e by t h e same p e r c e n ta g e a s th e i n c r e a s e o f p r o d u c t i v i t y
i n th e s e v e ry same firm s o r i n d u s t r i e s , m eaning i n e f f e c t
t h a t w a g e - in c r e a s e s in p a r t i c u l a r i n d u s t r i e s do n o t have t o
keep in l i n e w ith t h e a v e ra g e r i s e o f p r o d u c t i v i t y i n t h e
economy a s a w hole.
! a good exam ple i s th e d i s c u s s i o n on " g e n e r a l
g u i d e p o s ts " f o r n o n - i n f l a t i o n a r y wage and p r i c e b e h a v io r in
U .S ., P r e s i d e n t (K ennedy), Economic R epo rt o f t h e P r e s i d e n t
(W ashington: U.S. Government P r i n t i n g O f f i c e , 19(?2), pp.
185-90.
144
A part from th e e q u it y and i n c o m e - d i s t r l b u t i o n
I m p l i c a t i o n s o f such a p r o p o s i t i o n , a tte m p ts t o a p p ly t h i s
m i s i n t e r p r e t e d r u l e would ten d t o f a i l i n the r e a l w orld
o f wage co m p ariso n s. The re a s o n i s t h a t w o rk ers i n l e s s -
f a v o r e d f irm s --w h e re p r o d u c t i v i t y r a t e s (an d , h e n c e , wage-
r a i s e s ) a re below t h o s e o f th e more p r o d u c tiv e f i r m s —
would make i n v id i o u s com p ariso n s and demand w a g e - r a is e s
s i m i l a r t o th o s e o b t a i n e d in t h e h ig h ly p r o d u c t i v e s e c t o r s ,
r e g a r d l e s s o f t h e i r own e m p lo y e rs ' a b i l i t y - t o - p a y and
p r i c i n g p o w e r.1
I f such c la im s f o r " e q u a l i z i n g " w a g e - in c r e a s e s by
w a g e -e a rn e rs i n l e s s - f a v o r e d f i r m s were g r a n te d by t h e i r
e m p lo y e rs , th e r e s u l t would be an upward p r e s s u r e on th e
p r i c e l e v e l , b ecau se i n d i v i d u a l w a g e - in c re a s e s would te n d
t o e x c e e d th e p a r t i c u l a r r a t e s o f p r o d u c t i v i t y . As a con
se q u e n c e , p ro d u c e rs i n t h e l e s s - f a v o r e d s e c t o r s would be
f o r c e d to r a i s e p r i c e s ; th e e n s u in g c o s t - o f - l i v i n g i n f l a
t i o n would i n t u r n in d u c e th e m o r e -f a v o r e d w a g e -e a rn e rs to
se ek r e d r e s s f o r th e l o s s of r e a l incom e. Thus would be
u n lo o s e d a s u c c e s s io n o f wage a d j u s t m e n t s , b a sed on (a) th e
^ t i s p e r t i n e n t t o n o te th e c o n c e s s io n s t o such
r e a l i s t i c s i t u a t i o n s made in U . S . , P r e s i d e n t (K ennedy),
op. c i t . , pp. 189-90, w hich acknowledge t h a t in " s p e c i f i c "
c a s e s w a g e - in c r e a s e s may, f o r r e a s o n s o f " e q u i t y and
e f f i c i e n c y , " be a llo w e d to e x ce ed th e g e n e r a l g u id e r a t e .
145
r u l e o f condoning i n i t i a l w a g e - in c r e a s e s a c c o rd in g t o th e
p r o d u c t i v i t y o f t h e p a r t i c u l a r em p lo y ers i n v o lv e d , and (b)
th e v e ry p ro b a b le s p i l l - o v e r o f w a g e - in c r e a s e s from th e
more p r o d u c tiv e s e c t o r s t o th e l e s s - p r o d u c t i v e o n es.
P ro d u ct demand and l a b o r m o b i l i t y . — As i n d i c a t e d
abov e, th e a p p ro x im ate d e te r m in a n ts o f wage t r a n s m i s s i o n
a re th e m s e lv e s i n f l u e n c e d by more u n d e r ly in g d e te r m i n a n ts .
For i n s t a n c e , a b a s i c I n f l u e n c e i s th e manner i n which th e
" i n s t i g a t i n g " f ir m s (whose wages s e t th e p a t t e r n ) r e a c t to
wage n e g o t i a t i o n s , t h a t i s , w h e th er t h e y c u r t a i l t h e i r
demand f o r l a b o r , d e c id e t o r a i s e p r i c e s , o r a l t e r t h e i r
p r o f i t and in v e s tm e n t p l a n s . I n a d d i t i o n , th e p r i c e - and
i n c o m e - e l a s t i c i t i e s o f demand, o f w o rk ers r e c e i v i n g th e
w a g e - r a is e s and o f consum ers g e n e r a l l y , se rv e a s b a s i c
i n f l u e n c e s on th e p r o f i t a b i l i t y o f f i r m s and on t h e i r
demand f o r l a b o r .
The d e g re e of l a b o r m o b i l i t y — a n o th e r u n d e r ly in g
f a c t o r — i s b e li e v e d t o e x e r t i n v e r s e e f f e c t s on t h e wage
l e v e l , on t h e a s su m p tio n s t h a t (a) th e f ir m s i n i t i a t i n g th e
w a g e - r a is e s w i l l be in d u c e d t o la y o f f some w o rk e rs o r
c u r t a i l t h e i r demand f o r la b o r th e y would have h i r e d , and
(b) wages a re r e s p o n s i v e t o ch an ges i n th e su p p ly o f l a b o r .
However, i t may a l s o be a rg u e d t h a t t h e u l t i m a t e
d i r e c t i o n o f t h i s Im pact on wages i s a c t u a l l y n o t so c l e a r .
A h ig h d e g re e o f m o b i l i t y t h a t e n a b le s la b o r t o move t o
146
b e t t e r - p a y i n g f irm s can a l s o c r e a t e l a b o r s h o r t a g e s f o r
fo rm er em p lo y ers (which t h e l a t t e r w i l l want t o p r e v e n t)
and t h e r e b y may se rv e t o i n c r e a s e th e o v e r - a l l wage l e v e l .
Government econom ic p o l i c y . - - F u r t h e r m o r e , th e
i n c r e a s e d unemployment t h a t i s , on th e one h a n d , supposed
t o d i s s u a d e wage demands may, on th e o t h e r h a n d , in d u ce
governm ent a c t i o n s — in th e form of unemployment b e n e f i t s o r
econom ic a id t o " d i s t r e s s e d ” a r e a s — t h a t may have th e
r e v e r s e e f f e c t .
In d e e d , i t sh o u ld be e x p l i c i t l y acknow ledged t h a t
governm ent econom ic p o l i c y i t s e l f may be a s i g n i f i c a n t
u n d e r ly in g d e te r m in a n t o f th e e x t e n t t o which wage-
i n c r e a s e s a r e t r a n s m i t t e d th ro u g h o u t th e economy. Above,
i t became a p p a re n t t h a t t r a n s m i s s i o n e f f e c t s were c o n s i d e r
a b ly dep en d en t on th e l e v e l o f a g g re g a te demand— f o r
ex am p le, on th e shape o f consum ers' p r i c e - and incom e-
e l a s t i c i t i e s o f demand— and th e e x t e n t t o which t h e f i r m 's
r e a c t i o n s t o wage demands may be i n f l u e n c e d by demand
c o n d i t i o n s In th e p ro d u c t m a rk e t. Now i t i s n o te d t h a t
governm ent e n t e r s th e p i c t u r e In a s ta n d - b y r o l e , o b s e rv in g
th e e x t e n t t o w hich unemployment I s g e n e r a t e d by wage-
i n c r e a s e s and a s s e s s i n g th e need t o b o l s t e r any r e s u l t i n g
" d e f i c i e n c i e s " I n a g g re g a te demand.
I n t h i s c o n n e c tio n , t h e d i r e c t im pact o f wage-
i n c r e a s e s th e m se lv e s on th e l e v e l o f a g g re g a te Income and
147
demand— which may b o th ( a ) p e rm it a f u l l e r t r a n s m i s s i o n o f
i n i t i a l w a g e - in c r e a s e s and (b) i n s t i g a t e a su b s e q u e n t ro u n d
o f w a g e - r a i s e s —must a l s o be e x p l i c i t l y acknow ledged a t
t h i s p o i n t ; a more co m p lete d i s c u s s i o n of t h i s " w a g e -p u ll"
comes i n th e l a s t p a r t o f t h i s c h a p t e r .
C o s t - o f - l i v i n g a d j u s t m e n t s . — To com plete t h i s d e s
c r i p t i o n o f t r a n s m i s s i o n m echanism s, two a d d i t i o n a l f a c e t s
must be m en tio n ed . F o r one t h i n g , i n c r e a s e s in t h e c o s t -
o f - l i v i n g in dex t h a t may fo llo w on th e h e e l s o f i n i t i a l
wage- and p r i c e - i n c r e a s e s a ls o become an a d d i t i o n a l so u rc e
o f p r e s s u r e f o r t r a n s m i s s i o n of wage a d ju s tm e n ts t o th e
r e s t o f th e economy. However, t h i s does n o t mean t h a t a
r i s e i n c o s t - o f - l i v i n g n e c e s s a r i l y im p a r ts an In d ep e n d en t
upward push t o w ages; t h e l a t t e r would n o t be t r u e , f o r
i n s t a n c e , in c a se s where a l a r g e r w a g e - in c r e a s e was a lr e a d y
b e in g c o n s id e re d in re s p o n s e t o some o t h e r p r e s s u r e , s a y ,
wage co m p a riso n s.
S tim u lu s o r r e s p o n s e . — More s i g n i f i c a n t t h a n th e
wage t r a n s m i s s i o n mechanisms i s th e m e th o d o lo g ic a l problem
r a i s e d by th e p r o c e s s o f s e c u l a r wage a d ju s tm e n t i t s e l f :
w h ile th e p r o c e s s o f wage a d ju s tm e n t may seem, a t any g iv e n
p o i n t of tim e , t o be spasm odic and d i s c o n t i n u o u s , in d u c in g
th e n o tio n t h a t th e " i n i t i a l " s o u r c e o f w a g e - in c r e a s e s can
be r e a d i l y l o c a t e d , i t may a l s o be view ed as p a r t of a
c o n tin u o u s p r o c e s s i n which b e g in n in g and end ( o r s tim u lu s
1*8
and re s p o n s e p h a s e s ) a r e n o t so r e a d i l y d i s c e r n i b l e . In
t h i s p e r s p e c t i v e , what may a p p e a r a s an i n i t i a l s t im u lu s of
a su b se q u e n t ro u n d o f wage t r a n s m i s s i o n may a l s o be regarded
as t h e re s p o n se t o a p r i o r wave of wage t r a n s m i s s i o n .
T h is i s n o t to deny t h a t a t any p a r t i c u l a r tim e key
wage d e c i s i o n s do n o t s e rv e t o im pel a p a t t e r n of wage-
i n c r e a s e s i n t h e r e s t o f th e economy; i t I s m erely t o n o te
t h a t , In p r a c t i c e , i t would be d i f f i c u l t t o ju d g e t o what
e x t e n t the " i n s t i g a t i n g " w a g e - r a is e s a re a cause o f e n s u in g
i n f l a t i o n a r y p r e s s u r e s o r m ere ly a re s p o n s e to p r e v io u s
p r e s s u r e s .
From W a g e -in c re a se s t o P r l c e - I n c r e a s e s
T his s e c t i o n w i l l d i s c u s s b r i e f l y t h e n e x t m a jo r
p h ase In th e w a g e -p ric e se q u e n c e : how w a g e - in c r e a s e s may
r e s u l t In h i g h e r p r i c e s by f o r c i n g c o s t s t o r i s e . T h is
i s s u e co m p rises two d i s t i n c t a s p e c t s : (1) how wage-
i n c r e a s e s a f f e c t c o s t s , and (2 ) how v a r i a t i o n s i n c o s t s
im pinge on p r i c e - d e t e r m i n a t i o n p r o c e s s e s o f f i r m s . The
l a t t e r . a s p e c t w i l l be t r e a t e d i n th e n e x t c h a p t e r , on
p r i c i n g .
As a l r e a d y i n d i c a t e d , t h e im p a ct o f wages on c o s t s
i s only one g e n e r a l r o u t e by which w a g e - in c r e a s e s u ltim a te ]y
c ause p r i c e s t o r i s e ; th e o t h e r g e n e r a l r o u t e (w hich w i l l
be d i s c u s s e d l a t e r ) I s v i a t h e p r e s s u r e o f i n c r e a s e d
149
demand ( o r w a g e -p u ll) e x e r t e d on th e g e n e r a l p r i c e l e v e l .
U n it L abor C osts
As a p r e l i m i n a r y n o te i t may be r e c a l l e d t h a t th e
im m ediate im pact of a w a g e - in c re a s e i s on u n i t l a b o r c o s t s
(ULC). The u l t i m a t e s i z e o r s i g n i f i c a n c e o f t h i s im pact
w ould, o f c o u rs e , depend on th e shape of th e f l r m f s
p h y s i c a l p r o d u c tio n f u n c t i o n , which r e l a t e s th e p r o p o r t i o n s
o r c o m b in a tio n s of l a b o r , c a p i t a l eq u ip m en t, and o t h e r
i n p u t s r e q u i r e d t o p ro d u ce a u n i t o f o u t p u t . In t h i s
c o n n e c tio n , th e dilemma model assum es a r i g i d l i n k between
wages and ULC, t h a t i s , a g iv e n wage i n c r e a s e i s supposed
t o r e s u l t in a g iv e n i n c r e a s e in ULC.^
T h is i n t u r n i m p l i e s t h a t th e wage i n c r e a s e w i l l
n o t i t s e l f in d u ce any changes i n p r o d u c t i v i t y o r o u tp u t
p e r m an-hou r, but w i l l m erely r e t a i n th e f i x e d r e l a t i o n s h i p
betw een wages and ULC. In r e a l i t y , how ever, t h i s n o tio n
sh o u ld be m o d ifie d t o t h e e x t e n t t h a t a w a g e - in c r e a s e may
i t s e l f d i r e c t l y a f f e c t f u t u r e p r o d u c t i v i t y by in d u c in g o r
" sh o c k in g " th e f i r m i n t o c u t t i n g c o s t s , t h a t i s , i n t o
making s m a ll o r l a r g e im provem ents in th e p r o d u c tio n
f u n c t i o n t h a t a l t e r t h e p r o p o r t i o n s ( o r g r a d e s ) o f l a b o r o r
o t h e r f a c t o r s so a s t o re d u c e th e ULC r a t i o .
^T hls s e c t i o n and th e f o l lo w in g o n e , on u n i t t o t a l
c o s t s , a re b ased m a in ly on Bowen, op. c l t . . pp. 41, 5 6 -5 7 ,
231-45.
U n it T o t a l C osts
The n e x t im p o rta n t l i n k i n t h e dilemma m o d e l's
s e c o n d sta g e i s t h e im pact e x e r t e d by a g iv e n i n c r e a s e i n
ULC on th e f i r m ' s u n i t t o t a l c o s t s (UTC). H ere to o a r i g i d
l i n k i s commonly assumed: t h a t a r i s e in ULC w i l l cause
t o t a l c o s ts t o r i s e by t h e same am ount. In e f f e c t t h i s
I m p li e s t h a t l a b o r c o s ts a r e th e s o l e elem ent i n v a r i a b l e
c o s t s , and t h a t t h e r e f o r e u n i t v a r i a b l e c o s t s must i n c r e a s e
i n t h e same p r o p o r t i o n a s wage in c r e m e n ts e x c e e d p ro d u c
t i v i t y in c re m e n ts .
A c t u a l ly , how ever, t h e r e can be c o n s i d e r a b le " g iv e "
i n t h i s l i n k , p a r t i c u l a r l y because t h e firm may (1) d e c id e
t o s u b s t i t u t e o t h e r f a c t o r s f o r l a b o r in r e s p o n s e t o t h e
wage b o o s t , t h e r e b y r e d u c in g th e num ber of w o rk e rs employed;
(2) a l t e r i t s c a p i t a l and raw m a t e r i a l s c o s t s th ro u g h th e
improvement of p r o d u c t i v i t y ; o r (3 ) v a ry i t s s c a l e o f o p e ra
t i o n s , th e re b y a l s o a f f e c t i n g u n i t v a r i a b l e c o s t s . In o th e r
w o rd s, t o th e e x t e n t t h a t f ir m s i n c u r n o n - l a b o r c o s t s a s
w e l l as la b o r c o s t s in t h e p r o c e s s o f p r o d u c tio n and d i s t r i
b u t i o n , th e p resu m ed r i g i d i t y o f t h e l i n k betw een wage-
i n c r e a s e s and u n i t c o s ts i s weakened.
N e v e r t h e l e s s , d e s p i t e th e u n r e s o l v e d n a t u r e o f th e
d i s c u s s i o n on t h e r e l a t i o n betw een ULC and u n i t v a r i a b l e
c o s t s (UVC), and between UVC and UTC, t h e r e i s a te n d e n c y
to b e l i e v e t h a t a given a b s o l u t e i n c r e a s e i n ULC w i l l te n d
151
t o r e s u l t i n a t l e a s t a s la r g e an i n c r e a s e i n UVC an d UTC
( t h a t i s , t h e r i s e i n ULC w i l l s e t a f l o o r u n d e r t h e
e x p e c te d changes in UVC and UTC), and t h a t t h e a b s o l u t e
i n c r e a s e s i n UVC and UTC may even te n d to be g r e a t e r th a n
th e i n c r e a s e in ULC.
For i n s t a n c e , on th e b a s i s of r e c e n t e x p e r ie n c e i t
may be arg u e d t h a t w a g e - in c r e a s e s would c a u se th e a v e ra g e
v a r i a b l e c o s t c u rv e t o be r a i s e d due to t h e r i s i n g c o s t s o f
m a t e r i a l s and th e I n c r e a s e d use o f s a l a r i e d (non-w age)
p e r s o n n e l , t h e l a t t e r h a v in g been a c h a r a c t e r i s t i c accom
panim ent o f p o s t- w a r c a p i t a l in v e s tm e n t .^ I t may a l s o be
a rg u e d t h a t h i g h e r ULC may e x e r t a n upward push on th e
a v e ra g e t o t a l c o s t c u rv e in c a s e s where t h e wage b o o s t i s
b a s e d , a t l e a s t p a r t l y , on an Im provem ent In p r o d u c t i v i t y
i n v o lv i n g c a p i t a l o u t l a y s .
F i n a l l y , as i n d i c a t e d a b o v e , i t re m a in s f o r th e
f o llo w in g c h a p t e r (on p r i c i n g ) t o d i s c u s s w h e th er and how
th e i n c r e a s e in c o s t s a t t r i b u t a b l e to wages (o r any o t h e r
c o s t - f a c t o r ) w i l l (a ) be p asse d a lo n g in t h e form o f
h i g h e r p r i c e s , (b) be ab so rb ed o u t o f p r o f i t s , o r (c )
r e s u l t In a c o m b in a tio n of h i g h e r p r i c e s and re d u c e d
p r o f i t s .
■ktn t h i s c o n n e c tio n see t h e d i s c u s s i o n on t h e r i s e
o f s a l a r i e d o v e rh e ad d u r in g 1947-1957* i n C h a rle s L.
S c h u l t z e , R ecen t I n f l a t i o n in t h e U n ited S t a t e s . U . S . ,
C o n g re ss, J o i n t Economic C om m ittee, Study P a p e r No. 1
W e in tr a u b 's C o n t r i b u t i o n
B efo re p r o c e e d in g to a summary o f th e p r e c e d in g
c o n s i d e r a t i o n s on w a g e - d e te r m in a tio n , i t i s e s s e n t i a l to
n o te h e re t h e s u g g e s t i v e w age-push f o r m u la ti o n d e v e lo p e d by
S id n ey W ein tra u b . The r e a s o n f o r so d o in g i s t h a t Weintraub
does n o t b e l i e v e p r i c i n g p o l i c y p la y s an in d e p e n d e n t r o l e
i n d e te r m in in g th e p r i c e l e v e l . 1
F or W ein tra u b , t h e r e a r e n o rm a lly o n ly two p o s s i b l e
c a u se s of p r i c e r i s e s : i n c r e a s e d money s u p p ly , and
i n c r e a s e d c o s t s , p a r t i c u l a r l y w ages. S in c e th e Korean w ar,
how ever, he b e l i e v e s e x c e s s i v e w a g e - in c r e a s e s have been t h e
dom inant f o r c e f o r i n f l a t i o n . I n d e e d , he a s s e r t s , any
s u b s t a n t i a l w a g e - in c r e a s e must alw ays f o r c e a r i s e in
p r i c e s , and no s i g n i f i c a n t i n f l a t i o n o r upward p r i c e
s p i r a l can o c c u r w ith o u t s u b s t a n t i a l accom panying wage-
i n c r e a s e s .
The c o n s t suit m a rk -u p . — F o r our p u r p o s e s , what makes
W ein trau b*s t h e o r y n o te w o rth y i s n o t so much th e em p hasis
on w a g e - c o s ts b u t th e a s s e r t i o n t h a t th e s e l l e r s 1 m ark-up
o f p r i c e s above w a g e -c o s ts i s n e a r l y c o n s t a n t , an a s s e r t i o n
(W ashington: U .S . Government P r i n t i n g O f f i c e , 1 9 5 9 ), pp.
7 8 -9 6 , 122-25.
1T h is s e c t i o n i s b a se d p r i m a r i l y on W e in tra u b , A
G e n e r a l Theory . . . . o p . c i t . , p a s s im , and C l a s s i c a l
K ey nesianism . . . . op . c i t . , p a s s im .
153
t h a t he s u p p o r ts w ith d a t a f o r t h e long p e r i o d 1929-1957.
A ccording to W e in tra u b , th e m ark-up o f p r i c e s o v e r
w a g e - c o s ts — t h a t i s , th e m argin betw een t h e v a lu e of
" b u s i n e s s g r o s s p r o d u c t" and wages and s a l a r i e s — has
behaved so n e a r l y c o n s ta n t t h a t changes in p r i c e s m ust be
a t t r i b u t e d e n t i r e l y t o c h an g es in wages. A lo n g sid e t h i s
a s s e r t i o n , W eintraub p o i n t s to th e n e a r l y c o n s t a n t b e h a v io r
of a n n u a l In c re m e n ts i n p r o d u c t i v i t y , th e o n ly o t h e r
« *
p o s s i b l e o f f s e t t o ch an g es i n w a g e - c o s ts . In b r i e f ,
W eintraub i s s a y in g : "As wages g o , so go p r i c e s , becau se
th e p r i c e m ark-up o v e r w a g e -c o s ts i s f a i r l y c o n s t a n t . "
I t sh o u ld be n o te d t h a t W e in tra u b f s m ark-up o v e r
w a g e -c o sts r e p r e s e n t s t h a t p a r t o f s a l e s p ro c e e d s a v a i l a b l e
f o r c o v e rin g d e p r e c i a t i o n , p r o f i t s , i n t e r e s t , r e n t , a s w e ll
as p r o f i t - , p r o p e r t y - , and e x c i s e - t a x e s . Thus th e m ark-up
co m p rises a l l non-wage c o s t e le m e n t s , e x c e p t m a t e r i a l s .
Prom a n o th e r a n g l e , th e m ark-up may be view ed as b e in g
i n t i m a t e l y r e l a t e d t o th e d i v i s i o n o f income betw een wage-
and non-wage c a t e g o r i e s . O th e r p e r t i n e n t a s p e c t s o f
mark-up p r i c i n g , such a s t h e a c t u a l e x te n t o r d i s t r i b u t i o n
o f m ark-up p r i c i n g p r a c t i c e s , w i l l be d i s c u s s e d in t h e n e x t
c h a p te r .
R e l a t i o n t o e a r l i e r c o n c e p t s . — F o r t h e p u rp o se s of
t h i s c h a p t e r , i t i s n o t n e c e s s a r y h e re to e l a b o r a t e on
W e in tra u b f s d i s c u s s i o n o f th e c o n s t a n t m ark-up phenomenon.
154
What sh o u ld be n o te d I s th e I m p l i c i t f a m ily r e l a t i o n s h i p o f
h i s th e o r y t o two b a s i c c o n c e p ts d is c u s s e d i n p r e c e d in g
c h a p t e r s : (1 ) th e in c o m e - v e l o c i ty m odel of th e e q u a tio n o f
e x c h a n g e , i n C h a p te r i i , and (2) A. H. H a n se n 's n o t io n o f
e f f i c i e n c y - w a g e s , in C h a p te r l i i . By b u i l d i n g on th e s e two
f o u n d a t i o n s , and by " d i s c o v e r i n g " th e "m agic" c o n sta n c y o f
p r i c e m ark-ups o ver w ages, W ein trau b p u r p o r t s t o o f f e r u s
a more p o w e rfu l t o o l f o r p r e d i c t i o n o f th e p r i c e l e v e l .
I t w i l l be r e c a l l e d t h a t th e i n c o m e - v e lo c ity e q u a
t i o n ( d e r iv e d from F i s h e r ' s e q u a t io n o f exchan ge) re a d s a s
f o l lo w s : PyTy 5 8 M V y, t h a t i s , " s a l e s p ro c e e d s from
c u r r e n t o u tp u t" e q u a ls " e x p e n d i tu r e s " o r "m o netary demand."
I n W e in tr a u b 's hands t h i s s t r i c t l y m acro- economic t r u is m i s
tr a n s fo r m e d i n t o a combined m ic r o - and m acro-econom ic
t r u is m more r e p r e s e n t a t i v e o f a c t u a l p r i c e - d e t e r m i n a t i o n
p r o c e s s e s : PQ * kwN, i n which PQ i s sim ply a n o th e r way o f
s t a t i n g P yT y, w h ile t h e o ld MVy have been r e p l a c e d by k ,
w, and N.
Why d o e s W eintraub r e p l a c e th e o ld M Vy w ith kwN?
B ecause f o r him p r i c e s and s a l e s p ro c e e d s a re n o t d i r e c t l y
d e te rm in e d by th e m a c ro -econom ic phenomena o f money s u p p ly
and demand b u t by th e p r i c i n g d e c i s i o n s o f m i c r o - economic
b u s i n e s s u n i t s , t h a t i s , by f i r m s s e t t i n g p r i c e s a t some
m arg in above w a g e - c o s ts . T h is l a t t e r n o t io n he e x p r e s s e s
as kwN, where k s ta n d s f o r t h e m ark-up f a c t o r above th e
155
w a g e - b i l l wN ( i . e . , w f o r money-wages a n d s a l a r i e s , N f o r
volume o f em ploym ent).
Used f o r p r e d i c t i o n .--»To make t h i s e q u a t io n u s e f u l
f o r p r e d i c t i v e p u r p o s e s , W eintraub r e p h r a s e s h i s e q u a tio n
as P = kwN/Q. I n e f f e c t , t h i s e q u a tio n d e f in e s t h e p r i c e
l e v e l a s b e in g d e te r m in e d m a in ly by t h e r e l a t i o n s h i p of
wages t o t o t a l o u t p u t , on th e a ssu m p tio n t h a t k i s n e a r l y
c o n s t a n t . T h u s, w ith k c o n s t a n t , any r i s e in t h e w a g e - b i l l
(wN) r e l a t i v e t o Q w i l l c au se P to r i s e . However,
W e in tr a u b 's e q u a t io n u n d e rg o e s a f u r t h e r d e v elo p m e n t, and
h e re i s where H a n s e n 's e f f i c ie n c y - w a g e s e n t e r t h e p i c t u r e .
A cco rd in g t o H ansen, i t w i l l be r e c a l l e d , r i s i n g
p r i c e s a r e t i e d to th e c o m p a ra tiv e movements of wages and
l a b o r p r o d u c t i v i t y , as d e n o te d by th e r a t i o W/E. A lthough
W eintraub does n o t e x p l i c i t l y r e f e r t o t h i s p r e c e d e n t
n o t i o n , i t i s a p p a r e n t he i s i m p l i c i t l y u s in g i t t o t r a n s
form h i s own e q u a t io n i n t o i t s f i n a l f o r m , P = kw/A, from
th e e a r l i e r P = kwN/Q. Note t h a t in i t s f i n a l fo rm 1/A h a s
r e p l a c e d N/Q: by d e s i g n a t i n g Q/N as t h e average o u tp u t p e r
w o rk e r, and by r e p l a c i n g I t w ith th e sym bol A, N/Q becomes
1/A, i . e . , t h e p r o d u c t i v i t y f a c t o r In W e in tra u b * s e q u a t io n .
In t h i s way w/A becomes e s s e n t i a l l y a r e s t a t e m e n t of
H a n s e n 's W/E, th e b ig d i f f e r e n c e b eing W e i n t r a u b 's i n s e r
t i o n o f k i n th e n u m e r a t o r .1
■ * -A s i m i l a r a p p ro a c h u n d e r l i e s M o u lto n 's a n a l y s i s
156
I t i s now p o s s i b l e t o b e t t e r a p p r e c i a t e (1) why
W e in tr a u b 's main c o n t r i b u t i o n i s h i s " p ro o f" t h a t k b ehaves
l i k e a " c o n s t a n t , " and (2) why he a l s o r e g a r d s t h e n e a r
c o n s ta n c y o f A a s an im p o rta n t a l l y : w ith b o th k and A
b eh av in g a s c o n s t a n t s , we sim p ly end up w ith P = w. I f
changes In w can be p r e d i c t e d , so can changes i n P. In any
c a s e , p r i c e s a re d e f i n e d as r i s i n g d i r e c t l y w ith k and w
and i n v e r s e l y w ith A. So much f o r p r e d i c t i o n . The i m p l i
c a t i o n s f o r p o l i c y a r e e q u a l l y o b v io u s : i f changes in w
can be r e s t r i c t e d (w h ile k and A a re anyway c o n s t a n t ) , P
can be h e ld i n ch ec k .
The u n d e r l y i n g i d e a . — F i n a l l y , a n o te may be added
on th e r e l a t i o n o f W e in tra u b ’ s e q u a t io n t o th e i n h e r i t e d
body of d o c t r i n e . U n d e rn ea th t h e i r a p p a re n t d i f f e r e n c e s ,
W e in tra u b , H ansen, Keynes and F i s h e r seem to be s a y in g t h e
same t h i n g : t h a t t h e p r i c e l e v e l i s i n f l u e n c e d by th e
r e l a t i o n betw een (a ) a g g r e g a te m on etary demand, w h eth er
e x p re s s e d a s " e x p e n d i t u r e s , " " f a c t o r p a y m e n ts," o r "wages
p l u s m a r k - u p s ," and (b) a g g r e g a te s u p p l y , w h e th er e x p r e s s e d
a s " q u a n t i t y of g o o d s ," " c u r r e n t o u t p u t , " o r " p r o d u c t i v i t y
p e r m a n -h o u r." I n t h e e v o l u t i o n o f t h i s c o n c e p t, Keynes
s e r v e d t o embody (and c o n v e r t) F i s h e r ' s " e x p e n d i tu r e s " (MV)
o f i n f l a t i o n , M oulton , op. c i t . , pp . 4 7 -4 8 , 1 6 3 -6 4 , 1 7 0 -7 2 ,
i n which t h e lo n g - r u n l e v e l of1 p r i c e s depends p r i m a r i l y on
t h e ra c e betw een p r o d u c t i v i t y and l a b o r ' s r a t e o f rem u n era
t i o n .
157
i n t o f a c t o r incom es and " e f f e c t i v e demand"; Hansen th e n
s i n g l e d o u t th e r e l a t i o n betw een wages (a s c o s t s and
incom e) and p r o d u c t i v i t y ; and f i n a l l y W eintraub has s u p p l e
m ented wages w ith t h e non-wage m ark-up f a c t o r . By f o c u s in g
on t h e l a t t e r , W eintraub has a tte m p te d t o (a) acknow ledge
r e a l i s t i c m ic r o -econom ic a s p e c t s o f th e p r i c e - d e t e r m i n a t i o n
p r o c e s s , and (b) th e n r e l a t e them t o th e m a c ro -economic
phenomenon o f t h e p r i c e l e v e l . I n h i s own w o rd s, he h as
u n d e rta k e n t h e n e c e s s a r y " m a rria g e " of th e m ic r o - and
m a c r o - a s p e c ts o f th e i n f l a t i o n p r o c e s s .
B a sic A sp e c ts o f Wage-Push
In c o n c lu d in g t h i s p o r t i o n o f th e c h a p t e r , a number
o f b a s i c p o i n t s may be n o te d f o r c r o s s - r e f e r e n c e w ith
a n a ly s e s in o t h e r s e c t i o n s o f t h i s s tu d y .
Wages and P r o d u c t i v i t y
F i r s t , to r e t u r n to t h e b a s i c elem ent o f p ro d u c
t i v i t y — o u r p o i n t o f d e p a r t u r e f o r t h e d i s c u s s i o n of w age-
d e te rm in a n t s — i t s h o u ld be n o te d t h a t p r o d u c t i v i t y move
m ents and wage a g re em e n ts t e n d t o be i n d i r e c t l y lin k e d v i a
th e f i r m f s p r o f i t p o s i t i o n , o r more p r e c i s e l y , i t s p r o f i t
p r o s p e c t s .
T h us, on th e one hand, t h e a p p e t i t e f o r r i s i n g
wage-demands a t l e a s t te n d s t o be s t r o n g l y s t i m u l a t e d o r
in d u c e d by im provem ents i n p r o d u c t i v i t y t h a t im prove t h e
158
p r o s p e c t f o r p r o f i t s , a lth o u g h r e a l i z e d w a g e - in c r e a s e s w i l l
a l s o r e q u i r e t h a t a l l o t h e r w a g e -d e te rm in a n ts be f a v o r a b l e
a s w e ll. On th e o t h e r h an d , w a g e - in c r e a s e s may s t i m u l a t e
a grow th o f p r o d u c t i v i t y (and r e d u c t i o n of c o s t s ) a s th e
only means of c o m p en satin g f o r e x c e s s i v e wage demands,
becau se o n ly by i n c r e a s e d p r o d u c t i v i t y ( o r re d u c e d p r o f i t s )
s u f f i c i e n t t o o f f s e t r i s i n g f a c t o r c o s t s can th e firm
manage t o keep t o t a l c o s t s from r i s i n g .
Wages and Economic C o n d itio n s
S econd, th e s i z e of wage a d ju s tm e n ts would a p p e a r
t o be s t r o n g l y i n f l u e n c e d by th e g e n e r a l l e v e l o f econom ic
a c t i v i t y and a g g r e g a te demand, and th e f i r m 's p r o f i t p r o s
p e c t s i n p a r t i c u l a r . Thus an i n c r e a s e d demand in th e
p ro d u c t m ark et may in d u c e a r i s e i n wages v i a an i n c r e a s e d
demand f o r l a b o r o r an i n c r e a s i n g l y f a v o r a b l e p r o f i t
p o s i t i o n .
However, a somewhat c o n t r a s t i n g view must a l s o be
acknow ledged. W ein trau b r e g a r d s wages p r i m a r i l y as an
"autonom ous" o r "exogenous" v a r i a b l e i n th e se n se t h a t (a)
th e y w i l l te n d t o be i n f l u e n c e d m a in ly by p u b l i c a t t i t u d e s
and o t h e r i n s t i t u t i o n a l f a c t o r s m en tio n ed a b o v e, (b) th e y
a re l e s s d e te rm in e d by " p r e c i s e econom ic f o r c e s , " n o r a re
th e y " p r e d i c t a b l e by th e o r d i n a r y i n s i g h t s o f econom ic
a n a l y s i s , " and (c ) th e y w i l l t h e r e f o r e te n d t o r i s e
c o n tin u o u s ly (" a lm o s t r e g a r d l e s s " o f t h e s t a t e o f a g g r e g a te
J
159
dem and), e x c e p t p o s s i b l y i n t h e " d e e p e s t d e p r e s s i o n . "
However, W eintraub d o e s not c o m p le te ly r u l e out th e
i n f lu e n c e o f econom ic c o n d i t i o n s . F o r one t h i n g , he
acknow ledges t h a t ' i n p e r io d s o f e x p a n s io n , as unemployment
c o n t r a c t s , l a b o r s c a r c i t y w i l l te n d to f o r c e wages upw ard,
a lth o u g h he q u ic k ly adds t h e r e i s no n e c e s s a r y c o r r e l a t i o n
betw een t h e r e d u c t i o n in unemployment and th e s i z e o f w age-
i n c r e a s e s . F u rth e rm o re , he a s s e r t s t h a t any " im p o r ta n t"
r i s e in p r i c e l e v e l r e q u i r e s a s i t s c o u n t e r p a r t an "alm o st
e q u a l ly im p o r ta n t" i n c r e a s e i n money wages. W ithout th e
l a t t e r , t h a t i s , w ith o u t a r e f u s a l by w orkers t o a c c e p t a
c u t i n r e a l wages, i t would be im p o s s ib le t o g e n e r a t e a
l a r g e i n f l a t i o n .
Wages and t h e E nvironm ent
T h i r d , th e p r o c e s s e s and i n s t i t u t i o n s o f wage-
b a r g a i n in g and a d ju s tm e n t c a n n o t be r e g a r d e d a s " i s l a n d s
u n to th e m s e lv e s ." On th e one hand, th e y a re n o t d e riv e d
and s u s t a i n e d in a c o n te x t i s o l a t e d from th e econom ic,
s o c i a l , and p o l i t i c a l e n v iro n m e n t; on t h e o th e r hand,
n e i t h e r a r e th e y i n c a p a b le o f e x e r t i n g s i g n i f i c a n t im p a c ts
on t h a t e n v iro n m e n t, p a r t i c u l a r l y when i t i s r e a l i z e d t h a t
w a g e - d e c ls io n s can g e n e r a t e su c h co n sequen ces a s i n f l a t i o n ,
unem ploym ent, and r e d i s t r i b u t i o n of income and w ealth.^-
^-This poin t i s based on Bowen, op. c i t . » p. 222.
16 0
In t h i s c o n n e c tio n , r e f e r e n c e may be made t o our
b a s i c h y p o t h e s i s — w hich w i l l be d i s c u s s e d p a r t l y i n th e
n e x t c h a p t e r , and more f u l l y I n C h ap ter v i i — t h a t t h e i n f l a
t i o n p r o c e s s em anates b a s i c a l l y from an u n d e r l y i n g s t r u g g l e
o v e r th e d i s t r i b u t i o n o f incom e, w ith w a g e -e a rn e rs and
p r o f i t - r e c e i v e r s as t h e main p r o t a g o n i s t s . The p r e c e d in g
d i s c u s s i o n o f w a g e -d e te r m in a tio n has i n d i c a t e d how t h i s
tu g - o f - w a r o v e r In c o m e -sh a re s e x p r e s s e s i t s e l f v i a th e
econom ic i n s t i t u t i o n s o f w a g e -c o s ts and in co m es, p r o f i t s ,
and p r i c e s . I t a ls o I n d i c a t e d how th e i n t e r - r e l a t i o n s h i p
of w a g e -b a rg a in in g and th e econom ic e n v iro n m en t may be
r e f l e c t e d In t h e p r i c i n g p r a c t i c e s of f i r m s — who a r e under
p r e s s u r e to r e g a r d " p u b l i c o p in io n " a s w e ll as p r o f i t
m arg in s and o t h e r f a c t o r s — and may t h e r e f o r e I n f l u e n c e
g o v e rn m e n t’s conduct o f m o n e t a r y - f i s c a l p o l i c y a s w e ll as
i t s r e s p o n s e s t o a m u l t i t u d e o f p r e s s u r e g ro u p s co n cern ed
w ith unem ploym ent, i n f l a t i o n , and income r e d i s t r i b u t i o n .
The C l a s s i f i c a t i o n o f W a g e -in c re a s e s
F o u r t h , i t i s p o s s i b l e t o c l a s s i f y w a g e - i n c r e a s e s —
a lo n g l i n e s s u g g e s te d by F r i t z Machlup— a c c o rd in g t o th e
c o n d it i o n s u n d e r which th e y may a r i s e , a s was done i n th e
c a se o f d e m a n d -p u ll i n f l a t i o n . 1
■^Machlup, op. c i t . , pp. 130-31 , 139
“S pontan eo us" w a g e - i n c r e a s e s . — A w a g e - in c r e a s e can
be term ed " s p o n ta n e o u s" o r "autonom ous" i n th e se n se t h a t
i t w ould n o t have t r a n s p i r e d i n th e absen ce o f l a b o r un io n s
p o s s e s s i n g monopoly and p r ic e - m a k in g p o w e rs, t h a t i s , und er
p u r e ly c o m p e titiv e su p p ly and demand c o n d i t i o n s . For
exam p le, a union may s e c u r e a w a g e - in c r e a s e where i t would
n o t have been f r e e l y g r a n t e d by u n i l a t e r a l a c t i o n o f th e
em p lo y er.
" R espon sive" w a g e - i n c r e a s e s . — In c o n t r a s t , a wage-
r a i s e may be c a l l e d " r e s p o n s i v e " o r " c o m p e titiv e " i f i t i s
u n p ro v o k ed , t h a t i s , th e i n c r e a s e won by th e union i s th e
same a s would have been o b ta in e d w ith o u t c o l l e c t i v e b a r
g a in i n g under p u r e l y c o m p e titiv e su p p ly and demand c o n d i
t i o n s . An exam ple i s a w a g e - r a is e g r a n t e d by an em ployer
who d e s i r e s t o a s s u r e h i m s e l f a s te a d y su p p ly o f l a b o r i n
th e f a c e o f an e x c e s s demand ( o r s h o r t su p p ly ) in t h e l o c a l
l a b o r m a r k e t; t h a t i s , he i s r e s p o n s iv e t o an e x c e s s demand
f o r l a b o r .
" In d u c e d " w a g e - i n c r e a s e s . — There re m a in s a t h i r d
c a te g o ry of w a g e - i n c r e a s e , one t h a t i s n e i t h e r r e s p o n s i v e
( c o m p e titiv e ) n o r autonom ous, b u t r a t h e r i s "In d u ce d " by
changes In the econom ic s i t u a t i o n of th e f i r m o r t h e wage-
e a r n e r , such as (a) an i n c r e a s e i n th e f i r m ' s p r o f i t s , (b)
an i n c r e a s e in t h e wages of o t h e r l a b o r g r o u p s , o r (c) an
I n c r e a s e in th e c o s t - o f - l i v i n g . R e s p e c t i v e l y , t h e s e
162
s u b - c a t e g o r i e s may be r e f e r r e d t o as (a) " p r o f i t - i n d u c e d , "
(b) " s p i l l - o v e r " o r " i m i t a t i v e , " and (c) " d e f e n s i v e . "
C on cernin g d e f e n s iv e w a g e - i n c r e a s e s , Machlup
em ph asizes t h a t th e term " d e f e n s i v e " sh o u ld r e f e r t o wage
a d ju s tm e n ts t h a t m e re ly r e s t o r e (o r p r e s e r v e ) th e r e a l
e a r n i n g s o f s p e c i f i c w a g e - e a rn e r s t o t h e i r custom ary ( l o n g -
e s t a b l i s h e d ) s t a n d a r d and do n o t enhance i t . I n c o n t r a s t ,
a w a g e - ra is e t h a t pu shes r e a l e a r n i n g s above th e custom ary
l e v e l i s no l o n g e r d e f e n s iv e b u t i s " a g g r e s s i v e , " b e cau se
I t o b ta in s a n e t advance in r e a l incom e. I n n e i t h e r c a s e ,
how ever, does th e wage r i s e in re s p o n se t o an e x c e s s demand
f o r l a b o r .
D i f f i c u l t t o d i s t i n g u i s h * --O c c a sio n s may a r i s e i n
which i t would be d i f f i c u l t t o d i s t i n g u i s h betw een an
a p p a r e n t l y d e f e n s i v e and an a c t u a l l y a g g r e s s iv e wage-
i n c r e a s e . N o rm a lly , th e " a g g r e s s i v e " l a b e l would a p p ly t o
w a g e - in c r e a s e s i n th e p r o f i t - i n d u c e d , i m i t a t i v e , and a u to n
omous c a t e g o r i e s . However, an a p p a r e n t l y d e f e n s i v e c o s t -
o f - l i v i n g a d ju s tm e n t which r e s t o r e s some o f th e g a in s
a c h ie v e d by a p r e v io u s a g g r e s s iv e wage c o n t r a c t — g a in s
which had been p a r t i a l l y e ro d e d by th e r e s u l t i n g w age-push
I n f l a t i o n ( a id e d by th e in d u c e d or s u p p o r t i v e e x p a n sio n of
demand o f C h a p te r i i i ) — c o u ld n o t be r e g a r d e d a s s t r i c t l y
" d e f e n s i v e ."
C o n v e rs e ly , many a p p a r e n t l y a g g r e s s iv e wage v i c
t o r i e s may v a l i d l y be i n t e r p r e t e d as d e f e n s i v e , e s p e c i a l l y
when u n io n s ta k e t u r n s a t " d e fe n d in g " th e r e a l income of
t h e i r members a g a i n s t th e a g g r e s s iv e g a in s o f o t h e r u n io n s
w h ile a t t h e same tim e a tt e m p t in g t o o b t a i n a n e t advance
f o r th e m s e lv e s . For t h i s re a s o n Machlup c o n c lu d e s i t i s
n e c e s s a r y t o s p e c i f y a t l m e - i n t e r v a l in th e c l a s s i f i c a t i o n
of w a g e - i n c r e a s e s , i n o r d e r t o a v o id I n t e r p r e t i n g a wage
a d ju s tm e n t as d e f e n s iv e when i t a c t u a l l y c o n s t i t u t e s a
" b a t t l e t o d e fe n d th e ground j u s t g a in e d i n an a g g r e s s iv e
a c t i o n . "
A g r a p h i c p r e s e n t a t i o n .- - T h e above c l a s s i f i c a t i o n
o f w a g e - in c r e a s e s i n t o t h r e e m ain ty p e s — r e s p o n s i v e ,
a g g r e s s i v e , and d e f e n s i v e —may be v i s u a l i z e d i n a sim p le
o r g a n i z a t i o n c h a r t , s u g g e s te d by D ennis H. R o b e rts o n , as
f o l l o w s : ^
W a g e -in c re a se s
R espo nsive S p o n ta n e o u s ;
Autonomous
E
In d u ced
P r o f i t - I m i t a t i v e D e fe n siv e
in d u ce d
^•Dennis H. R o b e rts o n , G row th. Wages, Money
(Cam bridge: Cambridge U n i v e r s i t y P r e s s , 1961) , p. 3 1 *
164
Wages " a d m i n i s t e r e d ” . — In c o n n e c tio n w ith t h i s
c l a s s i f i c a t i o n t h e r e a r i s e s one f i n a l p o i n t . Any wage
a d ju s tm e n t , i n c l u d i n g re s p o n s iv e and d e fe n s iv e t y p e s , and
w h e th er d e c id e d by c o l l e c t i v e b a r g a i n in g o r by u n i l a t e r a l
d e c i s i o n of th e em plo yer— r e p r e s e n t s an " a d m in is te r e d
p r i c e " n o t o n ly in th e se n s e t h a t i t i s p r e s e n t e d i n a
n e g o t i a t e d c o n t r a c t , a fo r m a l announcem ent, o r i n some
o t h e r form of a d m i n i s t r a t i v e a c t i o n , b u t a ls o i n t h e sen se
o f b e in g " in d e p e n d e n t" of ( i . e . , n o t d i r e c t l y r e s p o n s iv e
to ) m arket demand and s u p p ly . Does t h i s mean t h a t a l l wage-
i n c r e a s e s q u a l i f y f o r th e "w age-push" o r i n f l a t i o n a r y
c a te g o ry ?
At one e x tre m e , th e t h r e e a g g r e s s iv e ty p e s of wage
a d ju s tm e n ts would d o u b t l e s s l y seem t o q u a l i f y . At th e
o t h e r e x tre m e , t h e r e s p o n s iv e or c o m p e titiv e ty p e of wage
a d ju s tm e n t s h o u ld be o m it t e d . What about d e f e n s i v e a d j u s t
m ents? These n o n - a g g r e s s iv e movements a re g e n e r a l l y
acknowledged t o be an im p o r ta n t component o f th e i n f l a t i o n
p r o c e s s : l i k e a g g r e s s iv e w a g e - i n c r e a s e s , th ey a r e cap a b le
o f b eh av in g a s an " im p u ls e ," on th e one h a n d , or as a
" p r o p a g a tio n " f a c t o r , on th e o t h e r . However, i t i s dou bt
f u l t h a t th e y can be w eighed on a p a r w ith a g g r e s s i v e wages
as a w age-push " c a u se " o f i n f l a t i o n . 1
^•Robertson, op. c i t . , p. 33; Machlup, op. c i t . ,
pp. 130-31.
165
W ag e -P u ll: The O th er S id e o f Wage-Push
In th e f i r s t p a r t o f t h i s c h a p te r i t was n o te d t h a t
w age-push a c t u a l l y c o n s t i t u t e d a tw o - f o ld p r e s s u r e on
p r i c e s — a "tw o -ed g ed sw o rd ," in t h e words o f Sidney
W e i n tr a u b .1 B ecause wages c o n s t i t u t e a money Income as
w e ll a s a c o s t o f p r o d u c t i o n , a w a g e -in c r e a s e n o t only s e t s
up p r e s s u r e s on c o s t s b u t a ls o I n c r e a s e s t h e a g g re g a te
demand of p o t e n t i a l p u r c h a s e r s . The c o s t- p u s h a s p e c t s
h a v in g been d is c u s s e d a b o v e, t h i s s e c t i o n w i l l d i s c u s s th e
dem a n d -p u ll a s p e c t s : (a ) th e t y p e s of " w a g e -p u ll" (demand-
i n c r e a s i n g ) p r e s s u r e s t h a t may r e s u l t from a w a g e - i n c r e a s e ,
and (b) th e c o n d it i o n s u n d e r w hich w a g e -p u ll may a c t u a l l y
in d u ce a n e t r i s e in th e o v e r - a l l p r i c e l e v e l . B e fo re
do ing s o , h ow ev er, s e v e r a l p r e l i m i n a r y comments a r e in
p l a c e .
Some P r e lim in a r y Comments
F i r s t , i n c l u s i o n o f w a g e - p u ll n o t only s a t i s f i e s
th e need f o r a more com plete a n a l y s i s of i n f l a t i o n , but i t
a l s o f o c u s e s a t t e n t i o n on a key f a c t o r i n th e " s p i r a l "
mechanism i n h e r e n t ( a lth o u g h n o t alw ays o p e r a t i v e ) in th e
i n f l a t i o n p r o c e s s . T hat I s , t o th e e x te n t t h a t p r i c e -
r i s e s do n o t ex ce ed w a g e - i n c r e a s e s , th e I n c r e a s e d demand
1SIdney W e in tra u b , "Anatomy of th e New I n f l a t i o n , "
C h a lle n g e » X ( J a n u a r y , 1 9 6 2 ), p . 40.
166
g e n e ra te d by th e w age-push can p r o v id e t h e d o l l a r volume of
sp en d in g needed t o su p p o rt th e h i g h e r p r i c e s ( t h a t had
r i s e n b e c a u se of h i g h e r wages and c o s ts ) and th e r e b y s u s
t a i n a c o n tin u o u s w a g e -p ric e s p i r a l . 1
" P e r m i s s i v e 1 1 e n v iro n m e n t. — A spects of t h i s wage-
p r i c e s p i r a l mechanism— i n which demand s e r v e s as a
" p r o p a g a t o r " — w i l l be d i s c u s s e d below and i n C h ap ter v i , on
th e " p r o c e s s " o f i n f l a t i o n . At t h i s p o in t i t s u f f i c e s t o
n o te th e s t r a t e g i c f a c t (m en tio n e d in the c h a p te r on money)
t h a t a " s e l f - f i n a n c i n g " w a g e - p r ic e s p i r a l — i n which h i g h e r
wage incomes ( i . e . , w a g e -p u ll) a u t o m a t i c a l l y se rv e to
s u s t a i n th e h i g h e r p r i c e s caused by h i g h e r c o s t s — r e q u i r e s
as a n e c e s s a r y c o n d it i o n a p e r m is s iv e m onetary e n v iro n m en t
( i . e . , i n c r e a s e d money and c r e d i t supply a n d /o r v e l o c i t y of
c i r c u l a t i o n ) . ^ O th erw ise t h e h i g h e r l e v e l of c o s t s can be
" f in a n c e d " only by o f f s e t t i n g c u ts i n o u tp u t and employ
m ent. As W eintraub has p u t i t : "W ithout ample fu n d s
b u s in e s s f ir m s w i l l curb l a b o r h i r e and re d u c e t h e i r o u tp u t.
. . . Any b u s i n e s s , no m a t t e r how l i m i t e d i t s f u n d s , can
always pay some men more by d i s m is s i n g o t h e r e m p l o y e e s . "3
•^Bowen, op. c i t . , p . 318. See a l s o A lb e rt G a llo r d
H a r t, Money, Debt and Economic A c t i v i t y (New York:
P r e n t i c e - r f a l l , l 9 4 d ) , p. 251.
2
Bowen, op. c i t . , p p . 3 2 0 -2 1 .
^ W e in tr a u b , A G e n e ra l Theory . . . , op. c i t . ,
p . 76. See a ls o R obert C. T u r n e r , ''R e la tio n s h ip o f P ric es to
167
To t h i s may be added a c o r o l l a r y , a l s o p ro p o se d by
W eintraub and o t h e r s : t h a t a s i g n i f i c a n t o r c o n ti n u i n g
r i s e in t h e p r i c e l e v e l i s n o t v e ry l i k e l y w ith o u t a s i m i
l a r a s s o c i a t e d r i s e i n wage c o s t s . 1 In o t h e r w ords, a
p e r m is s iv e m o n e t a r y - f i s c a l p o l i c y which " r a t i f i e s " t h e r i s e
i n wages i n t u r n e n a b l e s r i s i n g wages t o become th e p e r
m is s iv e (an d " c a u s a l " ) a g e n t o f th e w a g e -p ric e s p i r a l .
U nions and w a g e - p u l l . — Second, d i s c u s s i o n of wage-
p u l l a ls o r e a l i s t i c a l l y acknow ledges a s i g n i f i c a n t t r a d e -
u n io n i n s t i t u t i o n : (a) th e u n i o n ’ s t r a d i t i o n a l argum ent
f o r w a g e - in c r e a s e s a s a means o f en h an c in g t h e p u r c h a s in g
power o f w a g e - e a r n e r s , and (b) th e l i k e l i h o o d t h a t t h i s
argum ent w i l l be in v o k ed i n b oth d e p r e s s io n and p r o s p e r i t y
w ith a lm o st e q u a l " j u s t i f i c a t i o n . "
T h i r d , a lth o u g h p r o d u c t i v i t y may c o n c e iv a b ly be
a b le t o i n c r e a s e a s f a s t as w a g e - i n c r e a s e s , and w age-push
im p a c ts on c o s t s and p r i c e s may t h u s be n e u t r a l i z e d , th e
i n f l a t i o n a r y p r e s s u r e o f t h e w a g e -in c re a s e may s t i l l a s s e r t
i t s e l f by a f f e c t i n g demand and p r i c e s th r o u g h th e o p e r a t i o n
o f w a g e - p u ll.^
Economic S t a b i l i t y and Growth: A S ta te m e n t o f th e P ro b le m ,"
i n Compendium, The R e l a t i o n s h i p o f P r i c e s . . . , o p . c i t . ,
p p . 677 -78.
I W e in tr a u b , C l a s s i c a l K eyn esianism . . . , op. c i t . .
p . 47. See a l s o C h a rle s L. S c h u l t z e , P r i c e s , C osts and
Output f o r th e P o s t War Decade: 1947-1957 (iflew York:
Committee f o r Economic D evelopm ent, 1959)* P- 22.
p
Holzman, op. c i t . , p. 34.
168
D i r e c t Im p a c ts o f W age-Pull
As i n d i c a t e d a b o v e , w a g e -p u ll w i l l te n d t o a f f e c t
th e l e v e l and d i s t r i b u t i o n o f a g g re g a te demand v i a two
r o u t e s : (a) d i r e c t l y and im m e d ia te ly , th ro u g h t h e m a r g in a l
p r o p e n s i t y t o consume o f t h e w a g e -e a r n e r s who r e c e i v e th e
h i g h e r wages (com pared w ith t h e m a r g in a l p r o p e n s i t y of
f a c t o r y - o w n e r s whose p r o f i t - i n c o m e s may be d im in is h e d by
th e w a g e - i n c r e a s ) , and (b) i n d i r e c t l y , by in d u c in g lag g e d
o r lo n g - r u n changes' i n in v e s tm e n t, e x p o r t s , and governm ent
sp e n d in g .
I n c o m e - e l a s t i c l t y of demand. — The e x t e n t o f d i r e c t
w a g e -p u ll depends c o n s i d e r a b ly on th e i n c o m e - e l a s t i c i t y o f
demand o f th e w a g e -e a rn e rs r e c e i v i n g t h e h i g h e r wages. As
a lr e a d y i n d i c a t e d , t h e i n c r e m e n t a l i n c r e a s e i n t h e i r
sp e n d in g w i l l depend on t h e i r m a rg in a l p r o p e n s i t y t o con
sume compared w ith th e MPC o f p r o f i t - r e c e i v e r s . I f th e
w o rk ers r e c e i v i n g th e w a g e -in c r e a s e have a h i g h e r MPC th a n
do owners (who have fo re g o n e some o f t h e i r p r o f i t s ) , th en
t h e i r i n c r e a s e d sp e n d in g w i l l te n d to in d u ce a n e t i n c r e a s e
i n o u tp u t o f consum er goods and s e r v i c e s (even p o s s i b l y
i n c l u d i n g some " a c c e l e r a t o r ” e f f e c t s on in v e s tm e n t) and an
i n c r e a s e i n employment a s w e l l , th e l a t t e r p o s s i b l y o f f
s e t t i n g any r e d u c t i o n in employment t h a t may have o c c u rr e d
a s a consequence o f th e o r i g i n a l w age-push. However,
e m p i r i c a l d a t a on th e MPC o f d i f f e r e n t in c o m e - c la s s e s do
169
n ot p ro v e t h a t w orkers n e c e s s a r i l y have a h ig h e r MPC th a n
p r o f i t - r e c e i v e r s ; th u s a w a g e - p u ll w i l l n o t n e c e s s a r i l y
g e n e r a t e a n e t c o n t r i b u t i o n to a g g r e g a te sp ending and
o u t p u t.
F r i c e - e l a s t i c l t y of demand. — What about t h e p r i c e -
e l a s t i c i t y of demand o f th e s e w a g e - e a rn e rs ? How w i l l th e y
r e a c t t o th e r i s e in p r i c e s r e s u l t i n g from th e w age-push?
W ill t h e y m a i n t a i n t h e i r r e a l sp e n d in g i n th e f a c e of
h ig h e r p r i c e s (an d th e r e b y s u p p o rt th e i n f l a t i o n ; o r w i l l
th e y be d e t e r r e d from sp e n d in g and t h e r e b y dampen th e
i n f l a t i o n a r y p r e s s u r e s ? A c t u a l l y , we a re c o n ce rn e d h e re
n o t m ere ly w ith a r e l a t i v e r i s e i n the p r i c e of a s i n g l e
p r o d u c t (com pared w ith t h e p r i c e o f o t h e r p r o d u c ts ) and th e
p r i c e - e l a s t i c i t y o f demand f o r t h i s s p e c i f i c p r o d u c t;
r a t h e r we a re d e a l in g e s s e n t i a l l y w ith t h e co n su m ers'
r e a c t i o n - p a t t e r n o f a l l consum ers to th e g e n e r a l r i s e in
p r i c e s f o llo w in g th e ro u n d of w a g e - i n c r e a s e s .
The s i g n i f i c a n c e o f t h i s r e a c t i o n f o r th e
p r o p a g a tio n o f t h e i n f l a t i o n p r o c e s s i s o f th e f i r s t - o r d e r :
th e p r e - e x i s t i n g volume o f r e a l o u tp u t can n o t be s o ld a t
h i g h e r p r i c e s u n l e s s t o t a l d o l l a r sp en d in g i n c r e a s e s p ro
p o r t i o n a t e l y w i t h u n i t c o s t s and p r i c e s . I f m o n etary
sp e n d in g r i s e s l e s s t h a n - t h e r i s e in th e v a lu e o f o u t p u t ,
^■Bowen, op. c i t . , p. 333; P aul A. S am uelson,
Econom ics: An I n t r o d u c t o r y A n a ly s is (4 th e d . ; New York:
M cGraw-Hill Book Company, 1 9 5 8 ) » P* 216.
170
and t h e r e b y f a l l s to " v a l i d a t e " o r su p p o rt th e h ig h e r p r i c e
l e v e l , th en a d e c l in e must o c c u r in e i t h e r t h e volume of
r e a l s a l e s (an d o u t p u t ) , or t h e p r i c e s c h a r g e d , o r a com
b i n a t i o n of b o t h . 3-
In o t h e r w o rd s, th e demand g e n e r a te d by w a g e -p u ll
may o r may n o t su p p o rt an o n -g o in g w a g e -p ric e s p i r a l ; t h i s
would depend on w h eth er th e w a g e -in c re a s e was f u l l y s p e n t ,
and on th e p r i c e - e l a s t i c i t y of demand o f th e l e s s -
s u c c e s s f u l w a g e -e a r n e r s whose incom es may be la g g in g
b e h in d th e r i s i n g p r i c e l e v e l . O th e rw is e , " in a d e q u a te "
r e s p e n d in g o f th e i n c r e a s e d (an d o th e r ) wages w i l l l e a d to
(a) a d e c l i n e in o u tp u t and em ploym ent, and (b) d im in ish e d
upward p r e s s u r e on wages and p r i c e s . I n sum, only I f i t
can be assumed t h a t t h e h ig h e r Incomes a re a u t o m a t i c a l l y
t r a n s l a t e d i n t o in c r e a s e d e x p e n d i tu r e s s u f f i c i e n t t o buy up
th e c u r r e n t r e a l o u tp u t a t th e h ig h e r p r i c e s w i l l th e
n e c e s s a r y p r e s s u r e s f o r a c o n ti n u i n g w a g e -p ric e s p i r a l be
f o r t h c o m i n g .2
"M onetary e f f e c t s " . — I n t h i s c o n n e c tio n , i t has
been p o in te d o u t t h a t a r i s i n g p r i c e l e v e l m ight ind uce
"m onetary e f f e c t s " ( i . e . , h i g h e r i n t e r e s t r a t e s ) t h a t
iBowen, op. c i t . . p. 318.
^T his i s th e a ssu m p tio n b a s i c t o F i s h e r ' s w orld of
exchange t r a n s a c t i o n s ; see C h a p te r i i above.
171
would t e n d t o r e t a r d th e l e v e l of a g g r e g a te dem and.1
Because r i s i n g p r i c e s a ls o mean r i s i n g m oney-lncom es, i t i s
a rg u e d , and th e demand f o r money i s a f u n c t i o n o f money
incom e, i n f l a t i o n w i l l t h e r e f o r e in d u c e a r i s e in demand
f o r money. I f th e m o n e t a r y - f i s c a l a u t h o r i t i e s do not a c t
to i n c r e a s e t h e money su p p ly , th e n c r e d i t w i l l be l e s s
a v a i l a b l e and i n t e r e s t r a t e s w i l l r i s e , te n d in g t o dampen
th e p r e s s u r e s o f m onetary demand.
O ther D e t e r r e n t s t o W age-P rice S p i r a l
E co n o m ists have a ls o n o te d s e v e r a l o t h e r f a c t o r s
t h a t may s e r v e t o d e t e r or dampen a f u l l - b l o w n , c o n tin u in g
w a g e -p ric e s p i r a l , even th o u g h the m o n e t a r y - f i s c a l a u t h o r
i t i e s may e x e r c i s e an "easy-m oney" p o l i c y t h a t p e rm its an
e x p a n sio n o f m on etary demand.
"B u i l t - i n s t a b i l i z e r s " . —F o r one t h i n g , th e
" b u i l t - i n " o r " a u to m a tic " s t a b i l i z i n g powers o f th e income
ta x (w ith i t s p r o g r e s s i v e r a t e s t r u c t u r e ) w i l l b e g in t o
ta k e e f f e c t a s m oney-incom es r i s e more r a p i d l y th a n r e a l
o u t p u t. H ig h e r e f f e c t i v e t a x r a t e s w i l l d i v e r t i n c r e a s i n g
p r o p o r t io n s o f r e a l income away from p r i v a t e d i s p o s a l
tow ard governm ent d i s p o s a l . However, t h i s d e f l a t i o n a r y
im p act would be n e g a te d i f governm ent sim ply t u r n e d a ro u n d
^ G e ra ld S i r k l n , I n t r o d u c t i o n t o Macro-Economic
Theory (Homewood, 1 1 1 .: R ic h a rd D. I r w i n , I n c . , 19 61),
P. 172.
172
and r e s p e n t th e m a r g i n a l In c re m e n ts o f r e v e n u e , o r re d u c e d
t a x e s in o t h e r a r e a s . 1
Second, a s w i l l be e x p la in e d below, i n c r e a s e d wages
may e x e r t n e g a t iv e e f f e c t s on th e demand f o r l a b o r , i n v e s t
m ent, and e x p o r t s , by t e n d in g t o d e p re s s t h e volume o f
sp e n d in g fo rth c o m in g f o r such p u r p o s e s .
The "money i l l u s i o n ” . — T h i r d , t h e r e i s t h e l i k e l i
hood t h a t ex a n te (p la n n e d o r in te n d e d ) in v e s tm e n t w i l l n o t
r i s e s u f f i c i e n t l y t o o f f s e t ex. a n te sa v in g f o r an a d d it i o n a l
r e a s o n : p e o p le may save more (consume l e s s ) i n r e a l te rm s
due t o th e o p e r a t i o n o f th e "money i l l u s i o n . " 2 The term
"money i l l u s i o n " was o r i g i n a t e d by I r v i n g F i s h e r t o
d e s c r i b e p e o p l e 's f a i l u r e t o p e r c e i v e t h a t t h e d o l l a r ( o r
o th e r m on etary u n i t ) co uld s u f f e r changes i n p u r c h a s in g
power in term s of co m m o dities; in t h i s s t a t e p e o p le sim ply
ta k e i t f o r g r a n t e d t h a t th e d o l l a r h as a s t a b l e p u r c h a s in g
power.
A nother way of p u t t i n g t h i s i s t h a t p e o p le presum
a b ly have a te n d e n c y t o a c t on th e b a s i s of c h an g e s in
1Bowen, o p . c i t . , p . 32b; S i r k i n , op. c l t . , p . 173.
2F o r t h i s d i s c u s s i o n see Bowen, op. c i t . , p . 330;
A lfre d W. S t o n i e r and D ouglas C. Hague, A T ex tboo k of
Economic Theory (2d e d . ; London: Longmans, G reen and C o .,
L t d . , 1957)» P» 359; A. C. L. Day and S t e r i e T. B eza, Money
and Income (New York: Oxford U n i v e r s i t y P r e s s , I 9 6 0 ) ,
p. 322.
173
m onetary v a r i a b l e s ( e . g . , money income) r a t h e r th a n r e a l
v a r i a b l e s ( e . g . , r e a l income) so t h a t , f o r exam ple, th e y
w i l l te n d t o f e e l t h a t I n c r e a s e s in money-income ( e . g . ,
wages) a lw ay s s i g n i f y a p a r a l l e l i n c r e a s e in r e a l incom e,
even th o ugh consumer p r i c e s may have r i s e n a t th e same
t i m e .
C o n s e q u e n tly , p e o p le te n d t o h a r b o r th e i l l u s i o n
t h a t th e p u r c h a s in g power o f th e d o l l a r i s c o n s t a n t so lo n g
as p r i c e changes rem a in r e l a t i v e l y s m a ll . Hence, i n th e
c o n te x t of p r i c e i n f l a t i o n , a s p e o p le * s money (wage) i n
comes i n c r e a s e (w h ile p r i c e s r i s e o n ly s l i g h t l y ) , th e y w i l l
presum ably " f e e l r i c h e r , " w i l l save more i n r e a l te r m s , and
re d u c e t h e i r r e a l sp e n d in g on con sum p tion . A ll o f t h i s
n e c e s s a r i l y assum es a d e c l i n i n g a v e ra g e p r o p e n s i t y t o con
sume as m oney-incom es r i s e . I t a ls o assum es t h a t p r i c e
i n c r e a s e s a r e not b i g a n d /o r n o t i c e a b l e : i f p r i c e r i s e s
became n o t i c e a b l y and s u f f i c i e n t l y l a r g e t o d e s t r o y th e
" i l l u s i o n , " p e o p le would te n d t o r e a c t i n d e f e n s iv e ways to
r e s t o r e t h e r e a l v a lu e of t h e i r income and w e a lth .
"R e a l - b a l a n c e e f f e c t s " . — In a d d i t i o n t o th e money
i l l u s i o n , a n o th e r mechanism invo ked t o e x p l a i n how a r i s i n g
p r i c e l e v e l m ight s h i f t downward t h e s c h e d u le o f r e a l
sp e n d in g on consum ption i s t h e " Pigou e f f e c t " o r " r e a l -
b a la n c e e f f e c t . " A cco rd in g to t h i s c o n c e p t, a r i s e i n
p r i c e s would in d u ce p e o p le t o spend l e s s on r e a l
174
consum ption by f i r s t d e p r e s s in g t h e i r r e a l n e t w o rth (or
th e r e a l v a lu e o f t h e i r c a s h - b a l a n c e s ) w hich , in t u r n ,
would in d u ce p e o p le (who now " f e e l p o o r e r " as a r e s u l t o f
r i s i n g p r i c e s ) t o re d u c e t h e i r r e a l consum ption a n d , con
s e q u e n t l y , th e l e v e l o f a g g re g a te dem and.1
R e d i s t r i b u t i o n e f f e c t s . — A ggregate sp e n d in g on con
sum ption may a l s o be d e p r e s s e d i n a n o th e r way, even i f
t h e r e a re no a c t i v e money i l l u s i o n o r P igou e f f e c t s in d u c
in g p e o p le t o s h i f t t h e i r consum ption f u n c t i o n t o low er
l e v e l s : i f r i s i n g p r i c e s a re accom panied by a r e d i s t r i
b u tio n o f r e a l income away from p e o p le w ith r e l a t i v e l y h ig h
m a rg in a l p r o p e n s i t i e s t o consume t o th o s e w ith low er p ro
p e n s i t i e s . F o r exam p le, i f w o r k e r s 1 wages la g b e h in d
p r o f i t s , and fix e d -in c o m e g ro u p s r e c e i v e no upward a d j u s t
m e n ts, th en t h e r e d u c t i o n o f t h e i r consum ption may n o t be
f u l l y com pensated f o r by th e i n c r e a s e d consum ption o f i n f l a
t i o n ' s b e n e f i c i a r i e s . E m p ir ic a l s t u d i e s , how ever, su g g e st
t h a t th e e x t e n t o f such r e d i s t r i b u t i o n may be r a t h e r s m a ll,
and n o t n e c e s s a r i l y i n f a v o r o f h ig h -in c o m e (p resu m ab ly
low-MPC) g r o u p s . 2
^ o w e n , op. c i t . , pp. 3 31-3 2 ; S i r k i n , op. c i t . ,
pp. 6 6 -6 7 , 173.
2Bowen, op. c i t . , pp. 332-33* S i r k i n , op. c i t . ,
p . 173. See a l s o U .S ., C o n g re ss, J o i n t Economic Com m ittee,
S t a f f R eport on Employment, G row th, and P r i c e L e v e l s , 66th
C o n g ., 1 s t S e s s . , 1959* PP* i i O - I 2 .
175
For one t h i n g , w h ile i t i s o b v io u s t h a t f i x e d -
lncome gro u p s i n c a p a b le o f k e e p in g up w ith th e i n f l a t i o n
w i l l s u f f e r re d u c e d r e a l in co m es, t h e r e i s n o t s u f f i c i e n t
e v id e n c e on how th e s e g ro u p s have a c t u a l l y f a r e d , on
b a l a n c e , in r e c e n t y e a r s , p a r t l y becau se some o f them a re
d e b to r s as w e l l as c r e d i t o r s , p a r t l y b e cau se some o f them
have r e c e i v e d upward a d ju s tm e n ts in s o c i a l s e c u r i t y b en e
f i t s . Second, a v a i l a b l e e v id e n c e does n o t show t h a t r e c e n t
i n f l a t i o n h as i n c r e a s e d th e sh a re o f n a t i o n a l income g o in g
t o low-incom e g ro ups w hich a re presum ed t o p o s s e s s h ig h e r
m a r g in a l p r o p e n s i t i e s t o consume. F i n a l l y , a s i n d i c a t e d
a b o v e , t h e r e i s some e v id e n c e t h a t t h e MPC i s n o t s i g n i f i
c a n t l y d i f f e r e n t f o r v a r i o u s income c l a s s e s .
"S t r u c t u r a l d i s e q u i l i b r i a " . — A part from t h e above
f a c t o r s , w hich a re more o r l e s s c a p a b le o f dampening or
r e t a r d i n g t h e I n f l a t i o n a r y p r e s s u r e s g e n e r a t e d by a wage-
p u l l , th e r e i s a n o th e r b a s i c a s p e c t whose e f f e c t on a g g re
g a te demand i s much l e s s c e r t a i n : t h i s i s th e norm al
te n d e n c y to w a rd " in te r-c o m m o d ity s u b s t i t u t i o n " which i n
v o lv e s a change in th e c o m p o s itio n o f consumer e x p e n d i tu r e s
( f o llo w in g t h e w a g e - in c r e a s e s ) n o t m atched by an i d e n t i c a l
change in t h e c o m p o s itio n o f su p p ly ; th e r e s u l t i s a s h i f t
of demand from some consum er goods and s e r v i c e s ( c r e a t i n g
e x c e s s s u p p l i e s ) to w a rd s o t h e r goods and s e r v i c e s ( c r e a t i n g
e x c e s s dem ands). Such s i t u a t i o n s of " s t r u c t u r a l u n b a la n c e "
176
o r " d i s e q u i l i b r i a " a r e r a t h e r u s u a l , b u t i t i s n ot a lw ay s
c l e a r w h e th er th e d e f l a t i o n a r y p r e s s u r e s a f f e c t i n g some
s e c t o r s (due t o e x c e s s s u p p l i e s ) w i l l be more or l e s s o f f
s e t by th e i n f l a t i o n a r y p r e s s u r e s in t h e s e c t o r s e n jo y in g
e x c e s s demands.'*'
I f p r i c e s were p e r f e c t l y f l e x i b l e , i t could be
re a s o n e d t h a t t h e g e n e r a l p r i c e l e v e l w ould, on b a la n c e ,
rem a in u nchanged. On th e o t h e r han d , i f f irm s fa c e d w ith
e x c e s s s u p p l i e s d e c id e d to la y o f f w o rk ers r a t h e r t h a n
re d u c e p r i c e s , th e r e s u l t i n g unemployment would g e n e r a t e
d e f l a t i o n a r y p r e s s u r e s ; and i f th e f ir m s fa c e d w ith e x c e s s
demand d e c id e d n o t to r a i s e p r i c e s (w hich would "a b s o rb "
th e e x c e s s demand) b u t i n s t e a d had t h e i r c u sto m e rs w a it
u n t i l p r o d u c tio n caught u p , t h e u n in te n d e d sa v in g by d i s
a p p o in te d consum ers would p r o v id e a d d i t i o n a l d e f l a t i o n a r y
p r e s s u r e . I n c o n t r a s t , i t may a l s o be a rg u e d t h a t i n f l a
t i o n a r y ( r a t h e r th a n d e f l a t i o n a r y ) p r e s s u r e s could p r e
d o m in a te: downward p r i c e r i g i d i t y in t h e s e c t o r s f a c i n g
s l a c k demand may be accom panied by r i s i n g wages, c o s t s , and
p r i c e s in th e s e c t o r s e n jo y in g e x c e s s demand and b r i g h t
p r o f i t p r o s p e c t s , as i n S c h u l t z e 's " d e m a n d - s h if t" m odel of
i n f l a t i o n , i n C hap ter i i i .
-*-Bowen, op. c i t . , pp. 33^-35; Day and Beza, op. c it.
PP. 329-30.
177
The r o l e of e x p e c t a t i o n s . — F i n a l l y , i t sh o u ld be
n o te d t h a t any r e t a r d i n g e f f e c t s e x e r c i s e d by th e money
i l l u s i o n and o t h e r d e t e r r e n t s l i s t e d above may be o f f s e t by
p r o - i n f l a t i o n a r y e x p e c t a t i o n s i f enough p u r c h a s e r s become
con v in ced t h a t p r i c e s w i l l c o n tin u e t o r i s e and th e re u p o n
abandon t h e i r money i l l u s i o n . They w i l l t h e r e f o r e te n d t o
seek "h ed g e s" a g a i n s t a p r o s p e c t i v e l y m ounting i n f l a t i o n
t h a t t h r e a t e n s t h e i r r e a l income and w e a lth ; such d e f e n s i v e
a c t i o n s may m ere ly s e r v e t o a c c e l e r a t e t h e i n f l a t i o n s p i r a l
from a " c re e p " t o a " g a l l o p " o r even " h y p e r - i n f l a t i o n . "
F o r exam p le, l a b o r u n io n s may sp e a rh e a d d e f e n s iv e
a c t i o n s to p r e s e r v e th e r e a l incom es of t h e i r members.
Aware o f how w a g e - in c r e a s e s le a d t o f u r t h e r p r l c e - r i s e s ,
u n io n s may demand s t i l l l a r g e r p a y - i n c r e a s e s t o com pensate
f o r a n t i c i p a t e d p r i c e r i s e s . E m p lo y ers, f o r t h e i r p a r t ,
may a l s o r e a c t w ith o v e rc o m p e n sa tin g p r i c e i n c r e a s e s in
o r d e r t o m a i n ta in f u t u r e p r o f i t m a r g in s , i n th e f a c e o f an
a n t i c i p a t e d ro u n d o f wage demands. They th e r e b y f u r t h e r
a c c e l e r a t e t h e w a g e -p ric e s p i r a l .
I f p e o p le a ls o d e c id e t o p r o t e c t t h e i r r e a l w e a l t h ,
th e y w i l l t e n d t o s h i f t from such forms o f w e a lth a s bonds
and money— whose y i e l d o r v a lu e i s f i x e d i n money te r m s —
i n t o such r e a l form s as p a i n t i n g s , j e w e l r y , e q u i t y
s e c u r i t i e s , and r e a l e s t a t e whose p r i c e s a r e n o t f i x e d . In
extrem e c a s e s , such f l i g h t s from money sp a rk e d t h e
17»
h y p e r - i n f l a t i o n s o f Germany a f t e r World War I , and C hina,
G re e c e , and Hungary a f t e r World War I I . In more norm al
p e r i o d s , h ow ever, such extrem e outcom es a re n o t v e ry
l i k e l y : r a p i d i n f l a t i o n s seem t o have been im p e lle d more
by s p e c i a l " e x t e r n a l ” e v e n ts o r u p h e a v a ls — su ch a s r e v o l u
t i o n s and w a rs— th a n by " i n t e r n a l " s e l f - g e n e r a t i n g f o r c e s
c h a r a c t e r i s t i c of "norm al" p e a c e tim e p e r i o d s . N e v e r th e le s s ,
even i f extrem e h y p e r - i n f l a t i o n i s a v o id e d , u n w i l l i n g n e s s
t o save i n th e form of m onetary c la im s would s t i l l c o n s t i
t u t e an a d d i t i o n a l p r e s s u r e on demand and r i s i n g p r i c e s .
P ra n ce a f t e r World War I I h as been c i t e d as a t y p i c a l
e x a m p le .^
I n f l a t i o n f o s t e r s s p e c u l a t i o n . — F i n a l l y , I n f l a t i o n
may in d u ce p e o p le t o move beyond mere d e f e n s iv e hedging
a c t i o n s I n t o a g g r e s s iv e s p e c u l a t i v e v e n t u r e s . By making i t
more a t t r a c t i v e f o r p e o p le t o i n v e s t s p e c u l a t i v e l y i n r e a l
a s s e t s (su ch a s i n v e n t o r i e s o r r e a l e s t a t e ) t h a t can be
tu r n e d o v e r r a p i d l y and y i e l d s u b s t a n t i a l c a p i t a l g a in s
(w ith o u t n e c e s s a r i l y l e a d in g t o e x p a n sio n o f p r o d u c t i v e
c a p a c i t y ) , i n f l a t i o n can become a more o b v io u s means of
en h an c in g o n e 's r e a l income and w e a lth . To t h e e x t e n t t h a t
in v e s tm e n t fu n d s a re c h a n n e lle d i n t o s p e c u l a t i o n r a t h e r
th a n expanded p r o d u c t i v e c a p a c i t y , a g g re g a te m on etary
^Bowen, op. c i t . , p. 336; Day and B e za , op. c i t . .
pp. 323-24 ; S i r k i n , op. c i t . . p . 174.
179
demand w i l l te n d t o exceed a g g re g a te s u p p ly , so t h a t sp e c u
l a t i o n w i l l c o n s t i t u t e an a d d i t i o n a l a c t i v e demand p r e s s u r e
f o r f u r t h e r i n f l a t i o n . In n o rm al p e ac etim e p e r i o d s , how
e v e r , t h i s p a t t e r n of i n f l a t i o n - s p e c u l a t i o n s p i r a l may be
more p r e v a l e n t i n u n d e rd e v e lo p e d eco n o m ies, e s p e c i a l l y
L a tin A m erica, th a n i n advanced c o u n t r i e s . 1
I n d i r e c t Im p acts o f W age-Pull
As I n d i c a t e d above, w a g e -p u ll may a l s o e x e r t
i n d i r e c t o r d e la y e d e f f e c t s which i n f l u e n c e th e l e v e l of
a g g re g a te demand and e x p e n d i t u r e s , v i a i t s e f f e c t s on
i n v e s tm e n t, e x p o r t s , and governm ent s p e n d i n g .2
E f f e c t on i n v e s tm e n t . — F o r one t h i n g , the n e t
e f f e c t o f w a g e -p u ll on a g g re g a te sp e n d in g w i l l a ls o depend
on th e amount o f p r o f i t s a b s o rb e d by th e w a g e - i n c r e a s e . As
a f i r s t a p p ro x im a tio n , i t may be g e n e r a l i z e d t h a t th e
g r e a t e r th e amount o f p r o f i t s a b s o r b e d , th e g r e a t e r t h e
r e d u c t i o n i n " i n t e r n a l " fu n d s a v a i l a b l e f o r in v e s tm e n t.
A c t u a l l y , assum ing no o f f s e t t i n g changes in th e f i r m ' s r a t e
o f p r o d u c t i v i t y , t h e s i z e o f t h e im pact on p r o f i t s w i l l
depend s u b s t a n t i a l l y on th e g e n e r a l l e v e l o f o u t p u t ,
^ F e d e r a l R eserve Bank o f New Y ork, " I n f l a t i o n and
Economic D ev elopm ent," M onthly Review, XLI (A u gust, 1959)*
pp. 123-24.
^ U n less o th e r w is e i n d i c a t e d , th e f o llo w in g d i s
c u s s io n i s b ased l a r g e l y on Holzman, o p . c i t . , pp. 2 3 -2 9 .
ldO
em ploym ent, and demand. At high a n d /o r r i s i n g l e v e l s of
a g g r e g a te o u tp u t and em ploym ent, f ir m s may be a b le t o pass
on most i f n o t a l l o f th e w a g e -in c re a s e in th e form o f
h ig h e r p r i c e s , and p r o f i t m arg in s can be m a i n ta in e d ; con
v e r s e l y , p r o f i t m arg in s w i l l d im in is h a t lo w e r l e v e l s of
economic a c t i v i t y , when w a g e - in c r e a s e s a re more d i f f i c u l t
to p a s s a lo n g in h i g h e r p r i c e s .
The amount o f p r o f i t - a b s o r p t i o n , i n th e s h o r t - r u n ,
w i l l a l s o depend on th e p r i c i n g p r a c t i c e s o f f i r m s . While
t h i s im p o r ta n t s u b j e c t w i l l be more f u l l y exam ined i n th e
nex t c h a p t e r (on p r i c i n g ) , i t may be n o te d h e re t h a t p r i c
in g p ro c e d u r e s in th e s h o r t - r u n may be somewhat i n f l e x i b l e
(not p r o f i t- m a x i m iz i n g ) b ecause s e l l e r s do n o t p r e f e r to
r e a c t im m e d ia te ly t o e v e ry change in m arket demand.
In d e e d , a c c o rd in g t o G a l b r a i t h , o l i g o p o l i s t i c f ir m s o p e r
a t i n g a t h ig h l e v e l s o f c a p a c i ty w i l l te n d t o a cc u m u late
" u n l i q u i d a t e d monopoly g a i n s " i n th e s h o r t - r u n b e c a u se th e y
p r e f e r n o t t o r a i s e p r i c e s u n t i l a f t e r t h e y have had t o
r a i s e w ages, even though t h e y c o u ld have r a i s e d p r i c e s
p r o f i t a b l y (b e c a u se of h i g h l e v e l s o f demand) b e fo re th e
w a g e - in c r e a s e . The e x p l a n a t i o n i s t h a t a p r i c e i n c r e a s e
coming p r i o r t o th e w a g e -in c re a s e would m e re ly have
^-John K enneth G a l b r a i t h , "M arket S t r u c t u r e and
S t a b i l i z a t i o n P o l i c y , " The Review o f Econom ics and S t a t
i s t i c s , XXXIX (May, 1 9 5 7 ), PP. 127-29.
181
e n co u rag e d th e l a t t e r , w h ereas f i r m s would p r e f e r ( f o r
p u b l i c r e l a t i o n s r e a s o n s ) t o be a b le t o p o i n t t o h i g h e r
c o s t s ( i . e . , wages) as th e ex cu se f o r th e p r i c e ad v an c e.
I n any e v e n t , t o th e e x t e n t t h a t h i g h e r wages
r e s u l t i n low er p r o f i t s , th e y w i l l te n d to re d u c e t h e l e v e l
of in v e s tm e n t , a t l e a s t In t h e s h o r t - r u n , o t h e r t h i n g s
re m a in in g t h e same. Over th e l o n g e r - r u n , th e e f f e c t on
in v e s tm e n t may be th e v e ry o p p o s i t e : by t h e n , a s u c c e s s io n
of w a g e - r a te i n c r e a s e s may have s t i m u l a t e d th e f ir m t o
i n v e s t i n more l a b o r - s a v i n g m achin es and eq u ip m en t.
E f f e c t on e x p o r t s . — W a g e -in c re a se s may a l s o dampen
th e l e v e l of a g g re g a te d o m e s tic employment and demand by
r a i s i n g th e p r i c e s o f e x p o rt good s. B ecause wages com prise
an Im p o rta n t p a r t o f th e s e l l i n g p r i c e o f s e l e c t e d e x p o rt
p r o d u c t s , an i n c r e a s e in w a g e - r a te s In t h e s e i n d u s t r i e s
t h a t i s n o t accom panied by com parable i n c r e a s e s In wages
a b ro a d , o r i s n o t o f f s e t by i n c r e a s e d p r o d u c t i v i t y or
re d u c e d exchange r a t e s a t home, w i l l te n d t o r a i s e e x p o rt
p r i c e s and re d u c e t h e l e v e l . o f e x p o r t s . At th e same t im e ,
th e r i s e i n d o m e stic p r i c e s r e l a t i v e t o f o r e i g n p r i c e s w i l l
te n d t o d i v e r t sp e n d in g from d o m e stic p r o d u c ts t o i m p o r t s .^
Im pact on employment . — F i n a l l y . i t s h o u ld be n o te d
t h a t th e n e t c o n t r i b u t i o n o f w a g e - p u ll t o a g g re g a te demand
depends g r e a t l y on th e amount of unemployment d i r e c t l y
!0n t h i s p o in t see a l s o S ir k in , op. c i t . . p. 173.
182
caused by th e w age-push. I t i s r e a s o n a b le t o e x p e c t t h a t
em ployers* demand f o r l a b o r may be n e g a t i v e l y a f f e c t e d by
th e w a g e - ra te i n c r e a s e in two ways: by in d u c in g em p lo y ers
t o (a) l a y o f f some w orkers in o r d e r t o m eet t h e new wage
b i l l ( c r e a t i n g " o v e r t unem plo ym ent"), and (b) re d u c e th e
l e v e l o f p r o d u c tio n and th e number of w orking h o u rs
( c r e a t i n g "u n d erem p lo y m en t").
The im m ediate im pact on employment and a g g re g a te
demand w i l l depend m ainly on em ployers* e s t i m a t e s a s t o how
much th e y w i l l be a b le t o s e l l a t h i g h e r p r i c e s . T h is in
t u r n w i l l depend on (a) th e s t a t e o f m arket demand f o r th e
g iv e n p r o d u c t , and (b) th e amount of p r o f i t s t h a t can be
ab so rb ed by th e w a g e - i n c r e a s e , i f n e c e s s a r y .
F or exam ple, d u r in g a b u s i n e s s u p sw in g , n o t o nly
may f ir m s be i n a b e t t e r p o s i t i o n to a b so rb t h e wage-
i n c r e a s e v i a p r o f i t s , but i t may be e a s i e r t o p a s s a lo n g
some o f th e w a g e - b i l l in h i g h e r p r ic e s .^ - On th e o t h e r
hand, in a p e r i o d o f re d u c e d o r d e c l i n i n g em ploym ent, th e
r e v e r s e i s l i k e l y t o be t r u e . In o t h e r w o rds, th e demand
curve f o r l a b o r may be v e ry I n e l a s t i c a t h ig h and r i s i n g
l e v e l s o f employment and p r o f i t s , but c o u ld be f a i r l y
e l a s t i c in p e r i o d s o f re d u c e d employment and p r o f i t s .
3-See a l s o G ardn er A c k ley , Macroeconomic Theory
(New York: M acm illan Company, 1 9 6 1 ), p . 394.
183
What a b o u t th e u l t i m a t e Im pact on employment? I t
i s p o s s i b l e t h a t even i f , i n th e f i r s t i n s t a n c e , fir m s la y
o f f some o f th e w orkers r e c e i v i n g w a g e - i n c r e a s e s , th e
l a t t e r may e i t h e r (a) be r e - a b s o r b e d by more e f f i c i e n t
c o m p e t i t o r s , o r (b) have t h e i r p u r c h a s in g power s u p p o rte d
by unemployment b e n e f i t s , by employment on p u b l i c w o rk s, or
by s i m i l a r g o v e rn m e n t-fin a n c e d p r o j e c t s .
E f f e c t on governm ent s p e n d in g . — In t h i s c o n n e c tio n ,
and f o r o t h e r r e a s o n s , w age-push may have s t i m u l a t i n g
e f f e c t s , i n c o n t r a s t t o th e dampening e f f e c t s n o te d abo ve.
I n th e f i r s t p l a c e , to th e e x t e n t t h a t governm ent t r i e s t o
m a in ta in i t s own l e v e l of r e a l e x p e n d i tu r e s i n t h e f a c e of
r i s i n g p r i c e s f o r th e goods and s e r v i c e s which I t p u r
c h a s e s , t h e d o l l a r volume of i t s sp e n d in g w i l l have t o r i s e
I n s te p w ith th e p r i c e l e v e l .
F u r th e r m o r e , to t h e e x te n t t h a t governm ent a c t s to
f u l f i l l i t s commitment t o m a in ta in h ig h l e v e l s o f em ploy
m ent, and t h e r e f o r e spends more money f o r th e re-em ploym ent
o f w o rk ers l a i d - o f f a f t e r th e w a g e - in c r e a s e , i t s m o n e ta ry -
f i s c a l a g e n c ie s w i l l be a c t i n g t o " v a l i d a t e " th e w age-push
i n f l a t i o n . I n d e e d , a c c o r d in g t o M ilto n F rie d m a n , g o v e rn
m e n t 's ex p an d in g a n t i - d e f l a t i o n program s may, i n th e lo n g -
r u n , p ro v e t o be a s t r o n g e r p r o - i n f l a t i o n f o r c e t h a n t h e
w age-push p r e s s u r e s e x e r t e d by s tr o n g l a b o r u n i o n s . 1
^See Friedman, op. c i t . , pp. 226-31 .
184
In F rie d m a n 's v iew , governm ent may be e x p e c te d o v e r
th e lo n g - r u n t o be u n d e r s t r o n g e r p r e s s u r e t o combat d e f l a
t i o n and unem ploym ent, by " p u b l ic " or " w e lf a r e " p r o j e c t s ,
th a n t o c o u n t e r a c t i n f l a t i o n . The r e s u l t of t h i s s e c u l a r
b i a s to w ard i n f l a t i o n — b ased on th e a n t i c i p a t e d r e c u r r e n c e
o f r e c e s s i o n s and th e "perm anence" of expanded governm ent
b u d g e ts — may be t h a t " i n f l a t i o n w i l l prod uce s tr o n g u n io n s"
( i . e . , s t r o n g b a r g a i n in g p o s i t i o n s f o r u n io n s ) more th an
" s t r o n g u n io n s w i l l p ro d u ce i n f l a t i o n , "
The r e a s o n Friedm an r e v e r s e s th e u s u a l r o l e s
a s s ig n e d to l a b o r u n io n s and governm ent i n th e dilemma
model i s h i s a ssu m p tio n t h a t u n io n s ( a t l e a s t up t o 1951)
may a c t u a l l y have e x e r c i s e d more o f a r e s t r a i n i n g o r
" r i g i d i t y " e f f e c t th an an " u p w a rd - p r e s s in g " e f f e c t on wage
demands. In th e l o n g - r u n , how ever, he warns t h a t a p e r
s i s t e n t i n f l a t i o n a r y en v iro n m en t may so th ro w th e b a la n c e
of econom ic and p o l i t i c a l power i n f a v o r of u n io n s a s t o
in d e e d c o n v e rt them i n t o a t r u e cause of I n f l a t i o n .
Summary and C o n c lu s io n s
T h is c h a p t e r , l i k e t h e p r e c e d in g one on demand, h as
b ro u g h t us some more s t e p s c l o s e r t o a r e a l i s t i c u n d e r
s t a n d in g o f th e i n f l a t i o n p r o c e s s , as w e ll a s a s u b s t a n t i a l
d i s t a n c e from t h e s t a r k l y m e c h a n ic a l w o rld o f "p u re
exchange" p o r t r a y e d by t h e e q u a tio n o f exchang e.
185
The p r e c e d in g a n a l y s i s o f wage Im p ac ts on c o s t s and
p r i c e s s t a r t e d r e a l i s t i c a l l y w ith a d e s c r i p t i o n o f "m icro "
wage- and p r i c e - d e t e r m i n a t i o n p r o c e s s e s i n i n d i v i d u a l firm s.
I t was th e n shown how t h e s e m icro-eco nom ic p r o c e s s e s , w ith
th e a i d of t r a n s m i s s i o n and s p i r a l m echanism s, e n a b le d
"key" wage b a r g a i n s and p r i c e d e c i s i o n s to d e v elo p i n t o
g e n e r a l wage and p r i c e movem ents.
T his d i s c u s s i o n , how ever, was a c t u a l l y c o n cern ed
w ith only one s i d e of th e "tw o -edg ed sword" of wage-
i n c r e a s e s : th e c o s t - p u s h s i d e , where th e v a r i o u s wage-
d e te rm in a n t s a c t e d as s t i m u l i t o wage demands and p r e s s u r e s
on c o s t s . Thus i t was shown t h a t wage a d ju s tm e n ts were
m a in ly dep en d en t on ( i . e . , s t i m u l a t e d by) t h e f o l lo w in g
f a c e t s o f th e econom ic and i n s t i t u t i o n a l e n v ir o n m e n t:
1. The l e v e l o f em ploym ent, which in t u r n a f f e c t e d
wage a d ju s tm e n ts th ro u g h i t s " a s s o c i a t e d e f f e c t s " ( r a t h e r
th a n th ro u g h l a b o r m arket p r e s s u r e s p e r se ) on o t h e r
a s p e c t s o f th e economy, p a r t i c u l a r l y th e p r o f i t p o s i t i o n
of f i r m s .
2. P r o s p e c t i v e p r o f i t a b i l i t y o f f ir m s (one o f th e
c h i e f w a g e - d e te r m in a n t s ) , which depended m ain ly on a g g re
g a te demand.
3. U n i o n i z a ti o n and o t h e r i n s t i t u t i o n a l f a c t o r s .
Jj. I n f l a t i o n i t s e l f ( i . e . , c o s t - o f - l i v i n g i n d e x ) .
5. P r o d u c t i v i t y , which u s u a l l y a f f e c t e d wages
i n d i r e c t l y by i n f l u e n c i n g th e o t h e r w a g e - d e te r m in a n ts ,
e s p e c i a l l y th e p r o s p e c t i v e p r o f i t p o s i t i o n s of f i r m s . Thus,
w h ile p r o d u c t i v i t y may h e lp red u c e c o s t s , t h i s r e d u c t i o n
te n d e d to be o f f s e t by th e s t i l l l a r g e r wage a d ju s tm e n ts
t h a t p r o d u c t i v i t y te n d e d t o c a l l f o r t h .
6. The d i s t r i b u t i o n o f th e above f a c t o r s , e s p e
c i a l l y unemployment and p r o f i t a b i l i t y , among th e v a r i o u s
i n d u s t r i e s and s e c t o r s o f th e economy a s a w hole.
I t was a l s o se e n t h a t s i g n i f i c a n t w a g e - in c r e a s e s
te n d e d t o oome m ain ly when th e w a g e -d e te rm in a n ts o p e ra te d
i n c o m b in a tio n s , as " p o t e n t " g ro u p s . F o r exam ple, l a r g e
p r o d u c t i v i t y g a in s b£ th e m s e lv e s may n o t e x e r t a s i g n i f i c a n t
im pact on w ag es, b u t when combined w ith an a g g r e s s iv e unio n
and a h i g h ly d i f f e r e n t i a t e d p ro d u c t (among o t h e r t h i n g s ) ,
th e y may r e s u l t i n s i z e a b l e w a g e - i n c r e a s e s .
F o llo w in g th e d i s c u s s i o n o f th e c o s t - s i d e o f wage-
i n c r e a s e s , i t was n e c e s s a r y t o show how th e w a g e - p u ll s id e
o f wage a d ju s tm e n ts m ight s e rv e t o " p r o p a g a te " th e wage-
push on p r i c e s I n t o a f u l l - b l o w n w a g e -p ric e s p i r a l , depend
in g above a l l on (a ) th e e x t e n t t o which m o n e t a r y - f i s c a l
a u t h o r i t i e s p e r m i tt e d o r s u p p o r te d r i s i n g c o s t and p r i c e
l e v e l s , and (b) t h e e x t e n t t o which th e r e s u l t i n g w a g e -p u ll
p r e s s u r e s on demand were dampened by th e " a u to m a tic s t a b
i l i z e r s , " " r e a l - b a l a n c e e f f e c t s , " and o t h e r p o s s i b l e
d e t e r r e n t s t o sp e n d in g .
187
I n t h i s c o n n e c tio n i t may be em phasized t h a t th e
m o n e t a r y - f i s c a l a u t h o r i t i e s p la y a c e n t r a l l y im p o rta n t r o l e
as d e te r m in a n ts o f t h e w a g e -p ric e s p i r a l : on th e one hand,
a t i g h t money p o l i c y and r i s i n g r a t e s o f i n t e r e s t c o u ld
s u f f i c i e n t l y dampen sp e n d in g p la n s o f th e p u b l i c and r e t a r d
th e w a g e -p ric e s p i r a l ; i n th e o p p o s ite d i r e c t i o n , an e a s y -
money p o l i c y and fu11-em ploym ent program s would u n d o u b ted ly
se rv e t o " v a l i d a t e " th e i n f l a t i o n .
F i n a l l y , and most i m p o r t a n t , as our a n a l y s i s of th e
e s s e n t i a l l y i n t e r - r e l a t e d a s p e c t s of th e w a g e - d e te rm in a tio n
p r o c e s s u n fo ld e d , o u r b a s i c t h e s i s began to ta k e sh ap e:
t h a t wage and p r i c e a d ju s tm e n t s — i n b o th u n io n and no n
u n io n c o n t e x t s — a r e p ro b a b ly b e s t comprehended when
r e g a r d e d a s e v id e n c e o f an u n d e r l y i n g t u g - o f - w a r o v e r th e
d i s t r i b u t i o n of Incom e. In t h i s t u g - o f - w a r th e l e a d in g
c o n te n d e rs a re not o n ly i n t h e wage v e r s u s non-wage (o r
p r o f i t ) c a t e g o r i e s , b u t may a ls o be found among th e w orkers
th e m s e lv e s , w ith th e m o re -fa v o re d w a g e -e a rn in g g ro u p s
s e e k in g t o m a in ta in o r enhance t h e i r p o s i t i o n s a g a i n s t th e
l e s s - f a v o r e d la b o r g ro u p s .
T h is c o n tin u in g s k i r m is h in g o v e r income s h a r e s
seemed t o be in e v id e n c e a t many p o i n t s o f o u r d i s c u s s i o n :
i n t h e r e l u c t a n c e o f l a b o r to b in d i t s e l f by any r i g i d
fo rm u la f o r wage a d ju s tm e n ts (su c h as t h e " p r o d u c t i v i t y
p r i n c i p l e " ) , which m ight be i n t e r p r e t e d as a c c e p ta n c e of
188
th e e x i s t i n g wage s t r u c t u r e o r income d i s t r i b u t i o n ; in th e
g r e a t e x t e n t t o which wage demands a tte m p t to s h a r e in th e
e m p lo y e r 's a b i l i t y - t o - p a y and m arket pow er; i n t h e s t r a
t e g i c p r o t e c t i v e r o l e p la y e d by e s c a l a t o r c l a u s e s in wage
c o n t r a c t s ; i n th e r i v a l r y among u n io n s t o o b t a i n fa v o re d
p o s i t i o n s o r com parable w a g e - i n c r e a s e s ; in l a b o r ' s e x p e c ta
t i o n s o f " h a b i t u a l " w a g e - i n c r e a s e s ; a n d , f i n a l l y , in th e
a tte m p ts of p r i c e - s e t t e r s t o p r o t e c t t h e i r p r o f i t m arg in s
v i a m ark-up p r i c i n g p r a c t i c e s , t o be d is c u s s e d more f u l l y
i n th e n e x t c h a p t e r .
CHAPTER V
THE ROLE OP PRICING
As a lr e a d y i n d i c a t e d above ( p a r t i c u l a r l y i n C h a p te r
i i i ) , m arket s t r u c t u r e i s b e li e v e d t o e x e r c i s e a c o n s i d e r
a b le i f n o t p rim a ry i n f l u e n c e on th e p r i c i n g p r o c e s s , t h a t
i s , p r i c e s w i l l p resum ably be s e t in d i f f e r e n t f a s h i o n by
th e " p r i c e - t a k e r s " who dom inate th e w o rld of p u re ( o r
p e r f e c t ) c o m p e titio n th a n by th e " p ric e -ra a k e rs " o f monop
o l i s t i c c o m p e titio n and o l ig o p o l y .
In a se n s e t h e r e would be no n e ed f o r t h e p r e s e n t
c h a p t e r i f , In r e a l i t y , a l l p r i c e s were d e te rm in e d s o l e l y
by th e autonomous f o r c e s o f m arket s u p p ly and demand, as
p r e s c r i b e d by th e th e o r y o f pure c o m p e titio n . I n d e e d , I f
p r i c e s were e x c l u s i v e l y m a r k e t-d e te r m in e d in t h i s s e n s e ,
th e n th e excess-d em and t h e o r i e s of i n f l a t i o n d is c u s s e d In
C h a p te r i i i would have s u f f i c e d to e x p l a i n changes i n th e
g e n e r a l p r i c e l e v e l . However, In r e a l i t y p r i c e s a r e n o t so
e x c l u s i v e l y m a r k e t- d e te r m in e d , and a c c o u n t must a l s o be
ta k e n of th e " p a r t i c u l a r ways" in w hich p r i c e s a r e a c t u a l l y
s e t . F u r t h e r , th e u n d e r l y i n g n a tu r e o f e x c e ss demand c o u ld
n o t be r e f l e c t e d by a mere a g g r e g a tio n of component
" s e c t o r a l " e x c e ss demands u n l e s s i t c o u ld a ls o be assumed
189
190
t h a t th e sh a p e s of a l l component demand and s u p p ly c u rv e s
were I d e n t i c a l i n each s e c t o r and th ro u g h o u t t h e econom y.^
The p r e s e n t c h a p t e r , t h e r e f o r e , pays homage t o t h e
f a c t t h a t in numerous i n s t a n c e s p r i c e s a re d e c id e d d i r e c t l y
by f irm s ( i . e . , p ro d u c e rs and s e l l e r s ) r a t h e r t h a n by an
autonomous m a rk e t. T his i s n o t t o im ply t h a t su c h p r i c e -
making f ir m s n e c e s s a r i l y d i s r e g a r d m ark et c o n d it i o n s o f
su p p ly and demand, n o r t h a t th e y a re u n m in d fu l of " p r o f i t -
m axim izing" o p p o r t u n i t i e s when th e y d e c id e on t h e i r p r i c e s .
I t i s m ere ly t o i n d i c a t e th e n e e d , i n t h i s s t u d y , to
examine th e c o n s i d e r a t i o n s and p o l i c i e s which r e a l i s t i c a l l y
g u id e f ir m s i n t h e i r p r i c e - s e t t i n g d e c i s i o n s , i n o rd e r t o
e x p la in ( a ) how and t o what e x t e n t p r i c e s s e t by th e p r l c e -
m akers may d i f f e r from th e p r i c e s s e t by the " m a rk e t," and
(b) how t h e p r ic e - m a k e r s m ig h t a f f e c t th e g e n e r a l p r i c e
l e v e l and th e i n f l a t i o n p r o c e s s .
The p ro c e d u re fo llo w e d in t h i s c h a p t e r w i l l be s im i
l a r t o t h a t fo llo w e d in C h a p te r iv (on wages) i n t h a t I t
p ro c e e d s from a d i s c u s s i o n o f p r i c e d e t e r m i n a t i o n in
i n d i v i d u a l f i r m s , I n d u s t r i e s , and s e c t o r s of t h e economy,
and th e n se e k s t o assem ble t h e s e component p ro c e d u re s
w i t h in th e fram ework o f an o v e r - a l l o r g e n e r a l p r i c e l e v e l .
■^William G. Bowen, The W age-P rlce I s s u e ( P r i n c e t o n :
P r in c e t o n U n i v e r s i t y P r e s s , I 9 6 0 ) , pp. 306-fl
191
However, f o r a f u l l e r u n d e r s ta n d in g o f th e p r i c i n g
p o l i c i e s and p r a c t i c e s o f f irm s i t w i l l f i r s t be n e c e s s a r y
t o b r i e f l y i n d i c a t e (a) why th e " c l a s s i c a l " t h e o r i e s o f
p u re c o m p e titio n a r e n o t d i r e c t l y a p p l i c a b l e to m ajo r seg
m ents o f o u r modern economy, and (b) t o what e x te n t
t h e o r i e s o f " m o n o p o lis tic " ( " i m p e r f e c t" ) and " o lig o p o
l i s t i c ” c o m p e titio n may have c o n t r i b u t e d t o a more r e a l i s t i c
u n d e r s ta n d in g of p r i c i n g p o l i c i e s and p ro c e d u re s i n modern
f i r m s . To f a c i l i t a t e th e e x p o s i t i o n , th e s e two b o d ie s o f
t h e o r i e s o f p r i c i n g by th e f ir m w i l l h e r e a f t e r be r e f e r r e d
t o sim ply ( a l b e i t somewhat a r b i t r a r i l y ) a s " c l a s s i c a l " and
"modern" t h e o r y , r e s p e c t i v e l y .
P r i c i n g i n th e I n d i v i d u a l Firm
One of th e main re a s o n s why b o th th e " c l a s s i c a l "
and "modern" m odels of c o m p e titio n a re n o t d i r e c t l y a p p l i c
a b le to m a jo r p o r t i o n s o f th e economy i s t h a t t h e i r u n d e r
ly in g a ssu m p tio n o f p r o f i t - m a x i m i z a t i o n as t h e e x c l u s i v e
m o tiv a tio n and b e h a v i o r a l p r i n c i p l e o f th e f ir m i s , i n r e a l
l i f e , n o t r e a l i z e d in th e t h e o r e t i c a l l y assumed fo rm s.
E co nom ists a re g e n e r a l l y a g re e d t h a t f irm s a re (a) a l s o
s t r o n g l y g u id e d by " n o n - p r o f i t " m o t i v a t i o n s t h a t may o r
may n o t s a t i s f y t h e r e s u l t s e x p e c te d u n d e r f u l l s h o r t - r u n
p r o f i t - m a x i m i z a t i o n , and (b) u s u a l l y w i l l s a t i s f y th e s e
n o n - p r o f i t o b j e c t i v e s s u f f i c i e n t l y t o p r e v e n t th e p r i c e and
192
o u tp u t d e c i s i o n s of f ir m s from r e f l e c t i n g th e pure a p p l i c a
t i o n o f s h o r t - r u n m axim izing p r i n c i p l e s . ^
For th e p u rp o se s o f t h i s stu d y th e main g e n e r a l
q u e s t i o n to be answ ered i s : how i s t h e a c t u a l p r i c e
b e h a v io r of th e f irm l i k e l y t o d i f f e r from t h a t e x p e c te d in
modern th e o ry as a r e s u l t o f t h e f i r m ’s ad h eren ce t o n o n
p r o f i t m o tiv a tio n s ? I n s e t t i n g f o r t h an answ er i t w i l l be
n e c e s s a r y t o a l s o i n d i c a t e (a) th e n a t u r e of th e s e n on
p r o f i t m o t i v a t i o n s , and (b) i n what c irc u m s ta n c e s and t o
what e x t e n t th ey te n d t o i n f l u e n c e th e p r o f i t- m a x i m iz i n g
o b j e c t i v e . B e fo re p r o c e e d i n g , how ever, i t may be n o t e d
t h a t o t h e r im p o r ta n t d e v i a t i o n s from p u r e l y p r o f i t -
m axim izing b e h a v io r w i l l be d i s c u s s e d below i n o t h e r co n
t e x t s t h a t w i l l a ls o t r y t o i n d i c a t e t h e p r o b a b le im p a c ts
of such d e v i a t i o n s on p r i c e p o l i c i e s o f f i r m s .
S o c i a l P r e s s u r e s
There seems t o be a s t r o n g c o n se n s u s t h a t h ig h
among th e n o n - p r o f i t o b j e c t i v e s o f th e f ir m i s a r e g a r d f o r
v a r i o u s " s o c i a l p r e s s u r e s " f e l t from t h e s i d e of th e p u b l ic
■ ^ S trictly s p e a k in g , t h e s e " n o n - p r o f i t " o b j e c t i v e s
( e . g . , p u b l i c r e l a t i o n s ) canno t be r e g a r d e d as h a v in g no
e f f e c t o f p r o f i t s , s i n c e i t may be presum ed th e y a re
c a t e r e d to i n o rd e r t o y i e l d t h e firm more n e t p r o f i t s th an
o th e r w is e . P e rh a p s a more s u i t a b l e te rm i s " n o n -p e c u n ia ry "
o b j e c t i v e s .
193
and th e g o v e rn m e n t.1 T h is r e g a r d need n o t n e c e s s a r i l y
I n d i c a t e th e f i r m 's ad h eren ce t o " In n e r com pulsions" of
m o r a lity o r c o n s c ie n c e ; s u f f i c e i t th e y I n f lu e n c e th e f i r m ’s
p r i c e b e h a v io r in f a i r l y d e te rm in a te d i r e c t i o n s .
S iz e and n o b le s s e o b l i g e . —-For exam ple, l a r g e firm s ,
becau se of t h e i r very s i z e and n o b le s s e o b l i g e , may
e n v is io n th e m se lv e s as p a r t of a " s o c i a l l y i n t e g r a t e d
g ro u p , w ith r e s p o n s i b i l i t i e s " tow ard th e p e o p le manning th e
p i p e l i n e s of p r o d u c tio n and d i s t r i b u t i o n — t h e i r em ployees,
s u p p l i e r s , d i s t r i b u t o r s , d e a l e r s , c u sto m e rs, and s to c k
h o l d e r s . At th e same tim e t h e i r very s i z e a ls o makes th e
b ig f ir m s v u ln e r a b le as a t a r g e t f o r a n t i - t r u s t s u i t s ,
l e g i s l a t i o n , C o n g re s s io n a l i n v e s t i g a t i o n , and s i m i l a r
" r e s t r a i n i n g f o r c e s . " 2
U n l e s s o th e rw is e s p e c i f i e d , th e f o llo w in g s e c t i o n
on s o c i a l p r e s s u r e s i s b ased p r i m a r i l y on Bowen, op. c i t . ,
pp. 2 7 6 - b l , 296, and R o b ert F. L a n z i l l o t t i , " P r i c in g
O b je c tiv e s i n Large Com panies," The American Economic
Review, XLVIII (December, 1 9 5 6 ), pp. 93 6 -3 ?. See a l s o
M ilto n F rie d m a n , "Some Comments on th e S i g n i f ic a n c e of
Labor Unions f o r Economic P o l i c y , " The Im pact o f th e U n io n ,
ed. David McCord W right (New York: K e lle y & M illm an, l 9 $ 6 ) ,
p. 22d.
A ccording t o W illiam J . Baumol, managements of
la rg e f i r m s , i n o r d e r t o av o id d i f f i c u l t i e s w ith p u b lic
r e g u l a to r y a u t h o r i t i e s as w e ll as w ith s t o c k h o l d e r s , may
p r e f e r th e " q u i e t l i f e " of s e c u r i t y and r e s p e c t a b i l i t y t o
th e "ro ugh and tum ble" o f p r i c e c o m p e titio n . They te n d t o
depend on each o t h e r t o be " w e ll-b e h a v e d " and a d ju s t t h e i r
r e s p e c t i v e p o l i c i e s i n a " c o o p e r a tiv e s p i r i t " r a t h e r th a n
make l i f e u n p r e d i c t a b l e f o r one a n o th e r ; see h i s B u sin e ss
B e h a v io r, V alue and Growth (New York: M acm illan Company,
1959), p. 30 .
194
P e rh ap s t h e s e I m p l i c a t i o n s o f l a r g e s i z e a re r e
i n f o r c e d by t h e te n d e n c y of governm ent and th e p u b l i c t o
r e g a r d such f i r m s as " p a t t e r n - s e t t e r s " f o r th e r e s t of
i n d u s t r y , who a re n o t e x p e c te d t o ta k e f u l l a d v an tag e of
e v e ry s h o r t - r u n p r o f i t o p p o r t u n i t y . To quote from th e
Economic R epo rt of t h e P r e s i d e n t of J a n u a ry 1957: "And
b u s i n e s s e s m ust r e c o g n iz e th e b ro a d p u b l i c i n t e r e s t i n t h e
p r i c e s th ey s e t on t h e i r p ro d u c ts and s e r v i c e s .
I f s o c i a l p r e s s u r e s do i n f l u e n c e th e f i r m ' s p r i c i n g
d e c i s i o n s , can we i n d i c a t e how much and what ty p e o f an
i n f l u e n c e ? The answ er t o t h i s q u e s t i o n em braces two
a s p e c t s : (1) th e t r a n s l a t i o n of th e n o t io n of " s o c i a l
p r e s s u r e " i n t o an o p e r a t i o n a l c o n c e p t, such as th e ty p e o f
p r i c e s o r p r i c e p o l i c i e s d i c t a t e d by th e p u b l i c ' s p r e f e r
e n c e , a c c o rd in g to w hich p r e f e r e n c e i t co uld th e n be d e t e r
mined to what e x te n t th e f i r m 's p r i c i n g d e c i s i o n was m o ti
v a te d by s o c i a l m o tiv e s ; (2) th e c l a s s i f i c a t i o n o f th e
v a r i o u s s i t u a t i o n s ( f i n a n c i a l and o t h e r w is e ) In w hich f i r m s
f i n d th e m s e lv e s and w hich may be presum ed t o a f f e c t th e
e x t e n t t o which th e y w i l l te n d t o be m o tiv a te d by s o c i a l
p r e s s u r e s .
The p u b l i c ' s p r e f e r e n c e s . — W ith r e s p e c t t o th e
p u b l i c p r e f e r e n c e , t h e r e i s t h e f a m i l i a r and p ro b a b ly s a f e
■kj.S., P r e s i d e n t (E is e n h o w e r), Economic R eport o f
th e P r e s i d e n t (W ashington: U.S. Government P r i n t i n g O f f i c e ,
1 9 5 7 ), P. 3.
195
g e n e r a l i z a t i o n t h a t th e p u b l i c p r e f e r s low er p r i c e s t o
h i g h e r p r i c e s , and te n d s t o e x p e c t a s p e c i a l " j u s t i f i c a t i o n "
by th e firm f o r any s i g n i f i c a n t p r i c e i n c r e a s e i t may i n s t i
t u t e . E s p e c i a l l y n o te w o rth y i s th e a p p a r e n t p u b l ic a t t i
tu d e t h a t an i n c r e a s e d demand f o r th e f i r m 's p ro d u c t i s n o t
view ed as a s a t i s f a c t o r y j u s t i f i c a t i o n p e r s e , s in c e t h i s
amounts t o " c h a r g in g what t h e t r a f f i c w i l l b e a r . " On th e
o t h e r h a n d , th e p u b l i c a p p e a rs more i n d u lg e n t to w ard p r i c e
i n c r e a s e s pro voked by i n c r e a s e d c o s t s to w hich th e f irm can
p o i n t as a j u s t i f i c a t i o n .
Som etim es, as in t h e 1962 s t e e l - p r i c e d i s p u t e , we
may w itn e s s a s p e c i a l e x p r e s s io n o f th e p u b l i c p r e f e r e n c e
as I n t e r p r e t e d and f o r m u la te d by th e P r e s i d e n t and h i s
econom ic a d v i s e r s . On t h a t o c c a s io n th e s p e c i a l ex cu se
in v o k ed was t h e p o s s i b l e a d v e rs e im p a ct of a s t e e l - p r i c e
r i s e on th e n a t i o n ' s i n t e r n a t i o n a l b a la n c e o f paym ents.
The f i r m ' s s i t u a t i o n . — T h is b r in g s u s t o th e second
a s p e c t o f th e b a s i c q u e s t i o n : th e s p e c i f i c c irc u m s ta n c e s
i n which th e f i r m i s l i k e l y t o r e s p o n d t o s o c i a l p r e s s u r e s .
At one extrem e i s th e ty p e o f firm f o r whom c o n fo rm ity t o
s o c i a l p r e s s u r e s — s a y , due to a s p e c i a l d e s i r e t o a v o id
p u n i t i v e r e p r i s a l s by th e p u b l i c — h a p p ily c o in c id e s w ith
f u l f i l l m e n t of th e f i r m 's o t h e r o b j e c t i v e s , i n c l u d i n g
p r o f i t " m a x im iz a tio n ." F o r e x am p le , i t i s b e l i e v e d t h a t i n
th e case of U. S. S t e e l , management had e a r l y d e c id e d — a t
196
l e a s t u n t i l th e 1950’ s — on a r e l a t i v e l y low ’’t a r g e t " r a t e
o f p r o f i t r e t u r n s , in o r d e r t o l i m i t p r o f i t volume and
grow th o f th e f i r m as a means o f a v o id in g governm ent i n t e r
v e n tio n .^ - In any e v e n t , i n t h i s g e n e r a l case t h e f i r m 's
s e v e r a l m o tiv e s a r e a p p a r e n t l y m u tu a lly r e i n f o r c i n g , and i t
would be d i f f i c u l t (a s w e ll as u n n e c e s s a r y ) t o a t t r i b u t e
i t s p r i c e b e h a v io r t o any s i n g l e m o tiv e .
At th e o t h e r extrem e i s th e f ir m t h a t r e g a r d s con
c e s s io n s t o s o c i a l p r e s s u r e a s in v o lv in g a s i g n i f i c a n t
f i n a n c i a l c o s t . In such c a s e s i t may be re a s o n e d t h a t th e
f i r m 's s o c i a l m o ti v a ti o n s w i l l be s t r o n g e r (a) th e s m a ll e r
the f i n a n c i a l d r a i n i n v o lv e d , and (b) t h e s t r o n g e r i t s
o v e r - a l l f i n a n c i a l p o s i t i o n , which e n a b le s i t t o in d u lg e
i t s n o n - p r o f i t o b j e c t i v e s .
P ro b ab ly th e most common ty p e s o f firm s a r e th o s e
f o r whom i t may be very d i f f i c u l t t o p r e d i c t th e im pact on
p r o f i t s o f a l t e r n a t i v e p r i c e d e c i s i o n s . D e sp ite s tr o n g
s o c i a l m o t i v a t i o n , t h e s e f ir m s may fa c e c o n s i d e r a b le
u n c e r t a i n t y in a tt e m p t in g t o e s t i m a t e th e co m p a rativ e
p r o f i t a b i l i t y o f a l t e r n a t i v e p r i c e d e c i s i o n s . I n such
c a s e s , t o t h e e x t e n t t h a t f i r m s a re m o tiv a te d t o m a in ta in
th e p a tro n a g e o f cu sto m ers ( a s w e ll as th e f i r m 's sh a re o f
th e m a r k e t) , th e y w i l l te n d t o av o id a p r i c e i n c r e a s e In
■^Gardiner C. Means, P r i c i n g Power and t h e P u b lic
I n t e r e s t (New York: H a rp e r & B r o t h e r s , 1 9 6 2 ), p. 2 4 l.
197
r e s p o n s e t o i n c r e a s e d demand f o r f e a r o f i n c u r r i n g th e
im m ediate d i s f a v o r o f cu sto m ers as w e ll a s e n c o u ra g in g
c o m p e titio n of r i v a l s o r new f ir m s in th e lo n g e r r u n .
C l a s s i c a l Pure C o m p etitio n
The p r e c e d in g d i s c u s s i o n o f n o n - p r o f i t o b j e c t i v e s
s t r a d d l e s b o th t h e c l a s s i c a l and modern m odels o f c o m p e ti-
i
t i o n i n t h a t i t p e r t a i n s to th e common a ssu m p tio n o f
p r o f i t - m a x i m i z a t i o n . We now p ro c e e d t o a more d e t a i l e d
re v ie w o f th e o t h e r c h i e f u n d e rp in n in g s o f each o f th e s e
two m o d e ls .^
Absence o f monopoly pow er.- -T h e p red o m in an t m arket
c h a r a c t e r i s t i c o f c l a s s i c a l pure c o m p e titio n i s t h a t no f i m
e x e r c i s e s any " m o n o p o lis tic " c o n t r o l in i t s m a rk e t: no
f i r m p o s s e s s e s any means of c o n t r o l over su p p ly a n d , t h e r e
f o r e , p r i c e . E s s e n t i a l l y t h i s b o i l s down t o two u n d e r l y i n g
p r e r e q u i s i t e s : ( 1 ) t h e r e must be a s u f f i c i e n t l y la r g e
number of s e l l e r s and b u y e rs so t h a t no one ( o r g ro u p ) o f
them i s la r g e enough ( o r i s even i n t e r e s t e d ) t o e x e r t any
^■Unless o th e rw is e s p e c i f i e d , the main s o u r c e s f o r
t h i s s e c t i o n a re Edward H a s tin g s C ham b erlin , The Theory o f
M o n o p o lis tic C o m p etitio n ( 5 th e d . ; Cambridge: H a rv ard U ni
v e r s i t y P r e s s , 19^6)» PP. 6 - 8 , 10-29J T ib o r S c i to v s k y ,
W elfare and C o m p etitio n (C h icag o : R ic h a rd D. I r w i n , I n c .
1 9 5 1 ), p . 16; M. M. B o b e r, I n t e r m e d i a t e P r i c e and Income
Theory ( r e v . e d . ; New York: W. W. N orton & Company, 19 6 2 ),
p . 197; Jo e S. B a in , I n d u s t r i a l O r g a n iz a tio n (New York: John
W iley & S o n s, 1 9 5 9 ), p. 151.
198
I n f l u e n c e over m arket s u p p ly and p r i c e ;1 and (2 ) p r o d u c ts
must be i d e n t i c a l .
As a co n sequence o f th e f i r s t c o n d i t i o n , b o th buyers
and s e l l e r s would r e g a r d t h e m arket p r i c e a s " g iv e n t o
them" by th e " im p e r s o n a l f o r c e s " o f th e m a rk e t. No s e l l e r
would r a i s e h i s p r i c e b e c a u s e t h i s would cause him
d im in is h e d s a l e s . Nor would he ,t h i n k v e ry much of lo w e rin g
h i s p r i c e , s i n c e he c o u ld s e l l a l l he w anted a t th e p r e
v a i l i n g ( h ig h e r ) m arket p r i c e .
F u r t h e r , sh o u ld t h e s e l l e r d e c id e t o shade h i s
p r i c e as a r e s u l t of lo w e r c o s t s , and t h e r e b y i n c r e a s e h i s
s a l e s , t h i s a c t i o n would n o t provoke any r e t a l i a t i o n by
o th e r s e l l e r s b e ca u se h i s newly-won c u sto m e rs would c o n s t i
t u t e a mere f r a c t i o n of th o s e who buy from h i s numerous
r i v a l s . Thus eac h f ir m a d j u s t s i t s p r i c e and o u tp u t
" in d e p e n d e n tly " of any c o n s i d e r a t i o n of p o s s i b l e r e t a l i a
tio n by r i v a l s e l l e r s .
I d e n t i c a l p r o d u c t s .--T h e se c o n d b a s i c f e a t u r e of
pure c o m p e titio n i s t h a t a l l f ir m s prod uce an i d e n t i c a l
p ro d u c t and s e l l in th e same m a rk e t. By p ro d u c in g only
" p e r f e c t l y homogeneous" o r s t a n d a r d i z e d g o o d s, and b e in g
b e c a u s e la r g e num bers o f f ir m s i n th e c l a s s i c a l
model mean s m a l l - s i z e f i r m s , some w r i t e r s r e f e r t o t h i s
type o f c o m p e titio n and m arket s t r u c t u r e by th e more
d e s c r i p t i v e te rm " a t o m i s t i c " ; see e s p e c i a l l y B a in , op. c i t .,
p a ssim .
199
i n c a p a b le o f p r o d u c in g a n y th in g " s l i g h t l y d i f f e r e n t " from
th e p r o d u c ts o f o t h e r f i r m s , no s e l l e r can e x p e c t t o
r e c e i v e a p r i c e d i f f e r e n t from t h a t charg ed by a n o t h e r , and
no b u y e r can e x e r c i s e a p r e f e r e n c e r e s p e c t i n g th e s e l l e r
whose p ro d u c t he p u r c h a s e s .
As a c o r o l l a r y , i t m ust be added t h a t n o t o nly
p r o d u c ts b u t th e s e l l e r s t h e m selv es must be " s t a n d a r d i z e d . "
T hat i s , no a s p e c t o f any g iv e n f i r m — n e i t h e r i t s p r o d u c t ,
s e r v i c e s , n o r l o c a t i o n — can d i s t i n g u i s h i t from i t s r i v a l s .
Hence b u y e r s can have no i n c e n t i v e o r need t o pay more t o
one s e l l e r th an i s c h arg ed by any o t h e r . As C ham berlin
p u t s i t , i t i s e n t i r e l y "a m a t t e r of chance" from which
s e l l e r a b u y er makes h is p u r c h a s e .
These a re two key p i l l a r s o f pure c o m p e ti t io n , and
t h e r e a r e some o t h e r s . F o r th e purp o se of t h i s c h a p te r i t
i s n o t n e c e s s a r y t o enum erate th e o t h e r b a s i c f e a t u r e s :
on ly t h o s e which a r e r e l e v a n t t o our s u b j e c t w i l l be d i s
c u sse d b e l o w . I n a d d i t i o n , we w i l l n o t h e re d w e ll e x p l i
c i t l y upon the c r u c i a l a ssu m p tio n o f p r o f l t - m a x l i ti g a t i o n ,
a c c o rd in g t o which f i r m s , w ith th e a id o f " g iv e n " demand
and c o s t c u rv e s , a r e presum ed t o o p e r a te a t t h a t com bination
Isome o f t h e o t h e r b a s i c a ssu m p tio n s o f p u re compe
t i t i o n a r e subsumed u n d e r o r im p lie d by th e two c o n c e p ts o f
la r g e num bers and i d e n t i c a l p r o d u c t s ; see e s p e c i a l l y George
J . S t i g l e r , " P e r f e c t C o m p e titio n , H i s t o r i c a l l y Contem plated"
The J o u r n a l of P o l i t i c a l Economy, LXV ( F e b r u a r y , 1957)*
p p . 1 -17 .
200
o f p r i c e and o u tp u t w hich y i e l d s th e h i g h e s t amount of
r e t u r n s . T h is a s p e c t w i l l be d i s c u s s e d i n th e c o n te x t o f
o t h e r t o p i c s below .
F i n a l l y , our i n t e r e s t i n th e r e l e v a n t c h a r a c t e r
i s t i c s o f p u re c o m p e titio n (and d e p a r t u r e s th e r e f ro m ) i s
p r i m a r i l y t o d e te rm in e t h e i r i m p l i c a t i o n s f o r ( i . e . , p ro b
a b le e f f e c t s on) t h e p r i c e - o u t p u t b e h a v io r o f f i r m s . In
th e p r e s e n t i n s t a n c e , th e two a ssu m p tio n s of l a r g e numbers
and i d e n t i c a l p r o d u c ts im ply above a l l t h a t th e s e l l e r ’ s
p r i c e i s th e same as th e m arket p r i c e and , t h e r e f o r e , t h e
demand curve f a c i n g th e i n d i v i d u a l f ir m i s h o r i z o n t a l .
Thus no s e l l e r would have an I n c e n t i v e t o charge more or
l e s s th a n th e m arket p r i c e .
P ro d u c t D i f f e r e n t i a t i o n
In d i s c u s s i n g th e r e a l i s t i c d e p a r t u r e s from th e
c l a s s i c a l a ssu m p tio n of l a r g e numbers and u n ifo rm p r o d u c t s ,
i t I s more c o n v e n ie n t t o f i r s t c o n s i d e r th e f i r m ’ s p r a c t i c e
of " p r o d u c t d i f f e r e n t i a t i o n " (as th e o p p o s i t e o f p ro d u c t
s t a n d a r d i z a t i o n ) and i t s l i k e l y I n f l u e n c e on i t s p r i c e
p o l i c i e s . 1
iThe main r e f e r e n c e s f o r th e f o l lo w in g s e c t i o n a r e :
C ham b erlin , op. c l t . , pp. 9, 5 6 , 71; M eans, op. c i t . ,
p . 224; G a r d in e r C. M eans, "S ta te m e n t o f , " U . S . , C o n g re ss,
S e n a te , Subcom m ittee on A n t i t r u s t and M onopoly, Committee
on th e J u d i c i a r y , H e a r in g s . P a r t I , A d m in is te re d P r i c e s .
(W ashington: U.S. Government P r i n t i n g O f f i c e , 1 9 5 7 ),
pp. 74 -8 1 .
201
The te r m d e f i n e d . — The o r i g i n a t o r o f th e term
" p r o d u c t d i f f e r e n t i a t i o n , " C h am b erlin , d e f in e d i t sim p ly as
any c h a r a c t e r i s t i c s i n th e p r o d u c t and i n th e " c o n d i t i o n s
s u rro u n d in g i t s s a le " t h a t c o n s t i t u t e a " s i g n i f i c a n t b a s i s "
(w h e th e r " r e a l o r f a n c i e d " ) f o r d i s t i n g u i s h i n g th e goods or:
s e r v i c e s o f one s e l l e r from th o s e o f a n o th e r in th e ey es o f
th e b u y e r, and t h e r e f o r e can in d u c e th e b u y e r t o p r e f e r
one f i r m 's p ro d u c t o v e r a n o t h e r 's . The l a t t e r in d u c e m e n t,
a c c o rd in g to C h a m b e rlin , i s u s u a l l y s u p p o rte d and r e i n
f o r c e d by means o f a d v e r t i s i n g . In any e v e n t , t h e r e comes
w ith p r o d u c t d i f f e r e n t i a t i o n a "monopoly" power i n th e
se n se t h a t " u n iq u e n e s s " o r d i s t i n c t i o n o f p ro d u c t makes
c o m p e tito r p r o d u c ts l e s s p e r f e c t l y i d e n t i c a l and s u b s t i
t u t a b l e ( i . e . , c o m p e titiv e ) w ith i t .
S lo p in g demand c u rv e . — Of c h ie f i n t e r e s t f o r us i s
t h a t p ro d u c t d i f f e r e n t i a t i o n c a u se s th e f i r m 's demand
curve t o v e re from th e c l a s s i c a l h o r i z o n t a l p o s i t i o n toward
a downward s lo p e (from l e f t to r i g h t ) . 1 The c u r v e 's slo p e
and e l a s t i c i t y depends on, among o t h e r t h i n g s , th e d e g re e
o f p ro d u c t d i f f e r e n t i a t i o n . F u r th e rm o r e , th e more d i f f e r
e n t i a t e d th e p r o d u c t , th e s m a l l e r th e l i k e l i h o o d t h a t (a) a
r is e in i t s p r i c e w i l l d r i v e c u sto m e rs away t o c o m p e t i t o r s , or
ln The shape of th e demand curve f a c e d by t h e firm
u n d e r m o n o p o lis tic c o m p e titio n comes from p ro d u c t d i f f e r
e n t i a t i o n " ; R ic h a rd H. L e f tw ic h , The P r i c e System and
R esource A l l o c a t i o n ( r e v . e d . ; New York: H o l t , R in e h a r t
and W in sto n , 19& !), p . 103.
202
(b) a cut I n p r i c e w i l l a t t r a c t many o f i t s c o m p e t i t o r s ’
c u sto m e rs.
As a c o n se q u e n c e , th e f ir m h as g a in e d a c e r t a i n
" a r e a of d i s c r e t i o n " or ra n g e o f p r i c e s aro u n d (above or
below) i t s presum ed m axim um -profit p r i c e — a ra n g e l i m i t e d ,
t o be s u r e , by t h e f o r c e s o f m arket demand and su p p ly —
w i t h in w hich I t can charge alm o st any p r i c e w ith o u t f e a r of
l o s i n g o r g a in i n g any n o t i c e a b l e s a l e s volume. But th e
f i r m ’ s p r i c i n g problem re m a in s : how sh o u ld i t d ecid e which
p r i c e - o u t p u t co m b in atio n w i l l y i e l d maximum p r o f i t s ? The
f irm I s supposed t o c o n s t a n t l y seek a maximum of p r o f i t s by
d e te rm in in g w h e th e r s e l l i n g somewhat l e s s a t a h ig h e r p r i c e
i s more p r o f i t a b l e th a n s e l l i n g more a t a s l i g h t l y lo w e r
p r i c e , o r w h e th er i t s h o u ld sim p ly m a in ta in t h e e x i s t i n g
p r i c e .
U n c e r ta in ty o f demand. — One o f th e s i g n i f i c a n t
a s p e c t s c o n c e rn in g t h e s l o p i n g demand curve i s t h a t , w h ile
i t i s c e r t a i n l y more r e a l i s t i c th a n th e h o r i z o n t a l cu rve
f o r d e s c r i b i n g demand i n d i f f e r e n t i a t e d p ro d u c t m a r k e ts ,
I t s s lo p e and c o n to u rs a re n o t alw ays known t o th e f i r m
s u f f i c i e n t l y f o r I t to make p r e c i s e p r o f it- m a x i m iz i n g c a l
c u l a t i o n s . I n d e e d , th e f i r m may o f t e n be c o n s id e r a b ly
u n c e r t a i n a b o u t th e p r e c i s e shape o f i t s demand c u rv e ,
e s p e c i a l l y compared t o i t s c o s t curve f o r w hich d a ta a re
more a v a i l a b l e and c a l c u l a b l e .
203
The om nipresence of u n c e r t a i n t y c o n c e rn in g th e
f i r m ’s demand curve ( a s w e ll as i t s f u t u r e c o s t s ) i n t r o
duces a new d im ension i n t o t h e b a s i c c o n s i d e r a t i o n s
in v o lv e d i n the f i r m ’ s p r o f i t- m a x i m iz i n g c a l c u l u s . What
a re t h e m ain i m p l i c a t i o n s o f t h i s u n c e r t a i n t y f o r th e p r i c e
p o l i c i e s o f firm s? T h is le a d s us t o o u r n e x t s u b j e c t .
U n c e r t a i n t y
The e x i s t e n c e of u n c e r t a i n t y f o r th e f i r m owing t o
in c o m p le te o r u n a v a i l a b l e know ledge— p a r t i c u l a r l y c o n c e rn
in g f u t u r e demand an d c o s t s — means above a l l t h a t th e f ir m
c a n n o t a c t u a l l y b a se i t s p r i c e - o u t p u t d e c i s i o n s upon a
s i n g l e , u n iq u e p a i r o f demand and c o s t s c h e d u le s (assum ing
even t h e s e were e s t i m a b l e ) . I n s t e a d , i t m ust c o n s id e r an
a r r a y o f a l t e r n a t i v e p o s s i b l e s c h e d u l e s , whose p r o f i t o u t
comes w i l l range fro m th e m ost d e s i r a b l e ( i . e . , maximum
p r o f i t s ) t o th e l e a s t d e s i r a b l e ( i . e . , re d u c e d p r o f i t s o r
l o s s e s ) . Because m anagem ents may deem i t much more
u n d e s i r a b l e to i n c u r (a ) a r e d u c t i o n o f p r o f i t s o r o u t r i g h t
l o s s e s th a n to (b) f a i l t o i n c r e a s e p r o f i t s ( l e t a lo n e
maxim ize th em ), th ey may be i n c l i n e d t o f a v o r d e c i s i o n s
t h a t a v o id outcome " a " th an d e c i s i o n s t h a t a v o id outcome
" b . ”1
^T his s e c t i o n i s b a se d p r i m a r i l y on Bowen, op. c i t . ,
p p . 2 8 4 -8 9 , 295-97.
204
P o s s i b l e i m p l i c a t i o n s .--W h a t a re t h e l i k e l y im p a c ts
upon th e f i r m 's p r i c e p o l i c y o f such d e l i b e r a t i o n s a t t r i b u t
a b le t o th e e x i s t e n c e o f u n c e r t a i n t y ? E co n o m ists have
s u g g e s te d a f a i r l y im p o r ta n t c o n c lu s io n : f ir m s w i l l n o t
te n d t o e x p l o i t an i n c r e a s e in demand— a c t u a l o r a n t i c i
p a te d — f o r f e a r o f " r o c k in g th e b o a t . " T h at i s , th e f e a r
o f r a i s i n g p r i c e s w i l l w eigh h e a v i l y upon th e f ir m i f such
a move would le a v e i t f a r from c o n f id e n t t h a t demand i s
s t r o n g enough, i . e . , t h a t an i n c r e a s e in p r i c e would (a)
i n c r e a s e i t s s h o r t - r u n p r o f i t s and (b) o f f e r no s e r i o u s
s e tb a c k to th e lo n g - r u n p r o s p e c t s o f th e f i r m . On th e
o t h e r h a n d , a d e c r e a s e i n demand would c o n s t i t u t e a more
e m b a rra s s in g e v e n t f o r t h e firm a n d , h e n c e , a g r e a t e r p rod
t o a c t i o n . B ecause a re d u c e d demand p r e s e n t s an im m ediate
c h a lle n g e t o i t s i n d u s t r y p o s i t i o n or v e ry s u r v i v a l , th e
fir m i s p r e s s u r e d i n t o gam bling on a p r i c e cu t i n o r d e r t o
r e s t o r e o r r e g a i n i t s s a l e s volum e.
In c o n t r a s t to t h e s e p o s t u l a t e s c o n c e rn in g demand
c h a n g e s, e c o n o m is ts s u g g e s t i t i s p l a u s i b l e t o e x p e c t f ir m s
to g iv e c o s t s a w e i g h t i e r r o l e i n t h e i r p r i c e - s e t t i n g
d e l i b e r a t i o n s . The main r e a s o n s a re t h a t (a) th e c o s t -
d e te rm in in g v a r i a b l e s a re more e a s i l y known and m ea su ra b le
th a n t h e d e te r m in a n ts o f demand and i t s e l a s t i c i t y , and (b)
v a r i a t i o n s i n c o s t s a re l e s s r a p i d and c a p r i c i o u s th a n
v a r i a t i o n s In demand. T hus, a f i r m d e s i r o u s o f m a in t a i n in g
a m easure of s t a b i l i t y i n i t s p r i c e s w i l l f i n d ch an ges i n
c o s ts a more a c c e p t a b l e g u id e th a n changes i n demand.
R e a c tio n s t o c o s t - c h a n g e s . — However, t h e r e a c t i o n s
of p r ic e - m a k e r s t o changes in c o s t s need n o t be "sy m m e tri
c a l , " t h a t i s , an i n c r e a s e i n c o s t s may more r e a d i l y in sp ire
an i n c r e a s e i n p r i c e th a n a r e d u c t i o n o f c o s t s would in d u ce
a c u t i n p r i c e . T his may be e x p la in e d by s e v e r a l f a c t o r s .
For one t h i n g , f ir m s may have a g r e a t e r i n t e r e s t
in a v o id in g p r o f i t r e d u c t i o n s (a s m en tio n ed above) th a n i n
re a p in g s l i g h t l y h i g h e r p r o f i t s ; t h u s , w h ile r i s i n g c o s t s
may c o n s t i t u t e a p r e s s u r e t o which th e f ir m m ust re s p o n d in
o r d e r t o m a i n ta in p r o f i t m a r g in s , a c o st r e d u c t i o n need n o t
c o n s t i t u t e as w eigh ty a p r e s s u r e i n th e o p p o s i t e d i r e c t i o n ,
e s p e c i a l l y s i n c e p r o f i t s had been i n c r e a s e d t h e r e b y .
Second, t h e r e i s t h e f a c t t h a t w hereas (a) t h e f ir m
r e g a r d s th e r i s e in c o s t s as a s u re cause o f im m ediate
r e d u c t io n in p r o f i t s p e r u n i t o f s a l e s , (b) i t i s much l e s s
c e r t a i n about th e e l a s t i c i t y of demand f o r i t s p ro d u c t and
th e e f f e c t o f a p r i c e - c u t on i t s s a l e s volum e.
F i n a l l y , t h e r e i s th e f a c t t h a t t h e f i r m , t o th e
e x t e n t t h a t i t i s m o tiv a te d by lo n g - r u n c o n s i d e r a t i o n s and
a d e s i r e f o r g r e a t e r s t a b i l i t y and s e c u r i t y , may p r e f e r to
p o stp o n e a p r i c e - c u t in f a v o r o f an im m ediate p r o f i t -
i n c r e a s e in o r d e r t o b u i l d a r e s e r v e a g a i n s t th e day i t i s
com pelled to c u t p r i c e s t o meet a r i v a l ' s c o m p e titio n o r
206
s i m i l a r p r i c e p r e s s u r e . The f i r m may a l s o be p a r t i c u l a r l y
h e s i t a n t to c u t p r i c e s I f t h i s s t e p w ould be m i s i n t e r p r e t e d
by r i v a l s as t h e o p e n in g sh o t i n a d e s t r u c t i v e " p r i c e war"
t h a t none o f th e f irm s would p r e f e r t o e x i s t i n g s t a b l e
r e l a t i o n s h i p s .
Time H o rizo n s
While to u c h in g upon t h e s e a s p e c ts of th e c r u c i a l
s u b j e c t of p r o f i t - m a x i m i z a t i o n , p a r t i c u l a r l y how i t i s
a f f e c t e d by t h e d im en sio n of u n c e r t a i n t y , i t i s im p o r ta n t
t o i n d i c a t e a n o th e r r e a l i s t i c dim ension ( u s u a l l y a s s o c i a t e d
w ith u n c e r t a i n t y ) t h a t a ls o Im pinges on th e p r i c i n g p r o c e s s
but which i s n o t e n c o u n te re d e x p l i c i t l y i n th e p u r e -
c o m p e titlo n m odel.
P r e s e n t v s. f u t u r e . — The c l a s s i c a l model i s
" t i m e l e s s " i n th e s e n s e t h a t th e firm — i n making i t s p r i c e -
o u tp u t a d ju s tm e n ts a c c o rd in g t o th e m axim um -profit
c a l c u l u s — g i v e s no e x p l i c i t r e c o g n i t i o n t o f u t u r e tim e b u t
c o n s i d e r s o n ly th e p r e s e n t ( i . e . , a c t u a l ) demand and c o s t
c o n d itio n s p r e v a i l i n g I n th e c u r r e n t m a r k e t.
In r e a l i t y , how ever, f i r m s must g iv e c o n s i d e r a t i o n
to f u t u r e ( o r a n t i c i p a t e d ) demand and c o s t s as a m a t t e r o f
s u r v i v a l in a w orld i n which su c h m arket d im en sio n s a re In
c o n s t a n t f l u x . This may be p a r t i c u l a r l y th e c a s e In
o l i g o p o l i s t i c i n d u s t r i e s l i k e s t e e l , w here a r e l a t i v e l y few
l a r g e firm s dom inate t h e i n d u s t r y 's o u t p u t . I n such
207
i n d u s t r i e s p r i c e s a r e c h a r a c t e r i s t i c a l l y s e t in te rm s of
l o n g e r - r u n c o n s i d e r a t i o n s r a t h e r th a n a c c o rd in g t o s h o r t -
r u n v a r i a t i o n s i n demand and c o s t f a c t o r s , as i n p u re
c o m p e ti t io n . 1 Hence i t i s r e a l i s t i c t o e x p e c t t h a t th e
f i r m ’s c a l c u l a t i o n s c o n c e rn in g th e lo n g - r u n w i l l a f f e c t t h e
e x t e n t t o which i t w i l l be a b le (o r i n t e r e s t e d ) t o maximize
i t s s h o r t - r u n p r o f i t p o s i t i o n .
I m p l i c a t i o n s f o r p r i c i n g . — E cono m ists have a ls o
p o i n te d t o th e f a c t t h a t th e tim e spans o v e r which firm s
p la n t o maximize p r o f i t s w i l l vary from f i r m t o f i r m , as
w e l l as w i t h in th e same firm a t d i f f e r e n t p o i n ts i n i t s
h i s t o r y , so t h a t p r i c e d e c i s i o n s w i l l v a ry a c c o r d i n g l y . I s
i t p o s s i b l e t o g e n e r a l i z e a b o u t th e e f f e c t on th e f i r m ’ s
p r i c e b e h a v io r o f l o n g - p e r i o d c o n s i d e r a t i o n s com pared w ith
s h o r t - r u n c o n s i d e r a t i o n s ?2
I t a p p e a rs t h a t , f o r a number o f r e a s o n s , f ir m s
w ith more d i s t a n t tim e c o n s i d e r a t i o n s may be e x p e c te d to be
l e s s w i l l i n g t o r a i s e p r i c e s i n re s p o n s e t o i n c r e a s e d demand
th a n firm s who p la n more f o r t h e s h o r t e r ru n . M a in ly , th e
lo n g e r-m in d e d f ir m i s l i k e l y t o be more f e a r f u l o f in d u c in g
c o m p e titio n by r a i s i n g i t s p r i c e , and may t h e r e f o r e p r e f e r
t o c u l t i v a t e an e x p a n d in g m ark et by m a i n t a i n in g t h e low er
^ e a n s , P r i c i n g Power . . . , op. c l t . , p . 20.
P
cT h is s u b - s e c t i o n i s b a sed on Bowen, op. c i t . ,
p p . 282-84.
208
p r i c e . F u rth e rm o re , as i n d i c a t e d a b o v e , s o c i a l m o tiv e s may
s t i m u l a t e a p r e f e r e n c e f o r c u l t i v a t i n g th e com m unity's
g o o d - w i l l t o t h e f u l l e x p l o i t a t i o n o f s h o r t - r u n p r o f i t
o p p o r t u n i t i e s . F i n a l l y , f o r e g o i n g s h o r t - r u n p r o f i t s may
red u c e th e amount t h a t would have t o be sh a red w ith l a b o r ,
and th e r e b y a v o id s i n c u r r i n g h i g h e r wage l e v e l s t h a t l a t e r
co u ld n o t be r e a d i l y re d u c e d .
C o n v e rs e ly , i t i s a ls o l i k e l y t h a t f i r m s w ith t h e
long view w i l l be more r e l u c t a n t t o red u ce p r i c e s in
re s p o n s e t o re d u c e d demand. The m ain re a so n s would be t h e
f i r m 's (a ) d e s i r e t o a v o id h a v in g t o r a i s e p r i c e s a g a in i f
and when demand l a t e r i n c r e a s e d , and (b) a g e n e r a l p r e f e r
ence f o r some d e g re e of p r i c e s t a b i l i t y .
The Zone of I n d i f f e r e n c e
The e c o n o m is t, Means, h as n o te d t h a t t h e u n c e r
t a i n t y s u r r o u n d in g th e a c t u a l shape o f the f i r m ' s demand
curve i s not th e only f a c t o r e x p l a i n i n g th e f i r m ' s
i n a b i l i t y t o maximize c u r r e n t p r o f i t s as p r e s c r i b e d by
t h e o r y . He a l s o p o i n t s t o an e m p i r i c a l phenomenon t h a t he
term s th e "zone o f r e l a t i v e p r i c e i n d i f f e r e n c e " and r e l a t e s
to th e a b o v e-m en tio n ed " a r e a o f d i s c r e t i o n " i n p r i c i n g
p o s s e s s e d by th e f i r m . 1
1This s e c t i o n i s b a sed m ain ly on Means, P r i c in g
Power . . . . op. c l t . , p p . 218, 2 2 4 -2 9 , and " S ta te m e n t of,"
op. c l t .', pp. 77- 79 , 81 .
\
The zone e x p l a i n e d . — A ccording t o Means t h e zone o f
p r i c e i n d i f f e r e n c e sim ply d e s c r i b e s th e o b s e r v a t i o n t h a t
w ith in a c e r t a i n range o f p r i c e s t h a t th e f ir m can charge
f o r i t s p r o d u c t - - e s p e c i a l l y i f th e p ro d u c t i s a " s p e c i a l t y "
( i . e . , d i f f e r e n t i a t e d ) — any one o f s e v e r a l a l t e r n a t i v e
p r i c e s would p ro duce " a b o u t th e same p r o f i t . " Of c o u rs e ,
one o f t h e s e e l i g i b l e p r i c e s i s presu m ab ly th e p r o f i t -
m axim izing one w h ic h , a c c o rd in g t o t h e o r y , would be d e t e r
mined on th e b a s i s of p r e c i s e l y known demand and c o s t
c u rv e s . But s i n c e th e f i r m has o n ly a " fu z z y " i d e a about
i t s demand c u rv e , i t cann ot choose a p r i c e a c c o rd in g to th e
t h e o r e t i c a l c a l c u l u s , b u t must " p la y i t by e a r , " so to
sp e ak .
A ccordin g t o Means, how ever, firm s have d is c o v e re d
t h a t w h e th e r th e y charge a b i t more o r a b i t l e s s may have
no n o t i c e a b l e e f f e c t on th e t o t a l volume o f p r o f i t s . As a
c o n seq u e n ce , as lo n g as t h e f irm does n o t know i t s p r e c i s e
m axim um -profit p r i c e , i t w i l l te n d t o (a) be r e l a t i v e l y
" i n d i f f e r e n t " as t o which p r i c e i t a c t u a l l y c h a r g e s , and
(b) le a v e th e p r i c e unchanged even i n th e fa c e of changing
demand and c o s t c o n d i t i o n s , so long as t o t a l p r o f i t s s ta y
a b o u t th e same.
The l o g i c o f i n d i f f e r e n c e . — For M eans, th e lo g ic
b e h in d su c h i n d i f f e r e n c e t o p r i c i n g i s s im p le : why sh o u ld
t h e f i r m b o t h e r w ith th e d i f f i c u l t t a s k o f c a l c u l a t i n g th e
2X0
most p r o f i t a b l e p r i c e i f f o r a l l p r a c t i c a l p u rp o s e s any
p r i c e w i t h in th e f i r m 's zone o f i n d i f f e r e n c e i s " a s good"
i n term s o f p r o f i t s y i e l d e d ; th e f i r m 's p r i c e may be l e f t
more o r l e s s " c o n s t a n t " so lo ng as m arket f o r c e s do n o t
a l t e r demand and c o s t c o n d i t i o n s " c o n s i d e r a b l y , " i . e . , so
as to n o t i c e a b l y a f f e c t th e volume o f p r o f i t s .
F i n a l l y , i t sh o u ld be n o te d t h a t a c c o rd in g t o Means
a zone o f i n d i f f e r e n c e may be e x p e r ie n c e d even by f irm s
p ro d u c in g n o n - d i f f e r e n t i a t e d ( o r " i n t e r - c h a n g e a b l e " ) p r o
d u c t s , i n I n d u s t r i e s where p r o d u c e r s may p r e f e r t o " a r r i v e
a t and m a in ta in t h e same p r i c e s , " knowing t h a t t h e s e p r i c e s
would n o t be to o f a r o f f th e m axim um -profit p r i c e o f each
f i r m , and would be p r e f e r a b l e t o e n g ag in g i n a p r i c e war.
In summary, i t may be n o te d t h a t t h e d im en sio n s
d is c u s s e d above— p ro d u c t d i f f e r e n t i a t i o n , u n c e r t a i n t y , and
tim e h o r i z o n s — n o t only o f f e r some e x p l a n a t i o n s f o r (a) t h e
f a c t t h a t f irm s may n o t be a b le ( o r d e s i r e ) t o f u l l y m axi
m ize t h e i r p r o f i t s in th e s h o r t r u n , but a l s o f o r (b) th e
phenomenon c a l l e d t h e "zone o f p r i c e i n d i f f e r e n c e " a c c o rd
in g t o w hich f ir m s f i n d i t p o s s i b l e to be l e s s p r i c e -
r e s p o n s i v e — w i t h in c e r t a i n l i m i t s — t o m arket f o r c e s . As a
consequence i t becomes im p o r ta n t t o know what a l t e r n a t i v e
o r su p p le m e n ta ry c o n s i d e r a t i o n s — o t h e r th a n p r o f i t -
m a x im iz a tio n — e n t e r i n t o p la y in th e p r i c i n g d e c i s i o n s o f
f i r m s . Some of t h e s e have a lr e a d y been n o t e d ; o t h e r s remain
t o b e d i s c u s s e d below .
211
In te rd e p e n d e n c e of Firms
In a d d i t i o n t o t h e d e p a r t u r e from t h e key c l a s s i c a l
a ssu m p tio n o f i d e n t i c a l p r o d u c t s , t h e r e have been s i g n i f i
c an t d e p a r t u r e s from th e a ssu m p tio n of l a r g e numbers (and
s r a a l l - s i z e o r " a t o m i s t i c " f i r m s ) . T h is a ssu m p tio n would
a s s u r e t h a t eac h firm (a) rem ain s to o s m a ll and p o w e rle s s
t o i n f l u e n c e m arket p r i c e v i a any change i n i t s own volume
of o u t p u t , and t h e r e f o r e (b) s u b m is s iv e ly s e t s i t s p r i c e
a c c o rd in g t o t h e d i c t a t e s o f " im p e rso n a l" m arket f o r c e s and
" in d e p e n d e n tly " o f any p o s s i b l e r e a c t i o n s o f r i v a l f i r m s ,
which (as seen above) i t may s a f e l y n e g l e c t in a t o m i s t i c
m a rk e ts .
In r e a l i t y , h ow ever, t h e p r o g r e s s o f many
i n d u s t r i e s has been marked by a te n d e n c y t o c o n c e n tr a te
t o t a l o u tp u t i n th e hands o f a r e l a t i v e l y few l a r g e ( o l i g o
p o l i s t i c ) f i r m s , w ith t h e d e g re e of c o n c e n t r a t i o n v a ry in g
from case to c a s e . T h is means t h a t econom ic p r o g r e s s ,
p a r t i c u l a r l y in th e form o f econom ies o f l a r g e s c a l e , h as
s e rv e d t o p r e v e n t a t o m i s t i c c o m p e titio n In a l l b u t a few
segm ents o f th e economy, such as a g r i c u l t u r e , raw m a te r ia ls ,
and th e e x c h a n g e s .^
Meaning o f I n t e r d e p e n d e n c e . — One o f th e c h i e f con
se q u en c es of t h e p re v a le n c e o f o lig o p o l y h a s been th e
^T his s e c t i o n , u n l e s s o th e r w is e s p e c i f i e d , i s b ased
m ain ly on B a in , op. c i t . , pp . 8 5 -2 0 9 , 266-315.
212
abandonment o f " in d e p e n d e n t" p r i c i n g by t h e f i r m — t h a t i s ,
p r i c e s s e t w ith o u t c o n c e rn f o r a n t i c i p a t e d r e a c t i o n s o f
r i v a l s and w ith o u t c o n s u l t a t i o n o r c o l l u s i o n among them —
in f a v o r of a " r e c o g n iz e d in te r d e p e n d e n c e " among th e p r i c e -
makers and a w id e sp re a d u se o f " a d m i n i s t e r e d " p r i c e s , t o be
d is c u s s e d below.
Such i n t e r d e p e n d e n t firm s w i l l te n d t o a d j u s t t h e i r
p r i c e s and o u t p u ts on t h e a ssu m p tio n t h a t r i v a l s w i l l r e a c t
to t h e s e a d ju s tm e n ts i n s y s te m a t i c ways, w ith th e l i k e l i
hood t h a t (where o u t r i g h t p r i c e - w a r s a re a v o id e d ) p a t t e r n s
o f " c o l l e c t i v e , " " j o i n t , " o r " c o l l u s i v e " p r i c i n g by r i v a l
firm s w i l l em erge. I n d e e d , i t i s som etim es co ntend ed by
businessm en t h a t t h e i r d e s i r e to s t a b i l i z e p r i c e s by means
o f " p r i c e a d m i n i s t r a t i o n " r e f l e c t s p r i m a r i l y a d e c i s i o n t o
a v o id c u t t h r o a t form s o f c o m p e titio n and t o c r e a t e a d e v ic e
t h a t a p p ro x im a te s a "m arket e q u i l i b r i u m ." 1
Some r e l a t e d a s p e c t s . — B e fo re we e l a b o r a t e on th e
n a tu r e o f I n te r d e p e n d e n c e , i t may be n o te d t h a t t h i s i s n o t
the p l a c e to d i s c u s s s p e c i f i c a l l y th e d e te r m in a n ts o f con
c e n t r a t i o n and o l i g o p o l i s t i c m ark e t s t r u c t u r e s , and t h e i r
a s s o c i a t e d t e n d e n c i e s to w a rd in te r d e p e n d e n c e of p r i c i n g and
o u tp u t d e c i s i o n s . S u f f i c e i t t o b r i e f l y enu m erate such
s i g n i f i c a n t f a c t o r s (econom ic and i n s t i t u t i o n a l ) as t e c h n i
c a l p r o g r e s s and i n n o v a t i o n , econom ies o f l a r g e s c a l e ,
^ •L a n z lllo tti, op. c l t ■ . p. 937.
213
econom ies o f l a r g e - s i z e f ir m s and I n t e g r a t i o n , " b a r r i e r s t o
e n t r y , " f i n a n c i a l p ro m o tio n ( i n c l u d i n g m e rg e rs and a c q u i s i
t i o n s ) , and th e s e c u l a r e x p a n s io n o f m a r k e ts .
Nor i s t h i s th e p r o p e r c o n te x t f o r a p p r a i s i n g t h e
e x t e n t and n a tu r e o f in te r d e p e n d e n t ( " c o o r d i n a t e d " ) p r i c i n g
i n t h e economy as a w h o le, a lth o u g h t h i s q u e s t io n h as a
m e th o d o lo g ic a l s i g n i f i c a n c e to be d i s c u s s e d below , i n th e
c o n te x t o f th e g e n e r a l p r i c e l e v e l .
However, i t may be n o te d t h a t i n r e a l i t y th e
p r e v a le n c e o f "in d e p e n d e n c e " ( i n th e c l a s s i c a l s e n s e )
v e r s u s " c o l l u s i o n " o r o t h e r form s of i n te r d e p e n d e n t p r i c i n g
i s a m a t t e r of d e g re e . With v e ry few e x c e p t i o n s , n e i t h e r
o f t h e s e p a t t e r n s o f m arket conduct a r e fo u n d i n a p u re o r
extrem e form ; most a c t u a l p a t t e r n s o f p r i c i n g l i e somewhere
a lo n g th e sp e ctru m betw een t h e s e two p o l a r t y p e s , embodying
e le m e n ts o f b o th in d ep e n d en c e and c o l l u s i o n .
R ecognized I n t e r d e p e n d e n c e . - - F o r th e p u rp o se o f
t h i s stu d y th e c h i e f consequence o f o l ig o p o ly and " few n ess"
o f firm s i s t h e f a c t t h a t eac h firm now a c c o u n ts f o r a su b
s t a n t i a l sh a re of th e m a rk e t, so t h a t (a ) i t s p r i c e and
o u tp u t d e c i s i o n s w i l l e x e r t an i n f l u e n c e on t h e s e l l i n g
p r i c e s and s a l e s o f o t h e r f i r m s , (b) c o m p e tito r s w i l l r e a c t
t o th e f i r m ’ s p r i c e - o u t p u t a d ju s tm e n t s , and (c ) each f i r m
r e c o g n i z e s t h i s i n t e r - r e l a t i o n s h i p by s e t t i n g o r a l t e r i n g
i t s p r i c e s and o u tp u t i n th e l i g h t o f a n t i c i p a t e d r e a c t i o n s
by r i v a l s .
214
I t w i l l be n o te d b elo w , i n th e summary o f modern
t h e o r y , t h a t t h i s " r e c o g n iz e d " o r " c o n j e c t u r a l " i n t e r
dependence o f p r i c e - m a k e r s — w hich makes them e v e r c o n s c io u s
o f th e p ro b a b le p r i c e r e a c t i o n s o f c o m p e tito r s to any p r i c e
d e c i s i o n they may c o n s id e r ( e s p e c i a l l y i f t h e number o f
r i v a l s I s r e l a t i v e l y few )— a l s o makes i t d i f f i c u l t f o r them
to v i s u a l i z e t h e u l t i m a t e shape o f t h e i r r e s p e c t i v e demand
c u r v e s , which i n c o r p o r a t e s a l l c o n c e iv a b le r e a c t i o n s of
r i v a l s . 1
Thus th e f a c t t h a t th e in te r d e p e n d e n t f ir m cannot
r e g a r d i t s e l f as "an i s l a n d u n to I t s e l f " (a s i n th e c a se o f
p u re c o m p e titio n ) f o s t e r s a d e s i r e among r i v a l s to r e p l a c e
d e s t r u c t i v e form s o f c o m p e titio n (su c h as p r i c e w ars) w ith
th e c u l t i v a t i o n of " s t a b l e r e l a t i o n s h i p s . " T h is e x p la in s
th e te n d e n c y o f r i v a l s t o m a i n ta in th e " s t a t u s quo" ( f o r
m a lly o r i n f o r m a ll y ) so long a s th e demand and c o s t c o n d i
t i o n s th e y f a c e In common a re fu n d a m e n ta lly unchanged.
I m p l i c a t i o n s o f i n te r d e p e n d e n c e . — What a r e th e main
i m p l i c a t i o n s o f t h i s p r e f e r e n c e f o r s t a b l e r e l a t i o n s h i p s
f o r th e p r i c e p o l i c i e s o f f ir m s ? I t h a s been r e a s o n a b ly
a s s e r t e d t h a t i n te r d e p e n d e n t fir m s w i l l t e n d to a d j u s t
t h e i r p r i c e s m ain ly I n r e s p o n s e t o changes i n demand a n d /o r
^U nless o th e rw is e I n d i c a t e d , t h e re m a in d e r o f t h i s
s e c t i o n I s b a se d p r i m a r i l y on Bowen, o p . c l t . . pp. 290-93*
297.
215
c o s t c o n d it i o n s t h a t (a) a f f e c t m ost o r a l l of them in a
f a i r l y u n ifo rm m anner, and (b) a r e e x p e c te d to be r e l a t i v e l y
p e rm a n en t. S i n c e , as a r u l e , i t i s changes i n c o s t s t h a t
f u l f i l l t h e s e two c r i t e r i a much more s a t i s f a c t o r i l y th a n
changes i n demand, i t i s r e a s o n a b le t o co n clu d e t h a t firm s
w i l l t e n d t o a s s i g n a r e l a t i v e l y more a c t i v e r o l e in th e
p r i c i n g p r o c e s s t o changes in c o s t s th a n t o changes in
demand.
These c o n c lu s io n s a p p e a r t o be c o n s i s t e n t w ith th e
f i n d i n g t h a t th e f u l l - c o s t o r c o s t - p l u s t y p e of adm in
i s t e r e d p r i c e s ( t o be d is c u s s e d b e lo w ), a s a d e te rm in a n t o f
th e l e v e l of p r i c e , i s m ost s i g n i f i c a n t where th e m arket
s t r u c t u r e a p p ro x im a te s a p u re o lig o p o ly ( w ith s t a n d a r d i z e d
p r o d u c t s ) , marked by a h ig h d e g re e of c o n j e c t u r a l i n t e r
dependence and a i d e d , p e r h a p s , by c o n s u l t a t i o n . 1
An im p o rta n t e x c e p ti o n may be th e case of a firm
t h a t s u f f e r s a downward s h i f t i n i t s demand curve a t t r i b u t
a b le t o a p r i c e c u t by an im p o r ta n t r i v a l . In t h i s case
th e t h r e a t e n e d f ir m i s p r e s s u r e d i n t o r e t a l i a t i o n by
c u t t i n g i t s p r i c e to o i n o r d e r to p r o t e c t (a) i t s im m ediate
p r o f i t p o s i t i o n , (b) i t s lo n g - r u n sh a re o f th e m a r k e t, and
p o s s i b l y (c) any r e p u t a t i o n i t may have h a d f o r n o t b e in g
u n d e rs o ld .
R i c h a r d B. H e fle b o w e r, " P u l l C o s t s , Cost Changes,
and P r i c e s , " i n N a t io n a l Bureau o f Economic R e s e a rc h ,
B u s in e s s C o n c e n tra tio n and P r ic e P o lic y ( P r i n c e t o n :
P r i n c e t o n U n i v e r s i ty P r e s s , 1 9 5 5 ), p. 378.
2X6
Some B a s ic C o n c lu sio n s
In summary, i t may be co n clu d ed t h a t th e p e r v a s iv e
r o l e s of n o n -p e c u n ia ry o r s o c i a l m o ti v a ti o n s and t h e i n f l u
ence o f u n c e r t a i n t y and in te r d e p e n d e n c e w i l l te n d t o a f f e c t
th e r o l e s p la y e d by demand and c o s t s i n t h e f i r m 's p r i c i n g
d e c i s i o n s a p p ro x im a te ly as f o l lo w s :
1) P r i c e s w i l l t e n d t o be more " s e n s i t i v e " t o c o s t s
i n th e sense t h a t changes in c o s ts a re g e n e r a l l y more -
l i k e l y to provoke some p r i c e a d ju s tm e n t th a n are changes i n
demand.
2) I t i s more l i k e l y t h a t I n c r e a s e s i n c o s t s w i l l
lea d t o i n c r e a s e s in p r i c e s th a n t h a t d e c r e a s e s i n c o s ts
w i l l le a d to d e c r e a s e s in p r i c e s .
3) In th e case o f demand, i t i s more l i k e l y t h a t a
d e c re a s e in demand ( i . e . , a downward s h i f t of the demand
curve) w i l l in d u ce a p r i c e cut th a n t h a t an i n c r e a s e in
demand w i l l l e a d t o a p r i c e i n c r e a s e .
U n d e rly in g th e s e c o n c lu s io n s l i e s th e p e r v a s iv e
f a c t t h a t , as C ham berlin p u t s i t , p r i c i n g p o l ic y i n th e
w orld of m o n o p o lis tic c o m p e titio n — which i s a more
" g e n e r a l" c o n d i t i o n th a n p u re c o m p e titio n — m ust embrace
p o l i c y p r i n c i p l e s and o b j e c t i v e s " o t h e r th a n p r o f i t
m a x im iz a tio n ," s p e c i f i c a l l y th e " c o s t - p l u s " p r i n c i p l e
im p lie d above and t o be d is c u s s e d below . In c o n t r a s t ,
^owen, op. c i t . , pp. 293-96.
217
u n d e r pure c o m p e titio n th e p r a c t i c e o f " p r i c e p o lic y " by
th e f ir m i s im p o s s ib le s in c e th e s e l l e r ' s only a l t e r n a t i v e
i s t o conform to th e m arket p r i c e . 1
Modern P r i c i n g Theory
As a p r e f a c e t o a p o s i t i v e d e s c r i p t i o n of th e r o l e
of p r i c e " a d m i n i s t r a t i o n , " i t w i l l be u s e f u l t o p r e s e n t a
b r i e f summary of t h e c o n c lu s io n s of "modern" econom ic theory
c o n c e rn in g th e p o s s i b l e im p a c ts of s h i f t s in c o s t and
demand s c h e d u le s on th e p r i c e s s e t by th e f i r m . 2
As h a s become e v i d e n t by now, a c c o rd in g to modern
th e o r y p r i c e changes made by th e f irm a re "m ed iated " o r
c h a n n e lle d e x c l u s i v e l y th ro u g h th e f i r m 's c o s t and demand
c u r v e s , a c c o rd in g t o th e g u i d e l i n e s of th e p r o f i t -
m axim izing p r i n c i p l e . What a re th e c h i e f c h a r a c t e r i s t i c s
o f th e s e two b a s i c c u r v e s , a t v a r i o u s l e v e l s o f th e f i r m 's
o u tp u t?
The shape of c o s t s . — As f a r as th e p r o b a b le shape
o f th e c o s t curve i s c o n c e rn e d , t h e r e i s a g e n e r a l con
s e n s u s among e c o n o m ists t h a t , a t l e a s t in m a n u f a c tu r in g ,
a v e ra g e v a r i a b l e c o s t s t e n d t o be a p p ro x im a te ly c o n s ta n t
■^Edward H a s tin g s C h a m b e rlin , Towards a More G e n e ra l
Theory of V alue (New York: Oxford U n i v e r s i ty P r e s s , 1 9 5 7 ),
p. 24.
2U n le ss o th e r w is e s p e c i f i e d , t h e fo llo w in g summary
i s b ased on Bowen, op. c l t . , pp. 25 7-75.
218
o v e r a f a i r l y wide ra n g e of o u tp u t r a t e s (assum ing c o n s t a n t
f a c t o r p r i c e s ) . ^ However, a t f a i r l y " h ig h " l e v e l s o f o u t
p u t t h e s e v a r i a b l e c o s t s may be e x p e c te d t o (a) r i s e
g r a d u a l l y a t o u tp u t l e v e l s r e q u i r i n g o v e rtim e l a b o r , and
(b) r i s e s h a r p ly a t l e v e l s r e q u i r i n g f u l l u t i l i z a t i o n of
th e f i x e d f a c t o r s o f p r o d u c t i o n , so t h a t any a d d i t i o n a l
d o ses o f v a r i a b l e f a c t o r s can n o t i n c r e a s e p r o d u c tio n .
The shape of demand.- - A s f a r a s th e shape of th e
demand (and m a r g in a l re v e n u e ) curve i s c o n c e rn e d , much l e s s
can be s a i d a s c o n f i d e n t l y . While i t may be s a f e l y assumed
t h a t th e f i r m 's demand curve w i l l n o rm a lly have a n e g a t i v e
s lo p e th ro u g h o u t (and t h a t th e e l a s t i c i t y w i l l be g r e a t e r
th a n u n i t y a t th e p o i n t of th e "g o in g p r i c e " ) , th e p r o b a b le
shape o f th e curve depends c o n s i d e r a b ly on th e s u b j e c t i v e
" c o n j e c t u r e s " o f t h e p r ic e - m a k e r .
The r e a s o n f o r t h i s , as n o te d abo v e, i s t h a t t h e
s l o p i n g demand curve g e n e r a l l y c an n o t be c o n ce iv e d sim p ly
as a s c h e d u le of q u a n t i t i e s demanded a t v a r i o u s a l t e r n a t i v e
p r i c e s s e t by th e g iv e n p r ic e - m a k e r a l o n e , b u t must a l s o
r e f l e c t t h e q u a n t i t i e s demanded a f t e r th e r e a c t i o n s ( i . e . ,
p r i c e d e c i s i o n s ) o f r i v a l f i r m s s e l l i n g s i m i l a r p r o d u c ts
have been r e g i s t e r e d on th e m a rk e t. T hat i s , t h e shape of
th e demand cu rve f o r th e p r o d u c t o f t h e i n d i v i d u a l f i r m
■1-See th e d i s c u s s i o n o f th e " o p tim a l ra n g e " i n B a in ,
op. c i t . . pp. 152-55* and H e fle b o w e r, op. c l t . , 369— 73-
w i l l depend t o some e x t e n t upon th e p r i c e p o l i c i e s of r i v a l
f i r m s . The c o n j e c t u r a l in te r d e p e n d e n c e c h a r a c t e r i s t i c o f
su c h m a rk e ts may t h e r e f o r e in d u c e th e i n d i v i d u a l firm t o
c o n c e iv e o f i t s demand curve as a lr e a d y I n c o r p o r a t i n g " th e
f u l l e f f e c t " of r i v a l s ' p r i c e r e a c t i o n s ( t o any changes of
i t s own p r i c e s ) on t h e f i n a l s a l e s o f i t s p r o d u c t.
Changes in demand. — On t h e b a s i s of th e above
g e n e r a l i z a t i o n s , what does modern th e o r y s u g g e s t about th e
l i k e l y im p a c ts of ch an g e s i n demand and c o s t s on th e p r i c e s
c h a rg e d by th e firm ? To ta k e t h e c a se o f demand f i r s t , th e
e f f e c t on p r i c e w i l l g e n e r a l l y depend on (a) t h e n a t u r e of
t h e s h i f t i n the demand curve i t s e l f , and (b) th e shape of
t h e f i r m 's c o s t c u r v e s . S t a t e d somewhat more p r e c i s e l y :
t h e p r i c e e f f e c t d ep end s on th e b e h a v io r of th e m a r g in a l
c o s t curve i n the p o r t i o n a f f e c t e d by th e changed l e v e l s o f
o u t p u t , and th e c o m p a ra tiv e e l a s t i c i t y of demand a t t h e s e
two r e s p e c t i v e p o i n t s .
F o r exam ple, i f th e f i r m f i n d s i t s e l f o p e r a t i n g a t
l e s s than 100 p e r c e n t o f c a p a c i ty even a f t e r t h e s h i f t in
demand— a n d , as i n d i c a t e d a b o v e , v a r i a b l e c o s ts a re f a i r l y
c o n s t a n t o v e r t h i s ra n g e of o u tp u t— t h e n th e e f f e c t on
p r i c e w i l l depend e x c l u s i v e l y on any change i n th e e l a s
t i c i t y of demand b e tw ee n th e o ld and new r a t e s of o u t p u t.
However, t h e r e i s a b a s i c d i f f i c u l t y p o se d by t h i s
c a s e : a p p a r e n tly v e ry l i t t l e i s known about t h e p o s s i b l e
220
im p a c ts of s h i f t s i n demand on e l a s t i c i t y , so t h a t few i f
any r e l i a b l e p r e d i c t i o n s can be made a b o u t su c h im p a c ts .
At b e s t t h e r e i s th e h i g h ly t e n t a t i v e c o n c lu s io n o f J o a n
R obinson t h a t , s i n c e some r e d u c t i o n i n e l a s t i c i t y w i l l
o c c u r w ith an i n c r e a s e in demand, some i n c r e a s e in p r i c e
can be e x p e c te d .
At maximum c a p a c i t y . — At th e o t h e r extrem e i s t h e
c ase of th e f ir m t h a t i s a lr e a d y o p e r a t in g a t 100 p e r c e n t
o f c a p a c i t y . Here t h e slo p e o f th e demand cu rve i s no
lo n g e r c r u c i a l f o r t h e c a l c u l a t i o n of th e s i z e o f th e p r i c e
a d ju s tm e n t. I f i t was p r o f i t a b l e f o r t h e f i r m to be o p e r
a t i n g a t t h i s r a t e b e f o r e th e s h i f t i n demand, th e n th e
f ir m w i l l sim p ly s e t th e new p r i c e a t some p o i n t h i g h e r up
on th e v e r t i c a l p o r t i o n of i t s v a r i a b l e c o s t f u n c t i o n ,
where th e new demand c u rv e i n t e r s e c t s i t . In o t h e r words*
a p r i c e i n c r e a s e i s c e r t a i n , and i t s s i z e w i l l e q u a l t h e
m agnitude o f th e v e r t i c a l s h i f t i n t h e demand cu rv e .
F i n a l l y , i n th e case i n t e r m e d i a t e betw een t h e s e
two— where t h e i n c r e a s e d demand b r i n g s th e f ir m from l e s s
th a n 100 p e r cen t c a p a c i t y o p e r a t i o n s t o i t s maximum o u t
p u t — i t i s s a f e to sa y o n ly t h a t th e chances o f a p r i c e
i n c r e a s e a re g r e a t e r t h a n i n th e f i r s t case m entioned
a b o v e. But how much o f an i n c r e a s e , i f a t a l l , cannot be
c l e a r , b e c a u se th e o l d p r i c e h ad been i n f l u e n c e d by t h e
s lo p e o f t h e demand c u rv e as w e l l as i t s p o s i t i o n .
221
Changes I n c o s t s . — What does modern th e o r y s u g g e s t
abou t th e p r i c e e f f e c t s e x p e c te d from a change i n c o s t s ?
The f i r s t n o tew o rth y p o in t i s o f a t e n t a t i v e s o r t : w h ile
i t i s commonly a g re e d t h a t an i n c r e a s e i n c o s t s w i l l
n o rm a lly le a d t o some i n c r e a s e in p r i c e — d e p e n d in g , f o r
e x am p le, on th e b e h a v io r of m a r g in a l c o s t s in t h e o u tp u t
ran g e w i t h i n which th e firm i s o p e r a t i n g — th e i n c r e a s e i n
p r i c e w i l l a l s o depend c o n s id e r a b ly on th e shape o f th e
demand f u n c t i o n s above th e o ld p r i c e . As a c o n seq u e n ce , so
lo n g as th e f ir m la c k s d e f i n i t e knowledge about th e shape
o f i t s demand (and c o s t ) c u r v e s , t h e r e i s no re a s o n t o
e x p e c t any s p e c i f i c and u n v a ry in g n u m e r ic a l r e l a t i o n s h i p t o
e x i s t betw een changes in m a r g in a l c o s t s and p r i c e .
On th e o t h e r h an d , i t i s p o s s i b l e t o r e p o r t some
what more p o s i t i v e s p e c u l a t i o n s . In t h e f i r s t p l a c e , i t i s
v e ry l i k e l y t h a t i n a l l but th e most u n u s u a l c a s e s an
i n c r e a s e i n c o s t s w i l l r e s u l t i n a t l e a s t some I n c r e a s e I n
p r i c e . But how much o f an i n c r e a s e ? Theory s u g g e s ts t h a t
th e m agnitude o f p r i c e I n c r e a s e w i l l be of a s m a ll e r p e r
c e n ta g e th a n th e i n c r e a s e In m a rg in a l c o s t s . The r e a s o n
c o n s i s t s o f two p a r t s : (a) th e upward s h i f t i n th e
m a r g in a l c o s t curve w i l l I n v a r i a b l y move t h e f ir m up i n a
n o r th w e s t d i r e c t i o n a lo n g t h e g iv e n demand c u rv e , and (b)
th e i n c r e a s e d e l a s t i c i t y t y p i c a l o f t h i s p o r t i o n o f t h e
demand curve e x e r t s a downward p r e s s u r e on th e r e s u l t i n g
p r i c e .
222
C o n c lu sio n s a p p r a i s e d . - - I n a p p r a i s i n g t h e s e con
c lu s io n s of modern th e o r y on t h e p ro b a b le im p acts o f s h i f t s
i n demand and c o st c u rv e s upon th e p r i c e s charg ed by f i r m s —
u n d e r th e b a s i c a ssu m p tio n o f p r o f i t - m a x i m i z a t i o n —
e c o n o m ists c a u tio n a b o u t th e l i m i t e d a p p l i c a b i l i t y o f th e
c o n c l u s i o n s .
In t h e case o f c o s t s , t h e c o n c lu s io n s re a c h e d by
th e o r y cire a p p a r e n t l y b ased on models a p p l i c a b l e o n ly t o
changes f a c e d by th e i n d i v i d u a l firm . T hat i s , i f th e
f i r m ’ s c o s t s i n c r e a s e d owing t o an i n d u s t r y - wide wage
b o o st ( r a t h e r th a n owing t o an i n c r e a s e In i t s own wages
o n l y ) , th e im pact o f th e c o s t change c o u ld no lo n g e r be
a n a ly z e d on th e a ssu m p tio n t h a t th e f i r m ’s demand c u rv e was
" g i v e n ." The re a s o n I s t h a t an i n d u s tr y - w id e w a g e - in c r e a s e
a l s o c o n s t i t u t e s a w a g e - p u ll t h a t would cause somewhat of
an upward s h i f t In t h e f i r m 's demand c u r v e , a change t h a t
must a l s o be a c c o u n te d f o r by th e f ir m .
In t h e case o f demand changes I t seems more d i f f i
c u l t t o p r e d i c t w ith any c o n fid e n c e th a n i n th e c a se of
c o s t ch an g e s. For one t h i n g , th e firm I s on more s o l i d
ground In e s t i m a t i n g t h e shape o f i t s c o s t c u rv e s th a n I t s
demand c u rv e s . As a con sequence i t i s more l i k e l y t h a t a
p r i c e i n c r e a s e would fo llo w an I n c r e a s e i n c o s t s th a n I t
would f o llo w an I n c r e a s e in demand. Only i n th e s p e c i a l
c a se in w hich th e f i r m i s o p e r a t i n g a t c a p a c i ty p r i o r t o
223
the r i s e in demand c o u ld we r e a s o n a b ly e x p e c t i n c r e a s e d
demand t o in d u c e an i n c r e a s e in p r i c e s c h arg ed .
A d m in iste re d P r i c e s
F o r th e sake o f c o n v e n ie n c e , t h e p r i c i n g p o l i c i e s
and p ro c e d u re s o f p r ic e - m a k e r s w i l l be g e n e r a l l y r e f e r r e d
to h e r e a f t e r a s " a d m i n i s t e r e d p r i c e s . " In c o n t r a s t t o th e
w e l l - e s t a b l i s h e d s p e c u l a t i o n s o f modern th e o ry on th e
p r o c e s s e s of p r i c e d e t e r m i n a t i o n , th e s e p a r a t e and s t i l l -
grow ing body o f w r i t i n g s on a d m i n i s t e r e d p r i c e s may, f o r
th e p u rp o se o f t h i s s t u d y , be r e g a r d e d as com plem entary to
( r a t h e r th a n c o m p e titiv e w ith ) th e r e s u l t s o f t r a d i t i o n a l
th e o r y .
As a lr e a d y i n t i m a t e d abo v e, and i n th e c h a p t e r on
w ages, im p o r ta n t segm ents o f th e l i t e r a t u r e on i n f l a t i o n
p ro c e e d on t h e a ssu m p tio n t h a t a d m i n i s t e r e d p r i c e s ( i n c l u d
in g wages and p r o f i t s ) and markup p r i c i n g a re n o t o n ly a
w id e sp rea d phenomenon in o u r economy, b u t a l s o l i e a t t h e
h e a r t o f th e i n f l a t i o n p r o c e s s d u rin g "norm al" o r p e a c e tim e
p e r i o d s , when a g g r e g a te demand i s n o t " e x c e s s iv e " and th e
im p u lse s t o i n f l a t i o n stem m o stly from th e s id e o f w ages,
p r o f i t s and o t h e r c o s t s . In d e e d , one e co n o m ist h a s gone
so f a r as t o c la im t h a t th e i n f l a t i o n p r o c e s s i s " e s s e n
t i a l l y an a d m i n i s t r a t i v e o n e ," w h ile a n o th e r has w r i t t e n an
224
e n t i r e study aro u n d t h e p r o f i t m argin a s the fu lc ru m of
i n f l a t i o n . 1
O r ig in o f t h e te rm . — The term " a d m i n i s t e r e d p r i c e s "
was o r i g i n a l l y i n tr o d u c e d by G a rd in e r C. Means who in te n d e d
i t t o se rv e as a " n e u t r a l t e c h n i c a l " t e r m . I t was d e sig n e d
n o t t o imply any " c r i t i c i s m o r approbrium " c o n c e rn in g th e
p r i c i n g p o l i c i e s of com panies, b u t t o d e s c r i b e and e x p la in
how th e b e h a v io r of p r i c e s i n im p o rta n t segm ents o f th e
modern economy d i f f e r e d from t h e b e h a v io r p r e s c r i b e d by
c l a s s i c a l t h e o r y . 2
A ccording t o Means, t h e c h ie f c h a r a c t e r i s t i c of
a d m in is te r e d p r i c e s I s t h e i r te n d e n c y t o rem ain " c o n s t a n t "
o r " i n f l e x i b l e " f o r n o t i c e a b l e p e rio d s o f tim e (m onths o r
y e a r s ) In a p p a r e n t d i s r e g a r d o f presum ed changes i n demand
and s u p p ly c o n d i t i o n s i n th e m a rk e t. In d e e d , s a y s Means,
such p r i c e s a r e sim ply "not d e te rm in e d by th e law o f supply
and demand."
The l a t t e r s ta te m e n t sounds e x tre m e in t h e sen se
t h a t , as n o te d by Means h i m s e l f , the p r i c e - m a k e r 's " a r e a o f
^ R e s p e c t i v e l y , th ey a r e G ardner A ckley, "Admin
i s t e r e d P r i c e s and t h e I n f l a t i o n a r y P r o c e s s ," The American
Economic R eview , XLIX (May, 1 9 5 9 ), P. 42 8, and G a r d in e r C.
Means, P r i c i n g Power . . . . o p . c i t .
U n le ss o th e r w is e s p e c i f i e d , t h e f o llo w in g d i s
c u s s io n i s b a s e d m ain ly on M eans, P r i c i n g Power . . . ,
op. c i t . . p p . 9 , 11, 2 0 , 173- 8 5 , 268. hS ta te m en t o f . " op.
c i t . . p'p. 76 , 80, 90, and " D is c u s s io n " on "A d m in is te re d
225
d i s c r e t i o n " w ith in which he can a l t e r p r i c e s w ith o u t a p p re
c i a b l e e f f e c t on p r o f i t s i s a c t u a l l y l im i t e d by "m arket
f o r c e s . " That i s , th e s e l l e r i s " n o t f r e e to choose any
p r i c e he w ish e s and be a b le t o be econom ic": a t td o high
a p r i c e th e firm w i l l lo s e more from th e few er u n i t s so ld
th a n i t g a in s from th e p r i c e in c r e m e n t, and a t to o low a
p r i c e i t l o s e s more from th e p r i c e decrem ent th a n i t g a in s
from th e i n c r e a s e d u n i t s s o ld .
The r o l e o f m arket f o r c e s . — In d e e d , the concept o f
"m arket f o r c e s " a t work i n th e d e te r m in a tio n o f admin
i s t e r e d p r i c e s — which w i l l be f u r t h e r d is c u s s e d below —may
be p r o p e r ly expanded t o acco u n t e x p l i c i t l y f o r two
im p o rta n t m arket dim ensions d is c u s s e d above: (a) p ro d u ct
d i f f e r e n t i a t i o n , p r e v a l e n t over wide s e c t o r s o f t h e
economy, and (b) th e t h r e a t of " e n tr y " by a c t u a l o r
p o t e n t i a l c o m p e tito r s . These two d im ensions a r e a c t u a l l y
o p e r a t i v e in c o m b in atio n : w hereas p ro d u c t d i f f e r e n t i a t i o n
g iv e s th e f ir m a "m arket o f i t s own," t h e a b i l i t y to
e x p l o i t t h i s m arket i s l i m i t e d i n v a ry in g d e g re e s by the
p o t e n t i a l e n t r y o f new c o m p e titio n .^
P r i c e s R e c o n s id e re d ," The American Economic Review, XLIX
(May, 1959), p . 452.
■^Padraic P. P r u c h t , " ’ A d m in iste re d P r i c e s ' Re
exam ined," i n Chamber of Commerce o f th e U n ited S t a t e s ,
A d m in iste red P r i c e s and I n f l a t i o n (W ashington, D .C .:
Chamber o f Commerce of t h e U n ited S t a t e s , 1959), p . 59.
226
In any e v e n t , M eans' em p h asis on t h e r e l a t i v e
c o n sta n c y o r i n f l e x i b i l i t y of a d m i n i s t e r e d p r i c e s i s in
n o t i c e a b l e c o n t r a s t t o t h e f l e x i b i l i t y o f p r i c e s e x p e c te d
u n der p u re c o m p e titio n : h e re changes i n m ark et su p p ly and
demand a u t o m a t i c a l l y cause r e s p o n s i v e changes i n p r i c e s ,
which i n t u r n a re supp osed to " c l e a r th e m ark et" o f any
e x c e s s e s in demand o r s u p p ly , v i a th e e l a s t i c i t y o f b u y e r s ’
demand and s e l l e r s ' s u p p ly .
Some a d d i t i o n a l a s p e c t s . — I t may be n o te d t h a t i n
a d d i t i o n t o th e p rim ary c h a r a c t e r i s t i c o f p r i c e
" i n s e n s i t i v i t y " i n t h e s h o r t - r u n , Means l i s t s t h e f o l lo w in g
a s s o c i a t e c h a r a c t e r i s t i c s t h a t may e x i s t w h e ree v er a r e l a
t i v e l y few l a r g e f ir m s dom inate t h e o u tp u t o f an i n d u s t r y
o r p ro d u c t l i n e , p a r t i c u l a r l y i n t h e s t e e l i n d u s t r y :
a) Competing p r i c e a d m i n i s t r a t o r s , r a t h e r th a n t h e
m a rk e t, te n d t o s e t th e same p r i c e s o r m a i n ta in th e same
p r i c e d i f f e r e n t i a l s o v e r c o n s i d e r a b l e p e r i o d s o f tim e .
b) One f i r m i s l i k e l y t o be s i n g l e d o u t as " l e a d e r "
i n making p r i c e changes t h a t o t h e r f ir m s may o r may n o t
f o llo w .
c) P r i c e s te n d t o be s e t i n term s o f lo n g - r u n con
s i d e r a t i o n s r a t h e r th a n i n term s o f s h o r t - r u n v a r i a t i o n s in
demand and s u p p ly , th e i m p l i c a t i o n b e in g t h a t i n th e s h o r t -
ru n p r i c e a d m i n i s t r a t o r s o f t e n do n o t se ek t o maximize
p r o f i t s .
d) The l e v e l o f p r i c e s s e t by f i r m s (and t h e e n su
in g l e v e l of p r o f i t s ) w i l l te n d t o be h i g h e r th a n j u s t i f i e d
by th e " p u b l i c i n t e r e s t , " th e l a t t e r b e in g d e f in e d i n te rm s
of th e p r i c e - c o s t r e l a t i o n s h i p s e x p e c te d u n d e r p u re compe
t i t i o n .
Towards a p o s i t i v e d e f i n i t i o n . — F o r th e p u rp o se of
t h i s stu d y on i n f l a t i o n — p a r t i c u l a r l y th e im pact on p r i c e s
o f changes i n demand and c o s t s — Means* c r i t e r i o n o f i n f l e x
i b i l i t y i s n o t p e r se v e ry u s e f u l , even i f i t i s a c c e p te d
as e m p i r i c a l l y v e r i f i e d . Nor does Means* d e f i n i t i o n of
a d m in is te r e d p r i c e c o n s t i t u t e t h e o n ly o n e . 2
l F o r exam p le, th e " q u o te d " p r i c e s u se d i n s t a t i s t i
c a l s t u d i e s i n d i c a t i n g " p r i c e i n f l e x i b i l i t y " o f t e n may n o t
be th e f i n a l p r i c e s a c t u a l l y r e a l i z e d i n t r a n s a c t i o n s ,
a f t e r d i s c o u n t s , c o v e r t p r i c e s h a v in g , and o t h e r a d j u s t
m e n ts; se e W a lte r D. F a c k l e r , "The R e l a t i o n s h i p o f P r i c e s
t o Economic S t a b i l i t y and G row th," i n U . S . , C o n g re ss, J o i n t
Economic Com m ittee, C om m entaries, The R e l a t i o n s h i p of
P r i c e s t o Economic S t a b i l i t y aind'Growth (W ashington: U.S.
Government P r i n t i n g O f f i c e , 1 9 5 8 ), p. 93. F o r a c r i t i q u e
o f Means* te c h n iq u e o f d e f i n i n g and m ea su rin g p r i c e f l e x i
b i l i t y , s e e Chamber o f Commerce o f th e U n ite d S t a t e s ,
o p . c i t . , pp. 1*1-44. F u r t h e r , p r i c e i n s e n s i t i v i t y i n th e
s h o r t - r u n may m e re ly r e f l e c t th e " to o clumsy and slo w -
moving" d a y -to -d a y d e c is io n -m a k in g a p p a r a tu s of l a r g e f ir m s
which in d u c e s them t o even ig n o r e r i v a l s * a c t i o n s p ro v id e d
th e y a re " n o t to o r a d i c a l " ; see Baumol, op . c i t . , p . 28.
2F o r a l t e r n a t i v e d e f i n i t i o n s s e e , f o r e x am p le,
F a c k l e r , op . c i t . , pp. 92-93» and Committee on P r i c e D e te r
m in a tio n f o r th e C onferen ce on P r i c e R e s e a r c h , C ost
B e h av io r and P r i c e P o lic y (New York: N a t i o n a l B ureau o f
Economic R e s e a rc h , 1 9 4 3 ), pp. 4 2 -4 4 , 2 7 2 -8 7 .
228
As a f i r s t a p p ro x im a tio n , we would p r e f e r t o con
s i d e r a p r i c e " a d m in is te r e d " i f ( a ) i t i s o s t e n s i b l y s e t by
t h e f irm r a t h e r th a n by th e " m a r k e t," (b) i t i s th e r e s u l t
o f " p r i c i n g p o l ic y " d e c i s i o n s hammered o u t as a "compromise"
o f th e d i v e r s e gro u p s and i n t e r e s t s w ith in th e f i r m , (c ) i t
i s p r e s e n t e d i n some form o f a d m i n i s t r a t i v e a c t i o n , su c h as
a fo rm a l ( o r in f o r m a l) announcem ent or a n e g o t i a t e d
c o n t r a c t , and (d) i t i s im plem ented or " a d m in is te r e d " by an
a r r a y o f s u b o r d i n a te u n i t s w ith more o r l e s s d i s c r e t i o n t o
make a d ju s tm e n ts when n e c e s s a r y to m a in ta in o r expand
s a l e s . • * -
T h is m eaning i s much b r o a d e r and l e s s t e c h n i c a l
th a n t h a t o f Means, whose most s i g n i f i c a n t a p p l i c a t i o n o f
th e te rm has a p p a r e n t l y been t o t h e p r i c i n g p r a c t i c e s o f
" b ig c o r p o r a t io n s " o r o l i g o p o l i s t i c f i r m s . The b r o a d e r
se n s e o f th e te rm u sed h e re encom passes p r a c t i c a l l y a l l
p r i c e - m a k e r s , which i n e f f e c t means alm ost th e whole of
m a n u f a c tu r in g , w h o l e s a l i n g , r e t a i l i n g , and s e r v i c e i n d u s
t r i e s .
C o st— P lu s and Markups
As a se co n d a p p ro x im a tio n , we may c h a r a c t e r i z e as
" a d m i n i s t e r e d " th o se p r i c e s which a r e b e li e v e d t o be
■^See Committee on P r ic e D e te r m in a tio n , i b i d .
229
d e te rm in e d a c c o rd in g t o a genus o f "markup" p r i c i n g f o r
m u la s , as in such i n d u s t r i e s a s m a n u f a c tu r in g , th e d i s t r i
b u t iv e t r a d e s , and t h e p r o c e s s in g of a g r i c u l t u r a l raw
m a t e r i a l s . These markup fo rm u la s o f t e n go under t h e head
in g o f " c o s t - p l u s , " as w e ll as " f u l l - c o s t , " " g r o s s - m a r g in ,"
and " s t a n d a r d c o s tin g ? t o make up a somewhat h e te ro g e n e o u s
system o f p r i c i n g . T h is may be p a r t l y e x p la in e d by t h e
f a c t t h a t p r i c i n g m ethods o r fo rm u la s g e n e r a l l y t e n d t o
vary a c c o rd in g to t h e n a t u r e of t h e p ro d u c t and c o m p e titio n ,
as w e l l as th e s p e c i f i c g o a ls o f o v e r r i d i n g im p o rta n c e t o
th e f i r m . I n any e v e n t , th e v a r i e t y of f o r m u la ti o n s and
v e r s i o n s of t h e c o s t - p l u s d o c t r i n e h as made i t d i f f i c u l t to
d e f i n e i t p r e c i s e l y . 1
An a d d i t i o n a l p r e l i m i n a r y n o te m ust be made. The
c o s t - p l u s d o c t r i n e i s u s e f u l i n e x p l a i n i n g n o t only t h e
l e v e l o f th e p r i c e s e t by t h e f i r m a t a g iv e n tim e , b u t
a l s o t h e c o n d it i o n s u n d e r which t h a t p r i c e w i l l o r w i l l n o t
be changed by th e f i r m .
U n l e s s o th e r w is e s p e c i f i e d , th e f i r s t p a r t s o f
t h i s s e c t i o n a re b a se d m ainly on H e fle b o w e r, op. c i t . ,
pp. 3 6 2 -6 9 , 3 7 2 -7 3 , 378. See a l s o B a in , op. c i t . , p . 286;
Means, P r i c i n g Power . . . , op. c i t . . p . 2^8; C h a r le s L.
S c h u l t z e , R ecent I n f l a t i o n i n th e U n ite d S t a t e s . U . S . ,
C o n g re ss, J o i n t Economic Com m ittee, S tu d y P aper No. 1 (Wash
i n g t o n : U.S. Government P r i n t i n g O f f i c e , 1 9 5 9 ), p. 9 1 ;
G ard n er A ck ley, M acroeconomic T heory (New York: M acm illan
Company, 19 6 1 ), p . *452.
230
I t would a p p e a r a t f i r s t s ig h t t h a t m ain ly the
l a t t e r a s p e c t ( o f changes i n p r i c e ) i s most p e r t i n e n t t o an
u n d e rs ta n d in g of t h e s p e c i a l r o l e p la y e d by a d m i n i s t r a t i v e
p r i c i n g in th e i n f l a t i o n p r o c e s s . The re a s o n in g would be
t h a t markup p r i c i n g d e te rm in e s n o t only when p r i c e s a re
r a i s e d by th e f ir m b u t a l s o by how much and by what method
t h i s m argin i s d e te r m i n e d .1 In o th e r w ords, t h e f irm
cou ld r a i s e i t s p r i c e " s p o n ta n e o u s ly " by sim ply i n c r e a s i n g
i t s markup, w ith o u t a p r i o r r i s e i n c o s t s .
However, as w i l l be seen below , th e f i r s t a s p e c t
a ls o has s u b s t a n t i a l r e l e v a n c e , s in c e even an unchanged
p r i c i n g m argin can se rv e as a mechanism f o r th e p r o p a g a tio n
of i n f l a t i o n . On b o th of th e s e a s p e c t s much h a s a lr e a d y
been n o te d (above and in p r e c e d in g c h a p t e r s ) i n an e x p l i c i t
o r i m p l i c i t way; how ever, some a d d i t i o n a l f a c e t s must be
added below .
The meaning of c o s t - p l u s . — B r i e f l y s t a t e d , t h e
c e n t r a l i d e a in th e c o s t - p l u s p r i c i n g approach i s t h a t t h e
f irm s e t s i t s p r i c e p r i m a r i l y , i f n o t e x c l u s i v e l y , a c c o rd
in g to u n i t t o t a l c o s t s a t some assumed r a t e o f o u tp u t o r
volume. More p r e c i s e l y , th e f i r m 's p r i c i n g i s supposed t o
be g u id ed by th e l e v e l o f (and change i n ) e i t h e r o f th e
f o llo w in g : (1) some ty p e of " a v e ra g e t o t a l c o s t , " i n c l u d
in g b o th v a r i a b l e and f i x e d c o s t s , to which th e markup i s
1Ackley, ibid., p. 456.
231
a p p l i e d , o r (2) a " g r o s s m argin " w hich i s su p e rim p o sed o v e r
d i r e c t o r "prim e" c o s t s to c o v e r such item s a s a d e s i r e d
p r o f i t r a t e , c a p i t a l c h a r g e s , and o t h e r c o s t s , and i s
u s u a l l y s t a t e d i n p e r c e n t a g e form . Both o f t h e s e g u id e s
a re e s t i m a t e d f o r some " s t a n d a r d " o r a v e ra g e e x p e c te d
volume o f s a l e s o r o u t p u t.
A lthough v a r i a t i o n s a r e num erous, v e ry o f te n th e
a v e ra g e c o s t f i g u r e w i l l com prise p r i m a r i l y d i r e c t c o s t s
( l a b o r and m a t e r i a l s ) , w h ile th e markup m argin w i l l in c lu d e
p r o f i t s and o v e rh e a d . The markup o v e r d i r e c t c o s t s t h a t
y i e l d s t o t a l c o s t s i s u s u a l l y e s t i m a t e d by a p e r c e n ta g e
add-on to th e d i r e c t c o s t s , so t h a t n o t only d i r e c t c o s t s
a re presum ed t o change a c c o rd in g to v a r i a t i o n s in f a c t o r
p r i c e s , b u t t o t a l c o s t s to o a r e presum ed to move in th e
same p r o p o r t i o n as f a c t o r p r i c e s .
On th e o t h e r h an d , p r o f i t s a r e l e s s u n if o rm ly
t r e a t e d : som etim es th e y a re r e g a rd e d as a c o s t , o t h e r
tim es a s p a r t o f a g r o s s m arg in added to p a r t o r a l l o f
d i r e c t c o s t s . N e v e r t h e l e s s , a r e t u r n on in v e s tm e n t i s p a r t
o f th e p r i c i n g fo rm u la . In d e e d , t h e p r o f i t r a t e may be
s p e c i a l l y computed so as t o y i e l d a " t a r g e t " r a t e o f r e t u r n
on in v e s tm e n t a t "n o rm al" volume computed f o r some o u tp u t
l e v e l below c a p a c i ty o p e r a t i o n s .
"T a r g e t - r e t u m " p r i c i n g . — B ecause " t a r g e t " p r i c i n g
p o l i c y p l a y s an im p o rta n t r o l e i n th e a re a o f " b ig
232
b u s i n e s s ” o r o l i g o p o l i s t i c i n d u s t r y , a few s p e c i f i c rem arks
on i t a re h e re in p l a c e . ^ Some w r i t e r s r e g a r d t a r g e t
p r i c i n g — a p p a r e n t l y f i r s t a d o p te d by th e DuPont and G e n e ra l
M otors C o r p o r a tio n s — a s th e m ost l o g i c a l p r i c i n g p ro c e d u re
where (a ) c o m p e titio n i s among o n ly a r e l a t i v e l y few f i r m s ,
whose o p e r a t i o n s r e q u i r e b oth l a r g e a g g r e g a te s of c a p i t a l
and l a r g e amounts o f c a p i t a l p e r w o rk e r, making t h e e n t r y
of new c o m p e titio n d i f f i c u l t th o u g h p o s s i b l e , and t h e r e f o r e
(b) t h e p r i c e l e a d e r o r p r ic e - m a k e r s e e k s to s t r i k e a
s u c c e s s f u l b a la n c e betw een g r e a t e r c u r r e n t p r o f i t s and
g r e a t e r r i s k o f new e n t r y .
T h is r e l a t i v e l y new p r i c i n g p ro c e d u re a p p a r e n t l y
has p o t e n t i a l a p p l i c a t i o n in o t h e r f i e l d s of p r i c e a d m in is
t r a t i o n where such an advanced ap p ro ach would be more
s a t i s f a c t o r y ( i n th e o ry a t l e a s t ) th a n th e c ru d e r ty p e s of
s t a n d a r d m arkups over c o s t s p r e s e n t l y em ployed. The re a s o n
i s t h a t th e l a t t e r m ethods c a l c u l a t e c a p i t a l c h a r g e s in
sim ple ”b r o a d - b r u s h ” s t r o k e s r a t h e r th a n a c c o rd in g to th e
e x a c t i n g c a l c u l a t i o n s o f th e amount of c a p i t a l a c t u a l l y
in v o lv e d i n p r o d u c in g each p r o d u c t . N e v e r t h e l e s s , Means
■^-Unless o th e r w is e s p e c i f i e d , th e f o llo w in g su b
s e c t i o n s a re b a sed m o s tly on M eans, P r i c i n g Power . . . ,
op. c i t . . pp. 232-*l8.
233
s u s p e c t s t h a t th e c r u d e r m ethods employed p ro b a b ly t e n d t o
a p p ro x im ate th o s e o f t a r g e t p r i c i n g . ^
D e term ln in g th e t a r g e t . — In g e n e r a l , t h e p r i c e -
maker s e e k in g a p r i c e t h a t w i l l y i e l d a t a r g e t r a t e o f
r e t u r n on c a p i t a l in v e s tm e n t s t a r t s w ith (1) an e s t i m a t e of
th e h i g h e s t r a t e of d e s i r e d r e t u r n on in v e s tm e n t t h a t w i l l
j u s t a v o id in d u c in g new e n t r a n t s , and th e n (2) works b a c k
ward to d e te rm in e t h e p r i c e t h a t w ould y i e l d t h i s r a t e o f
r e t u r n when o p e r a t i n g a t some r e a s o n a b l e p e r c e n t of
c a p a c i t y . T a rg e t r a t e s a re u s u a l l y s t a t e d a f t e r income
t a x e s . The c r u c i a l f a c t o r i n d e te r m in in g th e t a r g e t r a t e
i s n o t demand and c o s t s but th e need t o a v o id t h e a t t r a c
t i o n o f new c o m p e titio n . The r a t e o f o p e r a t i o n chosen a s
th e " s ta n d a r d " volume of o u tp u t (and u n i t t o t a l c o s t s ) may
be t h e a c t u a l a v e ra g e e x p e r ie n c e d o v e r a s e l e c t e d p e r i o d o f
y e a r s o r a roun ded f i g u r e c lo s e t o t h e a c t u a l e x p e r i e n c e .
The f i r m 's e s t i m a t e o f a v e ra g e o r u n i t t o t a l c o s t s
o f p r o d u c tio n a t t h e s t a n d a r d r a t e o f o p e r a t io n i n c l u d e s
b o th v a r i a b l e c o s t s and f i x e d c o s t s . Then comes c a l c u l a t i o n
o f th e p r i c e t h a t would y i e l d th e t a r g e t r a t e o f r e t u r n a t
■^In t h i s c o n n e c tio n Baumol h a s n o te d t h a t manage
m e n t 's p r e o c c u p a t io n w ith t o p - l e v e l pro blem s f o r c e s i t
f r e q u e n t l y t o r e l y on sim p le r u le - o f - th u m b p r i c i n g ( e . g . ,
a s t a n d a r d markup o v e r c o s t s ) w hich, w h ile e f f i c i e n t ,
r e d u c e s th e c o m p e titiv e " g iv e and t a k e " among r i v a l s
b e cau se i t p r o v id e s no e l a b o r a t e d i r e c t i o n s f o r a d a p t a t i o n
t o each one o f t h e r i v a l s ' many p o s s i b l e moves; see Baum ol,
op. c i t . . p p . 28 -2 9 .
234
th e volume o f s a l e s n e c e s s a ry t o o p e ra te a t the s ta n d a r d
r a t e o f p r o d u c tio n . F i n a l l y , th e t a r g e t - p r i c e i s c o n sid
e r e d in th e l i g h t of a c t u a l m arket c o n d i t i o n s — in v o lv in g a
m arket a n a l y s i s of th e q u a n t i t y l i k e l y t o be demanded a t
th e t a r g e t - p r i c e — and a d o p te d by management i f no m o d ific a
t i o n s a re c a l l e d f o r .
M odifying the t a r g e t - p r i c e . — I f a n a l y s i s r e v e a l s
demand p r o s p e c ts a re r o s i e r th a n e x p e c te d , th e t a r g e t - p r i c e
w i l l u s u a l ly be adop ted and c a p a c ity w i l l be expanded as
q u ic k ly as p o s s i b l e in o r d e r to a llo w t h e s ta n d a r d o p e r a t
in g r a t e u n d er av erage c o n d i t i o n s . On th e o th e r h a n d , i f
s a l e s p r o s p e c ts tu rn o u t s i g n i f i c a n t l y l e s s than t h e
s ta n d a r d r e q u i r e s , th e n th e f ir m h as th e a l t e r n a t i v e o f (a )
n o t p ro d u cin g th e p r o d u c t, o r (b) s e t t i n g a lower p r i c e
b ased on a d r iv e t o c u t c o s ts s u f f i c i e n t l y to y i e l d the
t a r g e t r a t e o f r e t u r n a t the s ta n d a r d r a t e of o p e r a t i o n s .
S i m i l a r l y , on th e s id e o f c o s t s , t a r g e t p r i c i n g
in c l u d e s a s h o r t - c u t fo rm u la t o a d ju s t p r i c e s f o r changes
i n o p e r a t in g c o s t s , p a r t i c u l a r l y th e p r i c e s of l a b o r and
raw m a t e r i a l s . However, I f a t th e same tim e t h e r e o ccu rs
an i n c r e a s e o f e f f i c i e n c y in th e u se of la b o r and m a t e r i a l s
w hich se rv e s t o reduce t h e i r r e a l c o s t s p e r u n i t o f o u t p u t,
th e f a c t t h a t th e s h o r t - c u t fo rm u la p e r se s t i l l c a l l s f o r
a t a r g e t - p r i c e i n c r e a s e (b ecause o f th e nom inal r i s e in
l a b o r and m a t e r i a l s p r i c e s ) can g iv e r i s e to a " b u i l t - i n "
235
so u rc e o f p r i c e i n f l a t i o n . The a c t u a l e x te n t o f such
b u i l t - i n i n f l a t i o n w ould, o f c o u r s e , depend on how e x t e n
s i v e l y th e s h o r t - c u t f o rm u la i s a p p l i e d , a p o i n t on which
e v id e n c e i s n o t S u f f i c i e n t l y c l e a r .
T a r g e t - p r i c i n g o b j e c t i v e s . — I n t a r g e t p r i c i n g
p r o c e d u r e s , Means c o n te n d s , th e f ir m does n o t a tte m p t t o
maximize p r o f i t s b u t i n s t e a d se e k s t o m axim ize " v a l u e s . "
So long as th e f i r m 's p r i c i n g c a l c u l u s does n o t in v o lv e
c o n s i d e r a t i o n o f th e r i s k o f e n tr y o f new f i r m s and i t s
p o t e n t i a l Im pact on th e f i r m ' s a s s e t - v a l u e s , t h e n we have
a case o f " c l a s s i c a l " p r o f i t - m a x i m i z a t i o n . But t h i s
p r o f i t - m a x i m i z a t I o n , i n M eans' view , co m p rise s m erely a
s p e c i a l case of v a lu e - m a x im iz in g , which does in v o lv e t h e
b a la n c in g of l a r g e r c u r r e n t p r o f i t s a g a i n s t t h e g r e a t e r
r i s k o f e n t r y . T h is view seems c o n s i s t e n t w ith t h a t o f
R obert F. L a n z i l l o t t i , whose s t u d i e s on th e p r i c i n g
o b j e c t i v e s and m o t i v a t i o n s of la r g e f i r m s y i e l d a more
g e n e r a l i z e d s e t o f f i n d i n g s . 1
A cco rd in g t o L a n z i l l o t t i ' s f i n d i n g s , t h e most
f r e q u e n t l y m en tio n ed p r i c i n g o b j e c t i v e in a sam ple o f
^ h e re m a in in g p a r t o f t h i s s e c t i o n i s b ased m ain ly
on L a n z i l l o t t i , o p . c i t . , p p . 9 2 1 -4 0 , and "Some C h a r a c te r
i s t i c s and Economic E f f e c t s o f P r i c i n g O b je c tiv e s In L arge
C o r p o r a t i o n s ," i n U .S ., C o n g re ss, J o i n t Economic Com m ittee,
Compendium, The R e l a t i o n s h i p o f P r i c e s t o Economic S t a b -
i l i t y and Growth (W ashington: U.S. Government P r i n t i n g
O f f i c e , 1 9 5 b ) , PP. 441-59.
236
tw enty l a r g e companies was th e t a r g e t r e t u r n on c a p i t a l
in v e s tm e n t ( i n c l u d i n g lo n g - te r m d e b t ) , re g a rd e d i n most
c a se s a s a lo n g -r u n o b j e c t i v e . The p ro c e d u re i s g e n e r a l l y
d e sig n e d t o p r e v e n t s h o r t - r u n f l u c t u a t i o n s in volume from
unduly a f f e c t i n g p r i c e , e s p e c i a l l y in t h e case o f new
p r o d u c t s . In th e l a t t e r c a s e , p r e s c r i b e d t a r g e t s a re
u s u a l l y h i g h e r th an on e s t a b l i s h e d p r o d u c t s , a t l e a s t
i n i t i a l l y .
However, com panies a l s o s t a t e d o t h e r p rom inent
p r i c i n g o b j e c t i v e s , such as (a) s t a b i l i z i n g i n d u s t r y p r i c e s ,
m arg in s and p r o f i t s , (b) r e a l i z i n g a t a r g e t m a r k e t - s h a r e ,
and (c ) m e e tin g or p r e v e n t i n g c o m p e titio n . In m ost c a se s
one o f t h e s e g o a l s , I n c l u d i n g th e t a r g e t r e t u r n , p redom i
n a te d above t h e r e s t , b u t th e l a t t e r u s u a l l y s e rv e d as
c o l l a t e r a l o r c lo s e l y r e l a t e d o b j e c t i v e s . As a r u l e , no
s i n g l e o b j e c t i v e o r p o l i c y d om inated p ric e - m a k in g p o lic y i n
any g iv e n company.
J u s t i f i c a t i o n s and r a t i o n a l i z a t i o n s . — Among th e
j u s t i f i c a t i o n s o r r a t i o n a l i z a t i o n s o f f e r e d by f ir m s to
e x p l a i n th e s i z e o f p a r t i c u l a r t a r g e t r a t e s , th e m ost
f r e q u e n t l y m en tio n ed was a " f a i r o r r e a s o n a b le " r e t u r n .
However, o t h e r j u s t i f i c a t i o n s o f f e r e d I n c lu d e d ( a ) tjie
t r a d i t i o n a l i n d u s t r y c o n c e p t o f f a i r r e t u r n i n r e l a t i o n t o
" r i s k f a c t o r s , " (b) a d e s i r e t o " e q u a l o r b e t t e r " th e c o r
p o r a t i o n a v e ra g e r e t u r n o v e r a r e c e n t p e r i o d , (c ) what t h e
237
company f e l t " i t c o u ld g e t " as a lo n g - ru n m a t t e r , and (d)
u se o f a s p e c i f i c p r o f i t t a r g e t as a means o f " s t a b i l i z i n g "
i n d u s t r y p r i c e s .
These t y p i c a l j u s t i f i c a t i o n s may have a b a s i s in
th e " s p e c i a l c h a r a c t e r i s t i c s " o f th e f i r m s in v o lv e d w ith
r e s p e c t t o t h e i r m arket s t r u c t u r e , p r o d u c t p o l i c y , and c o s t
s t r u c t u r e . L a n z i l l o t t i found t h a t firm s u s in g a p r o f i t -
t a r g e t p r i c i n g p o l i c y g e n e r a l l y b elo n g e d t o i n d u s t r i e s
p o s s e s s i n g th e f o llo w in g c h a r a c t e r i s t i c s : (a ) th e number
o f f i r m s was r e l a t i v e l y few ; (b) th e f ir m s were " p r i c e
l e a d e r s " i n t h e i r r e s p e c t i v e i n d u s t r i e s ; (c ) t h e i r m a rk e ts
were more o r l e s s p r o t e c t e d by " b a r r i e r s to e n tr y " such a s
la r g e i n i t i a l c a p i t a l in v e s tm e n t r e q u i r e m e n ts ; (d) t h e y
f r e q u e n t l y in tr o d u c e d new p r o d u c ts o r new m o d els; ( e ) th e
r a t i o o f c a p i t a l t o s a l e s d o l l a r was r e l a t i v e l y h ig h ; ( f )
u n i t c o s t s ( v a r i a b l e , i n c r e m e n t a l o r o u t - o f - p o c k e t ) were
f a i r l y s t a b l e o v e r wide ra n g e s o f o u t p u t; and (g) a v e ra g e
f u l l c o s t s were assumed t o be r e l a t i v e l y r i g i d o v e r th e
c o u rs e o f th e b u s i n e s s c y c l e .
P la n n in g of p r o f i t s . — I n any e v e n t , L a n z i l l o t t i
i n f e r s t h a t i n l a r g e f i r m s m anagem ent's a p p ro a ch t o p r i c i n g
i s b a se d on what he te rm s " p la n n e d p r o f i t s , " t h a t i s , on an
a ssu m p tio n o f t h e need f o r a c e r t a i n amount o f c a p i t a l f o r
lo n g - te rm in v e s tm e n t i n p l a n t and e q u ip m e n t, i n c l u d i n g
" b u i l t - i n e x c e s s c a p a c i ty " s u f f i c i e n t to h o ld i t s p o s i t i o n
238
o r b ro ad en i t s m a r k e ts . In h i s v iew , th e o n ly way such
f i r m s — p ro d u c in g a wide v a r i e t y of p r o d u c t s and s e l l i n g i n
many d i f f e r e n t m a r k e ts — can a p p ro a ch p r i c i n g p o l i c y i s i n
term s o f p r o f i t - I n v e s t m e n t r a t i o s . In such c a s e s , r a t h e r
th a n speak o f a d m in is te r e d p r i c e s he would speak of
" a d m i n i s t e r e d p r o f i t s , " f o r a p p a r e n t l y lo n g - r u n p r o f i t
t a r g e t s s u i t th e o b j e c t i v e s o f management b e t t e r th a n th e
d e s i r e t o " p r o f i t e e r o r se ek w i n d f a l l p r o f i t s . "
I m p l i c a t i o n s of C o s t-P lu s
At f i r s t g la n c e th e m ain i m p l i c a t i o n s o f th e c o s t -
p lu s o r markup d o c t r i n e f o r t r a d i t i o n a l p r i c i n g th e o r y
would seem t o be th e f o l lo w in g :
1) The demand curve f o r th e f i r m 's p r o d u c t i s
a p p a r e n t l y r e l e g a t e d t o a s e c o n d a ry p o s i t i o n a s a d e t e r
m in an t o f th e f i r m 's p r i c e s , th e l a t t e r b e in g seem in g ly
r e l a t e d only t o c o s t s .
2) "M a rg in a l" c o n c e p ts , i n c l u d i n g m a r g in a l c o s t s ,
a r e t o be e l i m i n a t e d from th e e c o n o m is t's t o o l box of con
c e p ts i n f a v o r of " a v e r a g e s ."
3) As a c o n se q u e n c e , a v e ra g e c o s t s would seem t o
become th e c h i e f g o v e rn o r of p r i c e a d ju s tm e n ts by th e f i r m ,
and "maximum" p r o f i t becomes a mere a c c i d e n t a l r e s u l t
r a t h e r th a n a n e c e s s a r y f e a t u r e of p r i c i n g p r a c t i c e s .
To w hat e x t e n t th e s e I m p l i c a t i o n s a c t u a l l y se rv e t o
c o n t r a d i c t ( o r prove i n c o n s i s t e n t w ith ) t h e r e s u l t s y i e l d e d
239
by " m a r g i n a l i s t " p r i c i n g th e o r y n e ed n o t b e d is c u s s e d a t
le n g th h e r e . I t may w e l l b e , as Bowen c la im s , t h a t th e
o s t e n s i b l e d i f f e r e n c e s w ith t r a d i t i o n a l th e o r y a r e more
a p p a r e n t th a n r e a l . I t s u f f i c e s h e re to n o t e th e f o llo w in g
p o i n t s .
P r o f i t s , c o s t s , and demand. — F i r s t , th e f a c t t h a t a
a f i r m can n o t maximize i t s p r o f i t s so long as i t l a c k s
s u f f i c i e n t i n f o r m a tio n a b o u t c o s t s and demand does n o t
n e c e s s a r i l y im ply t h a t i t does n o t w ish t o do so , a t l e a s t
as b e s t i t can— e i t h e r i n th e s h o r t - r u n o r l o n g - r u n , or
b o th — a lt h o u g h , as i n d i c a t e d a b o v e , th e g o a l of p r o f i t -
m a x im iz a tio n may be d i l u t e d o r o f f s e t by such f a c t o r s as
n o n -p e c u n ia r y m o t i v a t i o n s , tim e h o r iz o n s o r "dynamic"
c o n s i d e r a t i o n s , and in te r d e p e n d e n c e of f i r m s .
Second, i t would seem t h a t th e c h i e f c o n t r i b u t i o n
of th e c o s t - p l u s d o c t r i n e i s th e s p o t l i g h t i t th ro w s on th e
r o l e o f c o s t s (an d c o s t c h an g es) i n th e p r l c e - d e t e r m i n a t i o n
p r o c e s s . C e r t a i n l y th e d o c t r i n e h as s t i m u l a t e d e m p i r i c a l
r e s e a r c h and t h e o r y i n th e f i e l d o f p r i c i n g . However, th e
r o l e o f c o s t s i n p r i c i n g i s n o t a n o v e l i d e a : t r a d i t i o n a l
t h e o r y , t o o , had been co n ce rn e d w ith the r e s p o n s i v e n e s s of
■^Unless o th e r w is e s p e c i f i e d , t h i s s e c t i o n i s based
m ain ly on Bowen, op. c i t . , pp. 2 5 2 -5 6 , 2 98; H e fle b o w e r,
op. c i t . . pp. 3 6 2 , 364, 3 6 6 , 390; Means, P r i c i n g Power . .
. , op. c i t . , p. 242.
240
p r i c e s t o movements i n c o s t s , b ut i t a l s o r e a l i s t i c a l l y
presum ed t h a t p r i c e s re s p o n d e d t o changes i n demand a s w e ll
as c o s t s . I n d e e d , as w i l l be seen b elo w , t h e u n d e r s ta n d in g
o f th e p r o b a b le im pact of c o s t v a r i a t i o n s on th e f i r m f s
p r i c e a d ju s tm e n ts i t s e l f i n v o lv e s c o n s i d e r a t i o n of th e
i n f l u e n c e o f m ark et demand i n p r i c i n g p r o c e d u r e s .
F i n a l l y , and most i m p o r t a n t , th e above d i s c u s s i o n
o f c o s t - p l u s does n o t n e c e s s a r i l y im ply t h a t t h i s p r i c i n g
method i s s t r i c t l y a "one-w ay s t r e e t " from c o s t s to p r i c e s ,
w ith no r e v e r s e in f lu e n c e from th e s id e o f demand, a lth o u g h
t h i s i s th e im p re s s io n one may g a in . The o b s e r v a t i o n t h a t
b u s i n e s s f ir m s do not a c t u a l l y " e q u a te " m a r g in a l c o s t s and
r e v e n u e s d o e s n o t p e r se p ro v e t h a t th ey a re s t r i c t l y
c o s t - p l u s , e x c lu d in g any c o n s i d e r a t i o n of demand and m ark et
f a c t o r s i n p r i c i n g p r o c e d u r e s . In r e a l i t y , c o s t - p l u s
p r i c i n g manages to i n c o r p o r a t e th e i n f l u e n c e s o f demand and
c o m p e titio n as w e l l as c o s t s , b o th i n the s e t t i n g o f th e
p r i c e and i n t h e a d ju s tm e n t t o changes in th e m a rk e t. Much
t h a t i s a p p l i c a b l e t o t h i s p o i n t h a s a lr e a d y been s a i d
above and i n p r e c e d in g c h a p t e r s , b u t h e re s e v e r a l f u r t h e r
rem ark s a re in o r d e r .
B ehind th e demand c u r v e . — I n th e f i r s t p l a c e , th e
n o t i o n o f "demand" in e co n o m ic s, as seen a b o v e, i s
e x p r e s s e d th r o u g h th e c o n v e n ie n t c o n c e p t o f th e demand
c u rv e — i t s s lo p e and e l a s t i c i t y , as w e ll as i t s s h i f t i n g
2H1
up or down. As a c o n se q u e n c e , any f a c t o r i n t h e m arket
t h a t a f f e c t s th e shape and p o s i t i o n of th e demand curve i s
n e c e s s a r i l y a "demand" f a c t o r . Leading i n s t a n c e s of such
f a c t o r s a r e p ro d u c t d i f f e r e n t i a t i o n ( i n c l u d i n g a d v e r t i s i n g )
and c o n j e c t u r a l in te r d e p e n d e n c e .
I t i s n o t s u r p r i s i n g , t h e r e f o r e , t o f i n d t h a t c o s t -
p l u s fo rm u la s th e m se lv e s r e f l e c t th e i n f l u e n c e s o f demand,
and once i n e f f e c t t e n d to be m o d ifie d t o r e f l e c t th e s e
i n f l u e n c e s . In t h e s e t t i n g o f p r i c e s , f o r e x am p le, con
j e c t u r e s c o n c e rn in g r i v a l s ' p r o b a b le r e a c t i o n s t o a p r i c e
d e c i s i o n subsumes c o n s i d e r a t i o n n o t only o f r i v a l s ' c o s ts
b u t a l s o o f t h e i r m arket p o l i c i e s and p r i c i n g p r a c t i c e s i n
d i r e c t r e l a t i o n t o t h e c r o s s - e l a s t i c i t i e s o f demand among
r i v a l p r o d u c t s . Even where to p management has d e c id e d upon
a p r i c e , m arket a n a l y s i s may l a t e r i n d i c a t e t h a t a
d i f f e r e n t p r i c e be e s t a b l i s h e d .
In a d d i t i o n , e x p e c t a t i o n s as t o p r o s p e c t i v e changes
i n demand (and c o s t s ) w i l l a l s o a f f e c t t h e s iz e o f th e
m arkup. I f demand i s e x p e c te d t o rem ain m o d e ra te , then
markups may r e l y p r i m a r i l y upon h i s t o r i c a l or e x p e r ie n c e d
c o s t s . But i f demand i s e x p e c te d to i n c r e a s e s u f f i c i e n t l y
t o e x e r t upward p r e s s u r e s on f u t u r e l a b o r and m a t e r i a l
c o s t s , th e n th e s e p r o j e c t e d c o s t s a ls o t e n d to be a p p lie d
t o m arkups, th e l a t t e r t h e r f o r e te n d in g t o r i s e w ith t o t a l
demand. I n any e v e n t , th e p r i c e and m a rg in f i n a l l y s e t by
2k2
th e f irm may be a s c l o s e l y r e l a t e d t o what i t " t h i n k s i t
can g e t" a s i t i s t o c o s t s . *
Working b a ck from p r i c e . — P ro b a b ly th e most d i r e c t
a p p l i c a t i o n of m ark et demand i n p r i c i n g i s th e v a r i a n t of
f u l l - c o s t p r i c i n g i n which th e f irm s t a r t s w ith p r i c e a s a
" g iv en " a n d works back from i t by a d j u s t i n g th e q u a l i t y
(and component c o s t s ) of th e p ro d u c t u n t i l i t s f u l l ( t o t a l )
c o s t j u s t e q u a ls th e " g iv e n " p r i c e . The g iv e n p r i c e may
be some e x i s t i n g m ark et p r i c e o r some " t r a d i t i o n a l or
c o n v e n ie n t" p r i c e t h a t h as a lr e a d y p ro v ed " a c c e p ta b le to
con su m ers. " 2
F i n a l l y , c e r t a i n changes i n th e f i r m ’s own c o s t s —
such a s I n c r e a s e d a d v e r t i s i n g and r e s e a r c h and developm ent
— may a l s o e x e r t im p o rta n t upward i n f l u e n c e s on th e demand
curve f o r i t s p r o d u c ts .
A djusting to demand. — Once p r ic e s have been s e t by
the firm , i t is no t to be expected— f o r reasons set f o rth
above— th a t p ric e s w i l l be changed when sa le s volume r i s e s
or f a l l s only m oderately, u n le ss (a) a r i v a l changes h is
p ric e f i r s t , (b) th e re i s a concurrent change in d ir e c t
■^O n t h i s p o in t see Ackley, Microeconomic Theory.
op. c i t . . pp. *156-57; Ronald Coase, " Comment,H in N atio n al
Bureau of Economic R esearch, op. c i t . , p. 39**. See a lso
Means, P ric in g Power, op. c i t . , pp. 23 8 -3 9 ; B ain, op. c i t .,
p . 286.
2 Committee on P r i c e D e te rm in a tio n f o r th e C onfer
ence on P r i c e R e s e a rc h , op. c i t . , p. 282.
243
c o s t s of l a b o r o r m a t e r i a l s , or (c ) th e h i g h e r s c a l e o f
o p e r a t i o n s d r iv e m a r g in a l c o s t s above p r i c e . ' 1 ' O th e rw ise an
i n c r e a s e i n demand may sim p ly be r e c e i v e d i n th e form of
l a r g e r volum e, w h ile a d e c r e a s e i n demand and s a l e s — a t
l e a s t down t o the p o i n t where th e f i r m ' s f i n a n c i a l s e c u r i t y
i s th r e a te n e d - —w i l l be m inim ized by c o s t - c u t t i n g d r i v e s and
c o s t d e fe rm e n ts . Beyond t h a t , l o s s e s w i l l be a b so rb e d out
of p r o f i t s .
I n th e case of im m oderate o r e x c e p t i o n a l and p r o
lo nged v a r i a t i o n s o f demand, how ever, th e r e l a t i v e i n s e n s i
t i v i t y of p r i c e s charg ed may be e x p e c te d t o b re a k down. In
p e r i o d s o f e x c e p t i o n a l l y h ig h demand some f ir m s may
a c t u a l l y c h a rg e more them t h e i r f u l l c o s t s , w h ile i n
p e r i o d s o f v e ry d e p re s s e d s a l e s th e y may c h arg e l e s s .
P r i c e s "q u o te d " and " r e a l i z e d " . — I t i s im p o r ta n t to
n o te t h a t th e s e f i n d i n g s on th e n o n - r e s p o n s i v e n e s s o f p ric e s
r e l a t e p r i m a r i l y t o " q u o te d " p r i c e s , and a r e l e s s t r u e of
a c t u a l " t r a n s a c t i o n s " or " r e a l i z e d " p r i c e s . The l a t t e r may
be m o d ifie d from t h e q u o ted l e v e l as a r e s u l t of v a r i a t i o n s
i n th e number of " s a l e s " and th e v a r i e t y o f p r i c e con
c e s s i o n s , r e c l a s s i f i c a t i o n o f c u s to m e rs , and a d ju s tm e n ts in
f r e i g h t c h a rg e s and s e r v i c e s which t y p i c a l l y accompany
^T hls and t h e f o llo w in g two s u b - s e c t i o n s a r e b ased
m ain ly on H e fle b o w e r, op. c i t . , p p. 366- 6 7 * 389-92. See
a l s o A ck ley, " A d m in is te re d P r i c e s , " op. c i t . , pp. 4 26-2 8.
2HH
changes i n demand. As a r e s u l t i t has been found t h a t
t r a n s a c t i o n s p r i c e s as a r u l e v a ry t o some d e g re e r e l a t i v e
to q u o ted p r i c e s when th e l a t t e r f a i l to move in r e s p o n s e
to demand.
Some c o n c l u s i o n s .- - A number of c o n c lu s io n s may be
drawn. I t i s a p p a r e n t t h a t once p r i c e s have been s e t by
th e f i r m , no c o s t - p l u s fo rm u la can p r o t e c t them from t h e
n e c e s s i t y to s ta n d th e t e s t of th e m arket p l a c e in com p eti
t i o n w ith th o s e o f r i v a l p r o d u c t s . N e v e r t h e l e s s , t h e f a c t
rem ain s t h a t q u o ted p r i c e s t e n d t o be " s t i c k y ” when demand
v a r i e s , and t r a n s a c t i o n s p r i c e s re s p o n d only somewhat more
q u ic k ly o r d i r e c t l y t o demand.
The u l t i m a t e re a s o n s may l i e in th e f i r m 's u n c e r
t a i n t y ab out (a ) r i v a l s ' r e a c t i o n s t o p r i c e c h a n g e s, a s
w e ll as (b) f u t u r e d ev elo p m en ts a f f e c t i n g t h e group a s a
whole. As a consequence f i r m s may p la c e more f a i t h i n
c o s ts as a guide t o p r i c i n g d e c i s i o n s and t e n d t o a d o p t
s h o r t - t e r m p o l i c i e s t h a t r e f l e c t b o th lo n g e r - te r m c o s t and
demand c o n s i d e r a t i o n s .
Demand once m ore.- - A f i n a l n o te on demand may be
added. The p r e c e d in g rem ark s on demand a p p l i e d e s s e n t i a l l y
to what may be term ed th e d i r e c t i n f l u e n c e s o f demand on
c o s t - p l u s p r i c i n g , i n th e se n s e t h a t th ey p e r t a i n d i r e c t l y
to th e p r i c e - m a k e r 's demand e s t i m a t e s . B u t, a s w i l l be
seen b e lo w , demand can a l s o e x e r t an i n d i r e c t i n f l u e n c e on
2 45
p r i c i n g , v i a th e f i r m ' s c o s t s . In p a r t i c u l a r , t h e r e i s th e
im p o r ta n t c ase a n a ly z e d by G ardn er A ckley, in w hich g e n e r a l
e x c e s s demand f o r f i n a l goods c r e a t e s e x c e s s demand f o r
b o th raw m a t e r i a l s and l a b o r , which c au ses a r i s e in t h e i r
p r i c e s , and t h i s r i s e in c o s t s in t u r n c a u se s an upward
a d ju s tm e n t o f a d m in is te r e d p r i c e s .
In t h i s c o n n e c tio n two p o i n t s may be add ed . F i r s t ,
th e mechanism o f p r i c e a d m i n i s t r a t i o n ( s p e c i f i c a l l y , markup
p r i c i n g ) becomes one of th e " s t r a t e g i c c h a n n e ls " th ro u g h
w hich a demand i n f l a t i o n can o p e r a t e . T h is im p o r ta n t
phenomenon w i l l be d is c u s s e d i n d e t a i l below , i n t h e
c o n te x t o f A c k le y 's "markup" model of th e i n f l a t i o n p ro c e ss .
Second, and e q u a lly i m p o r ta n t, i s th e f a c t t h a t a
r i s e in c o s t s ( e s p e c i a l l y i n raw m a t e r i a l s ) t h a t f o r c e s an
upward a d ju s tm e n t o f a d m in is te r e d p r i c e s i s i t s e l f o fte n a
r e f l e c t i o n o f an i n c r e a s e in demand. As a co n seq u e n ce , th e
e n s u in g r i s e in p r i c e s must be i n t e r p r e t e d n o t as "cau sed "
by p r i c e a d m i n i s t r a t i o n p e r se b u t as " in d u c e d " by
i n c r e a s e d demand. As a m a t t e r of d e f i n i t i o n , Means would
seem t o be c o r r e c t i n im p ly in g t h a t a " t r u e " a d m in is te r e d
p r i c e i n f l a t i o n i s one t h a t a r i s e s i n th e a b sen c e o f e x ce ss
demand, a lth o u g h he a l s o a s s e r t s i t co uld n o t l e a d t o a
runaway i n f l a t i o n i n the absence o f such e x c e s s demand o r
" e x c e s s i v e money s u p p l y . " 1
^■Means, "Discussion," op. c i t . , pp. 453-54.
2 46
A d m in is te re d P r i c e s as a Source o f I n f l a t i o n
At t h i s s ta g e o f o u r d i s c u s s i o n i t i s p o s s i b l e t o
a n a ly z e in a more c r y s t a l l i z e d p e r s p e c t i v e th e p e c u l i a r
a t t r i b u t e s of p r i c i n g as a " c a u s a l ” f a c t o r in th e i n f l a t i o n
p r o c e s s . In p r e c e d in g c h a p t e r s i t became a p p a re n t t h a t th e
firm c o u ld a f f e c t th e g e n e r a l p r i c e l e v e l in two ways: (a)
as a v e h i c l e f o r c h a n n e llin g or r e f l e c t i n g th e f o r c e s of
demand and su p p ly ( th e l a t t e r subsum ing p r o d u c t i v i t y and
such c o s t s as wages and p r o f i t s ) as th e ap p ro x im ate d e t e r
m in a n ts of p r i c e movements; and (b) as a g e n e r a t o r of
in c r e a s e d demand in th e form o f w a g e - p u ll. F o r th e p r e s e n t
c h a p t e r i t i s th e form er ( " v e h i c l e " ) a s p e c t t h a t h a s th u s
f a r had most r e le v a n c e f o r our d i s c u s s i o n o f a d m in is te r e d
p r i c e s and markup p r i c i n g .
In th e f o llo w in g p a r t s o f t h i s c h a p t e r , two main
t a s k s rem ain : (1) a more rounded t r e a t m e n t of t h e r o l e
p la y e d by markup p r i c i n g in th e i n f l a t i o n p r o c e s s , i n c l u d
in g I m p o rta n t new d im ensions n o t f u l l y d i s c u s s e d abo v e, i n
o rd e r t o u n d e r s ta n d how a d m i n i s t e r e d p r i c e s can s e r v e as an
in d e p e n d e n t o r autonomous " c a u s e " of i n f l a t i o n ; and (2) an
e s t i m a t e o f th e d i s t r i b u t i o n of th e v a r i o u s modes of p r i c e -
s e t t i n g in d i f f e r e n t s e c t o r s o f th e economy, i n o r d e r t o
e v a l u a t e t h e i r r e s p e c t i v e im p a cts on th e g e n e r a l p r i c e
l e v e l ( i . e . , t h e i r c o n t r i b u t i o n t o th e i n f l a t i o n p r o c e s s ) .
Role o f Markup P r i c i n g
I n a v a r i e t y of c o n te x ts d i s c u s s e d a b o v e, a p e r
v a s iv e u n d e r l y i n g a ssu m p tio n has been t h a t th e f i r m , i n
r a i s i n g i t s p r i c e as i t s s c a l e o f o u tp u t and l e v e l o f c o s t s
r i s e , would a p p ly a markup o r m argin o v e r c o s t s t h a t m ain
t a i n e d a p r o p o r t i o n a l o r s t a b l e r e l a t i o n s h i p betw een move
ment i n c o s t s and p r i c e s . T his was c e r t a i n l y th e key
assu m p tio n i n W e in tr a u b 's wage-markup m odel of I n f l a t i o n ;
i t w as: a l s o a b& slc assu m p tio n i n ex cess-dem and and
" s e c t o r a l " or " d e m a n d -s h if t" m odels o f i n f l a t i o n . I n a l l
th e s e m o d els, t h e r i s e i n wages and o t h e r c o s t s i s e x p e c te d
to r e s u l t alm ost a u t o m a t i c a l l y i n a c o rr e s p o n d in g r i s e in
p r i c e s ch arg ed by th e f i r m , w ith th e p r i c e r i s e m o d ifie d
only t o t h e e x t e n t t h a t c o s t - p l u s or p r o f i t m arg in s a r e
a llo w e d t o a b so rb some o f th e c o s t i n c r e a s e . I t w i l l now
be u s e f u l t o d i s c u s s th e s p e c i f i c m odel of "markup i n f l a
t i o n " d e v elo p ed by G ard n er Ackley b e ca u se i t f o c u s e s on
s e v e r a l c h a r a c t e r i s t i c a t t r i b u t e s o f th e p r i c i n g p r o c e s s
and t h e r e b y c o n t r i b u t e s s u b s t a n t i a l l y to th e u n d e r s ta n d in g
of i n f l a t i o n . 1
•^The m ain s o u r c e s f o r t h e f o llo w in g d i s c u s s i o n of
th e "markup i n f l a t i o n " m odel i s G ardn er A ck ley , "A T h ir d
Approach t o th e A n a ly s is and C o n tro l of I n f l a t i o n , " in
U .S ., C o n g re ss, J o i n t Economic C om m ittee, Compendium. The
R e l a t i o n s h i p of P r i c e s t o Economic S t a b i l i t y and Growth
(W ashington: U .S . Government P r i n t i n g O f f i c e , 1 9 5 b )> PP.
619-3&* "A d m in iste re d P r i c e s , " op. c i t . , pp. 4 1 9 -3 0 , and
M icroeconom ic T h e o ry , o p . c i t . , pp. 452-59.
2 40
P e r v a s iv e u se of m arkups*— The f i r s t im p o rta n t
a ssu m p tio n made by Ackley i s t h a t a l l b u s in e s s f i r m s — p r o
d u c in g goods as w e ll as s e r v i c e s — a s s i d u o u s l y ap ply a
markup p r i c i n g p o l i c y , u s in g a s t a n d a r d markup ( c o v e rin g
b o th overhead and p r o f i t s ) o v e r t h e i r d i r e c t c o s t s o f l a b o r
and m a t e r i a l s . A second b a s i c a ssu m p tio n i s t h a t l a b o r
seek s and o b ta in s w a g e - in c r e a s e s to m atch (com pensate f o r )
any i n c r e a s e i n th e c o s t - o f - l i v i n g in d e x ; t h a t i s , l a b o r
to o i n e f f e c t p r i c e s i t s s e r v i c e s on th e b a s i s of a " f i x e d
markup" over i t s c o s t of l i v i n g .
F o r Ackley th e s e a ssu m p tio n s a re n o t f a r - f e t c h e d ,
f o r i n h i s view th e p r i c e s o f l a b o r and most com m odities
a r e n o t s e t i n a u to m a tic re s p o n s e t o supp ly and demand
f o r c e s but a re " a d m i n i s t e r e d ." He t h e r e f o r e r e g a r d s th e
i n f l a t i o n a r y p r o c e s s as " e s s e n t i a l l y an a d m i n i s t r a t i v e one,"
a r i s i n g from a " l a r g e l y autonomous" upward p r e s s u r e on
wage r a t e s r e l a t i v e t o th e c o s t of l i v i n g , w ith th e l a t t e r
i n c o r p o r a t i n g th e e f f e c t s of r i s i n g a g r i c u l t u r a l and raw
m a t e r i a l p r i c e s . As a r e s u l t , n o t o n ly do " p r i c e s f o llo w
wages" b u t "wages a l s o f o llo w p r i c e s . "
G e n e ra tio n o f s p i r a l . — A ccording t o A c k ley , h i s
markup model o f i n f l a t i o n can g e n e r a t e e i t h e r a s t a b l e ,
r i s i n g , o r f a l l i n g p r i c e l e v e l , depen d in g on th e s i z e o f
th e r e s p e c t i v e markups employed by f ir m s and l a b o r . F o r
exam p le, i f l a b o r o b t a i n s a w a g e -in c r e a s e t h a t exceeds
249
p r o d u c t i v i t y and g e n e r a t e s a r i s e i n p r i c e s and t h e c o s t -
o f - l i v i n g in d e x , c l e a r l y an " e n d le s s upward s p i r a l " o f
wages and p r i c e s would ensue so lo n g as b o th wages and
p r i c e s were form ed on th e b a s i s o f f i x e d m arkups. The
s p i r a l would p ro c e e d f a s t e r i f th e markup f o r p r i c e s a n d /o r
wages was e x p re s s e d as a p e r c e n ta g e markup r a t h e r t h a n as
a f i x e d amount o f d o l l a r s and c e n t s .
In any e v e n t , th e im p o r ta n t f a c t i s t h a t t h e
markup b a s i s o f p r i c i n g , f o r b o th la b o r and th e f i r m , can
g e n e r a te a s p i r a l l i n g p r o c e s s o f "v ery c o n s i d e r a b le " m agni
tu d e and d u r a t i o n , assum ing o f c o u rs e t h a t th e r e s p e c t i v e
income cla im s o f la b o r and th e f i r m can not be "h arm o n ized ”
o r o f f s e t th ro u g h s u f f i c i e n t i n c r e a s e s in p r o d u c t i v i t y .
In d e e d , I f p r o d u c t i v i t y In c re m e n ts were s u f f i c i e n t l y
l a r g e , t h i s "e n g in e " o f i n f l a t i o n - - r e p r e s e n t i n g a " s t r u g g l e
betw een l a b o r and b u s i n e s s " n o t o n ly (a ) t o p r e s e r v e t h e i r
r e s p e c t i v e l e v e l s o f Incom e, b u t a l s o (b) t o enhance t h e i r
r e s p e c t i v e income s h a r e s beyond th e c a p a c i ty of t h e
economy a s a w hole— m ig h t e v e n t u a l l y have t o s p u t t e r t o a
h a l t .
Markup P r i c i n g as an I n f l a t i o n Mechanism
C oncerning A c k le y fs markup I n f l a t i o n , t h r e e
im p o r ta n t a s p e c t s sh o u ld be n o te d and d is c u s s e d i n t u r n .
They may be b r i e f l y l i s t e d as f o l l o w s : (1) th e r o l e o f th e
markup as a " s p i r a l mechanism" o f i n f l a t i o n , which i n t u r n
250
r e f l e c t s (2) th e " s t r u g g l e ” betw een l a b o r and management
o v e r t h e i r " f a i r ” s h a r e s o f th e income p i e ; and (3) th e
p r i c e im p acts o f i n c r e a s e d o r " e n la r g e d " markup m a rg in s .
The s p i r a l m echanism . — In th e f i r s t a s p e c t n o t e d ,
th e a d h eren ce by t h e f ir m and l a b o r t o f i x e d markups o v er
th e " c o s t s " th e y r e s p e c t i v e l y have to pay p r o v id e s th e
mechanism t h a t a s s u r e s t h e " le a p f r o g g in g " o f wages and
p r i c e s which (a) c h a r a c t e r i z e s t h e upward " s p i r a l " o f wages
and p r i c e s and (b) e n a b le s i t t o p ro c e e d i n th e f a s h i o n
p o s t u l a t e d .
Ackley does n o t i n s i s t t h a t i n i n d i v i d u a l c a se s
markups w i l l alw ays be so m e c h a n ic a lly r i g i d , and ad m its
th e y may v a ry a c c o rd in g t o demand and su p p ly c o n d i t i o n s i n
s p e c i f i c m a r k e ts . However, he b e l i e v e s t h a t th e upward
r e v i s i o n o f markups in some m a rk e ts w i l l te n d t o be o f f s e t
by downward r e v i s i o n s i n o t h e r s , so t h a t on b a la n c e th e
a v e ra g e l e v e l o f m arkups can rem ain u n a f f e c t e d by t h e s e
i n t e r n a l s h i f t s .
I t i s A c k le y f s h y p o t h e s is t h a t p r i m a r i l y when th e
l e v e l o f t o t a l demand changes w i l l th e a v erag e l e v e l of
markups i t s e l f a l s o be a f f e c t e d . More p r e c i s e l y , th e
a v e ra g e markup l e v e l w i l l te n d t o i n c r e a s e somewhat as
a g g re g a te demand i n c r e a s e s , and f a l l some as demand
d e c l i n e s . L ik ew ise he contend s t h a t th e markups a p p li e d
te n d t o move in i n v e r s e p r o p o r t io n to changes i n th e
volume of unemployment.
251
The t h e s i s r e s t a t e d . — In t h i s f a s h i o n Ackley p r e -
%
suraes t o d e m o n s tra te th e r e le v a n c e of demand t o th e e x p la n
a t i o n o f th e p r i c e l e v e l . Thus h i s com plete t h e s i s would
r e a d a s f o l lo w s : (a) th e p r i c e l e v e l w i l l te n d t o r i s e
p r i m a r i l y i n re s p o n s e t o a r i s e i n c o s t s , u s u a l l y n o t
b e f o r e ; and (b) th e e x te n t o f th e p r i c e r i s e w i l l be approx
i m a te ly th e same as th e r i s e i n c o s t s when a g g r e g a te demand
l e v e l s a re " m o d e r a te ,” somewhat g r e a t e r (b u t n o t much so)
when demand i s a t a h i g h e r l e v e l , and somewhat (b u t n o t
much) l e s s when demand i s lo w er.
In summary, Ackley i s sa y in g t h a t however th e
i n f l a t i o n may s t a r t , th e p r o c e s s in v o lv e s b o th demand and
markup e le m e n ts . Hence i t becomes p o s s i b l e t o e x p la in why
I n f l a t i o n may o c c u r even w ith some s l a c k and unemployment
In th e economy.
" S tic k y " p r i c e s a g a i n . — I t i s a p p r o p r i a t e a t t h i s
p o i n t to n o te some a d d i t i o n a l f a c e t s about th e phenomenon
o f " i n f l e x i b l e " m arkups (and c o r r e s p o n d in g ly i n f l e x i b l e or
" s t i c k y " p r i c e s ) t h a t s e rv e s as an I n t e g r a l mechanism In
s e v e r a l m odels of th e I n f l a t i o n p r o c e s s . One v e ry
im p o r ta n t and f a m i l i a r s t r a n d o f th o u g h t i s t h e h y p o th e s is
t h a t i n p e r i o d s o f g e n e r a l l y h ig h economic a c t i v i t y th e
p r e v a le n c e of a d m in is te r e d p r i c e s ( i n c l u d i n g wages) and
f i x e d m arkups— p a r t l c u l a r l y I n o l i g o p o l i s t i c I n d u s t r i e s —
would t e n d t o keep p r i c e s from r i s i n g as much ( o r as
252
r a p i d l y ) as th e y would u n d e r c o n d it i o n s of p u re c o m p e ti
t i o n . 1
Some o f th e r e a s o n s f o r t h i s phenomenon have
a lr e a d y been o u t l i n e d above and in t h e c h a p t e r on wages.
I t s u f f i c e s h e re t o n o te t h a t , in th e case o f o l i g o p o l i e s ,
th e main consequence i s a tim e la g betw een th e i n c r e a s e in
demand and th e p r i c e a d ju s tm e n t made t h e r e t o by th e f i r m ,
c r e a t i n g in th e i n t e r i m what G a l b r a i t h has term ed
'" u n liq u id a te d monopoly g a i n s . 1 1 As lo n g as su ch p o t e n t i a l
g a in s rem ain " u n l i q u i d a t e d " — t h a t i s , p r i c e s a r e n o t
r a i s e d — th e f i r m i s f a i l i n g t o e x p l o i t i t s a b i l i t y t o m axi
mize s h o r t - r u n p r o f i t s . 2
But what i f demand s t o p s i t s s te a d y r i s e and l e v e l s
o f f b e fo r e p r o f i t s have been " l i q u i d a t e d " ? The e co n o m ist
John M. B l a i r b e l i e v e s th e o l i g o p o l i s t i c firm s t i l l would
n o t r a i s e i t s p r i c e t o y i e l d f u l l s h o r t - r u n maximum p r o f i t s ,
m ain ly f o r two r e a s o n s : ( a ) i t f e a r s t h i s would a t t r a c t
th e e n t r y of new f ir m s o r e x p a n sio n by e x i s t i n g s m a ll e r
c o m p e t i t o r s , and (b) i t may p r e f e r t o adhere t o t h e lo n g -
ran g e " t a r g e t " r a t e o f r e t u r n which i s u s u a l l y b ased on a
■^John M. B l a i r , " A d m in is te re d P r i c e s : A Phenomenon
In S e a rc h o f a T h e o ry ," The American Economic Review , XLIX
(May, 1959)* p . 433. On th e wages a s p e c t , see F ried m an ,
op. c i t . , p p . 226-30.
Joh n K enneth G a l b r a i t h , "M arket S t r u c t u r e and
S t a b i l i z a t i o n P o l i c y , " The Review o f Economics and S t a t
i s t i c s . XXXIX (May, 19 5 7 ), p . 127.
253
" s ta n d a r d " volume o f o u tp u t w e l l below c a p a c ity l e v e l s and
would t h e r e f o r e y i e l d a l e s s " e m b a rr a s s in g " (th o u g h a d e
q u a te ) b a tc h of p r o f i t s th an i f i t had r a i s e d p r i c e s t o
m axim ize p r o f i t s a t f u l l - c a p a c i t y l e v e l s . 1
U n d e r - u t i l i z e d c a p a c i t y . — What about p r i c i n g
t e n d e n c i e s of o l i g o p o l i e s in p e r i o d s when th e economy i s
l e s s th a n e x u b e r a n t , and p l a n t c a p a c i t y i s " m o d e ra te ly
u n d e r - u t i l i z e d " ? Here B l a i r a s s e r t s t h a t , b ased on the
e x p e r ie n c e o f th e 1957-195# r e c e s s i o n , p r i c e s would n e i t h e r
d e c l i n e n o r rem ain I n f l e x i b l e , b u t would te n d t o r i s e . F o r
B l a i r t h e r e a re t h r e e main r e a s o n s why th e f ir m w i l l te n d
t o r a i s e p r i c e s w ith o u t a p p re h e n s io n t h a t o t h e r firm s w i l l
n o t fo llo w s u i t .
F o r one t h i n g , t h e r e i s th e c o n tin u e d p r e s s u r e o f
" c o s t - p u s h , " p a r t i c u l a r l y l a b o r c o s t s , which may be ex
p e c t e d t o be o p e r a t i v e even d u rin g r e c e s s i o n s . On th e one
hand t h e r e i s o r g a n iz e d l a b o r , which can be depended on
( f o r v a rio u s re a s o n s en u m e rated in t h e c h a p te r on wages) t o
c o n tin u e i t s p r e s s u r e f o r w a g e - in c r e a s e s and o t h e r form s of
c o m p e n sa tio n . On t h e o t h e r h a n d , t h e r e i s th e te n d e n c y f o r
r i v a l f ir m s t o b a r g a i n " in c o n c e r t " w ith th e u n io n , so
t h a t (a) th e i n c e n t i v e of i n d i v i d u a l f i r m s to r e s i s t wage
^U nless o th e r w is e s p e c i f i e d , t h e f o l lo w in g f o u r
s u b - s e c t i o n s a re b a se d m ain ly on B l a i r , op. c i t . , pp.
W - 4 9 .
254
demands i s w eakened, and (b) t h e range of u n c e r t a i n t y a s to
r i v a l s ’ p ro b a b le p r i c e - r e a c t i o n s t o wage ad v an ces i s
c o r r e s p o n d in g ly re d u c e d .
Overhead c o s t s . — Second, to th e e x te n t t h a t f ir m s
em phasize " n o n - p r ic e " c o m p e ti t io n — such a s p ro d u c t d i f f e r
e n t i a t i o n and a d v e r t i s i n g — as a g a i n s t p r i c e c o m p e ti t io n ,
th e u n i t c o s ts o f such c o m p e titiv e a c t i v i t i e s may n o t o n ly
c o n s t i t u t e a s i g n i f i c a n t c o st e le m e n t b u t a l s o a s i g n i f i c a n t
o v e rh e ad c o st w hich in d u c e s management t o i n c u r them even
when ( o r p o s s i b l y b e c a u se ) s a l e s and o u tp u t have f a l l e n
o f f , t h e r e b y c a u s in g u n i t p r i c e s t o r i s e .
Role o f t a r g e t p r i c i n g . — F i n a l l y , B l a i r r e f e r s to
th e p r i c e - r a i s i n g i n f l u e n c e s o f " t a r g e t r e t u r n " p r i c i n g
a p p l i e d e x t e n s i v e l y in th o s e o l i g o p o l i s t i c i n d u s t r i e s i n
which th e dom inant firm i s th e a c t u a l o r e f f e c t i v e p r i c e
l e a d e r . He does n o t im ply t h a t t a r g e t p r i c i n g , b a se d on
lo n g - te rm o b j e c t i v e s , i s i n f l a t i o n a r y p e r s e , n o r t h a t i t
w i l l " n e c e s s a r i l y " cause p r i c e s t o r i s e when c a p a c i t y i s
" s i g n i f i c a n t l y " u n d e r - u t i l i z e d . H is r e a s o n i n g i s s p e l l e d
out m a in ly in t h e form o f t h r e e f a c t o r s t h a t he b e l i e v e s
w i l l " l e n d im p e tu s" to upward r e v i s i o n s o f p r i c e s by f i r m s .
L east s u b t l e o f th e f a c t o r s i s a m a n a g e r ia l
d e c i s i o n to i n c r e a s e o f e n la r g e i t s p r o f i t t a r g e t . A ccord
in g t o Means, an i l l u s t r a t i o n o f t h i s c ase i s t h e p r i c i n g
b e h a v io r of t h e U. S'. S t e e l C o rp o ra tio n in th e 19 5 0 ’ s ( t o
255
be d i s c u s s e d f u r t h e r below) b e cau se o f th e s t r a t e g i c
im p o rta n c e o f s t e e l i n th e s t r u c t u r e o f p r o d u c t i o n .
A somewhat more s u b t l e f a c t o r i s th e f i r m ' s e s t i
m ate of th e e l a s t i c i t y o f demand f o r i t s p r o d u c t . To th e
e x t e n t t h a t management r e g a r d s i t s demand i n e l a s t i c , i t
w i l l be in d u c e d to meet a drop In s a l e s w ith an i n c r e a s e in
p r i c e in o r d e r t o m a in ta in t h e volume of r e tu r n s .^ -
F i n a l l y , th e most s u b t l e f a c t o r i s t h e inducem ent
t o management t o m agnify c o s t i n c r e a s e s i n i t s p r i c e
d e c i s i o n s b e cau se o f th e i n c e n t i v e t o do so " i n h e r e n t " in
t a r g e t p r i c i n g . S in c e many f ir m s s e t t h e i r p r i c e s t o c o v er
a f u t u r e tim e p e r i o d ( u s u a l l y a y e a r ) , in a d v a n c e , t h e y
w i l l te n d t o have more i n c e n t i v e t o be " o v e r l i b e r a l " In
a p p ro x im a tin g f u t u r e c o s t s — e s p e c i a l l y where t h e r e I s a
rew ard f o r e x c e e d in g th e t a r g e t p r o f i t r a t e — th a n t o u n d e r
e s t i m a t e f u t u r e c o s t s .
P r i c e l e a d e r s h i p . — U n d e rly in g th e s e t h r e e f a c t o r s ,
sa y s B l a i r , I s th e ten d e n cy o f o l i g o p o l i s t i c f ir m s to
" f o llo w " th e p r ic e - c h a n g e made by th e " p r i c e l e a d e r " — by
"m atching" h i s p r i c e t o "meet th e c o m p e titio n " — a lm o s t
r e g a r d l e s s o f th e d i r e c t i o n o f change. F o r M eans, th e
ten d e n cy t o d e v elo p p r i c e l e a d e r s h i p i s p a r t i c u l a r l y
c h a r a c t e r i s t i c of i n d u s t r i e s where " s ta n d a r d " p r o d u c t s a r e
^On t h i s p o i n t , see a l s o L a n z i l l o t t i , "Some Char
a c t e r i s t i c s . . . ," op. c i t . , p. 454.
256
m a in ly c o n c e rn e d .^ In th e case o f a p r i c e - i n c r e a s e by th e
p r i c e l e a d e r , t h e o t h e r f ir m s may hav e n o th in g t o g a in by
f a i l i n g t o do l i k e w i s e , s i n c e in su c h a c ase t h e l e a d e r
would m erely r e s c i n d h i s a c t i o n .
S e c o n d ly , th e g r e a t e r d e g re e of p r o d u c t d i v e r s i f i
c a t i o n c h a r a c t e r i s t i c of "dom in ant" o l i g o p o l i s t i c f ir m s
g iv e s them v a r i o u s forms o f " l e v e r a g e " ( i n any p a r t i c u l a r
p ro d u c t l i n e ) compared w ith s m a l l e r , l e s s d i v e r s i f i e d
r i v a l s f o r whom a p r i c e - c u t t i n g war ( i n a g iv e n p ro d u c t
l i n e ) would r e s u l t in a g r e a t e r r e l a t i v e l o s s o f s a l e s
re v e n u e .
The above a n a l y s i s assum es, o f c o u r s e , t h a t " o t h e r
t h in g s rem ain e q u a l " ; s p e c i f i c a l l y , t h a t th e r i s e in p r i c e s
i n o l i g o p o l i s t i c i n d u s t r i e s d u rin g t h e r e c e s s i o n i s n o t
o f f s e t by d e c l i n i n g p r i c e s i n o th e r s e c t o r s , su c h as a g r i
c u l t u r e , which a r e presumed t o be c h a r a c t e r i z e d by more
f l e x i b l e , m a rk e t-d e te rm in e d p r i c e a d ju s tm e n t s . However,
t h i s m a t t e r , i n v o l v i n g as i t does c o n s i d e r a t i o n of th e
o v e r - a l l p r i c e l e v e l — and th e im p a c ts e x e r t e d on i t by th e
s e p a r a t e ty p e s o f p r i c e d e t e r m i n a t i o n in d i f f e r e n t s e c t o r s
of th e economy— rem ain s t o be d i s c u s s e d in th e l a s t p a r t of
t h i s c h a p te r .
!Means, P r ic in g Power . . . . op. c i t . , pp. 2 9 ,
2 43- 44.
257
The new e n v iro n m e n t, — An im p o rta n t e le m e n t o m itte d
by B l a i r but em phasized by A lv in H. Hansen i s t h a t admin
i s t r a t i v e p r i c i n g i s to d a y o p e r a t i n g i n a v e ry new e n v ir o n
ment o f econom ic p o l i c y . T h is e n v iro n m en t i s c h a r a c t e r
iz e d by th e a p p l i c a t i o n o f modern f i s c a l and m onetary
p o l i c i e s and b u i l t - i n s t a b i l i z e r s . Thus, i n th e e v e n t o f
a r e c e s s i o n , when th e s e p o l i c i e s and i n s t r u m e n t s a r e used
to b o l s t e r th e sag in a g g r e g a te demand, p r i c e a d m i n i s t r a
t o r s a r e u n d e r l e s s p r e s s u r e t o r e d u c e t h e i r p r i c e s .
On t h e s id e o f c o s t s , Hansen p o i n t s t o two s p e c i a l
p r e s s u r e s t e n d i n g to m a i n t a i n o r even i n c r e a s e p r i c e s in
p e r i o d s of r e c e s s i o n . One i s th e f a c t t h a t , owing t o th e
" p o w e rfu l r e s i s t a n c e " o f t r a d e u n i o n s , wage r a t e s a re no
lo n g e r as e a sy t o a d j u s t i n th e downward d i r e c t i o n a s
f o r m e r ly . Second, t h e r e h a s been a s u b s t a n t i a l r i s e i n
o v e rh e ad and f i x e d c o s t s — due t o a u to m a tio n and r e l a t e d
heavy in v e s tm e n ts i n equipm ent and p e r s o n n e l ( a f a c t o r t o
be d i s c u s s e d b e lo w )— which makes f ir m s wary o f r e d u c in g
t h e i r p r i c e s .
A r e c e s s i o n phenomenon. — I n t h i s c o n n e c tio n i t
sh o u ld be n o te d t h a t , m a in ly f o r th e r e a s o n s n o te d a b o v e,
Hansen b e l i e v e s i t i s p r i m a r i l y i n r e c e s s i o n p e r i o d s t h a t
*The m ain r e f e r e n c e f o r t h e f o l lo w in g d i s c u s s i o n i s
A lvin H. H ansen, Economic I s s u e s o f th e 1960s (New York:
M cGraw-Hill Book Company, 1 9 6 0 ), p p . 1 3-1 4 , 17 -1 0 .
25b
a d m in i s t e r e d p r i c e s " e n t e r th e p i c t u r e . " T hat i s , he i s
a p p a r e n t l y r e f e r r i n g t o th e p e c u l i a r ways i n which admin
i s t e r e d p r i c e s c o n t r i b u t e t o th e phenomenon t h a t r e c e s s i o n s
no lo n g e r b r i n g w ith them th e d e f l a t i o n of demand, c o s t s ,
and p r i c e s t h a t was custom ary in th e p a s t ; in d e e d , th e y may
even be c h a r a c t e r i z e d by a c o n tin u in g r i s e i n p r i c e s ,
c a l l e d th e " r a t c h e t e f f e c t . "
S tr u g g le f o r F a i r Income S h a re s
The second n o tew o rth y a s p e c t of A c k le y 's markup
i n f l a t i o n i s t h a t t h e markup s p i r a l mechanism i s r e a l i s t i
c a l l y a t t r i b u t e d t o u n d e r ly in g b e h a v io r p a t t e r n s i n which
l a b o r and management a re view ed as " s t r u g g l i n g " f o r l a r g e r
s h a r e s of th e income p ie th ro u g h a tte m p ts t o expand t h e i r
r e s p e c t i v e m arkups.
The en g in e of i n f l a t i o n . — I n th e absen ce o f s u f f i c
i e n t improvement i n p r o d u c t i v i t y , th e t o t a l income p ie ( i n
r e a l t e r m s) cannot accommodate b o th of t h e s e c la im s I n a
s im u lta n e o u s f a s h i o n . F o r A ckley, th e c o m p e titiv e a tte m p ts
of l a b o r and b u s in e s s t o expand t h e i r r e s p e c t i v e markups
o r s h a re s c o n s t i t u t e th e "p rim a ry e n g in e " o f i n f l a t i o n .
C o n seq u en tly th e d e t e r m i n a t i o n of th e " a p p r o p r i a t e " s h a re s
of la b o r and c a p i t a l becomes th e " fu n d a m e n ta l q u e s tio n "
r a i s e d by i n f l a t i o n .
As Ackley h a s put i t , I t i s as thou gh (a) th e two
p a r t i e s were demanding " i n c o n s i s t e n t " o r " e x c e s s iv e " s h a re s
259
o f th e n a t i o n a l Income t h a t add up to "more t h a n 100 p e r
c e n t of th e t o t a l n a t i o n a l inco m e," and (b) t h e r e f o r e th e
a tt e m p t o f eac h p a r t y to o b t a i n i t s d e s i r e d " f a i r s h a re "
m ust p ro d u ce an " i n d e f i n i t e i n f l a t i o n a r y s p i r a l . "1
Of c o u r s e , t h e a c t u a l markups f i n a l l y " r e a l i z e d " by
ea c h p a r t y a r e no lo n g e r i n c o n s i s t e n t w ith eac h o t h e r : th e
e n s u in g p r i c e i n f l a t i o n manages to " c h i s e l away" any r e a l
e x c e s s i n t h e cla im s of the p a r t i e s t o e n la r g e d income
s h a r e s . The i r o n y , in A c k le y 's view , i s t h a t n e i t h e r p a r t y
o s t e n s i b l y seek s i n f l a t i o n as su c h , b u t m erely a tte m p ts t o
s e c u r e what i t r e g a r d s as a f a i r r e l a t i o n s h i p o r m argin
betw een i t s own c o s t s ( o r c o s t o f l i v i n g ) and i t s s e l l i n g
p r i c e ( o r r a t e ) .
E n la rg e d P r o f i t M argins
The f i n a l n o te w o rth y a s p e c t o f A ck ley ’ s m odel i s
t h a t i t p r o v id e s f o r th e p o s s i b i l i t y t h a t markup i n f l a t i o n ,
u s u a l l y a t t r i b u t e d t o r i s i n g c o s t s o f l a b o r and m a t e r i a l s ,
can a ls o o r i g i n a t e from w i t h i n th e b u s i n e s s s e c t o r i t s e l f ,
even i f wage r a t e s (and p resum ably m a t e r i a l s c o s t s , to o )
a r e s t a b l e .
P r i c e s a re c o s t s . — In th e economy as a w h o le,
a c c o rd in g t o A c k ley , most s a l e s by th e " a v e ra g e " f i r m a r e
% o t e th e s i m i l a r i t y betw een A c k le y 's "markup"
m odel and Abba P. L e r n e r 's " s e l l e r s ' i n f l a t i o n " d i s c u s s e d
i n C h ap ter i v .
260
made t o o t h e r f i r m s . As a c o n se q u e n c e , i f f o r any re a s o n
one f ir m r a i s e s i t s p r i c e s t o o th e r f i r m s , and t h e l a t t e r
( i n o r d e r t o p r e s e r v e t h e i r m arkups) p a s s a lo n g t h e i r
i n c r e a s e d c o s t s , th e n a " c o n s i d e r a b le ro u n d ” o f markup
i n f l a t i o n would be p o s s i b l e w i t h in th e b u s in e s s s e c t o r .
A lthough Ackley i s n o t s u f f i c i e n t l y c l e a r on t h i s
p o i n t , he i s r e f e r r i n g e s s e n t i a l l y t o th e case n o te d by
B l a i r and Means where th e i n s t i g a t i n g firm " e n l a r g e s " i t s
custom ary markup ( r a t h e r th a n m erely " p r e s e r v e " i t ) f o r
r e a s o n s o t h e r th a n i n c r e a s e d d i r e c t c o s t s o r demand, such
as expanded ov erhead e x p e n d i tu r e s on r e s e a r c h and d e v e lo p
m e n t, s a l a r i e d p e r s o n n e l , d e p r e c i a t i o n , or m o d e r n iz a tio n of
p l a n t and eq u ip m en t.
I t would seem t h a t t h i s i s th e most im p o r ta n t aspect
of markup i n f l a t i o n i n th e se n se t h a t th e im p u lse t o th e
s p i r a l em an ates " s p o n ta n e o u s ly " o r autonom ously from th e
e n la rg e m e n t by th e f ir m of i t s custom ary markup r a t h e r th a n
from an a tte m p t to p r e s e r v e i t s m argin a g a i n s t th e r i s i n g
d i r e c t c o s t s t h a t i t h as to pay.
I n t h e l a t t e r c a s e , p r e s e r v a t i o n of th e custom ary
m arg in s e r v e s m erely as a " v e h i c le " o r t r a n s m i s s i o n mech
anism f o r p a s s in g a lo n g th e I n f l a t i o n a r y p r e s s u r e s o r i g i
n a t i n g o u t s i d e th e f ir m . In c o n t r a s t , th e e n la rg e m e n t of
m a rg in s may be c o n s id e r e d as a t r u l y " in d e p e n d e n t" cause of
i n f l a t i o n , g e n e r a te d from w i t h i n th e f i r m . In o t h e r w ords,
261
th e t r u l y " a d m i n i s t r a t i v e " t y p e o f i n f l a t i o n would presum
a b ly be d e f i n e d p r i m a r i l y as a sp o n tan eo u s i n c r e a s e o f th e
p r o f i t m arg in o r r a t e . 1
F i n a l l y , i t may be n o t e d t h a t the e n la r g e d p r o f i t
m argin may prove t o be only t h e d i r e c t im p u lse f o r th e
e n s u in g p r i c e r i s e , whose u l t i m a t e m agnitude may a l s o
r e f l e c t th e w orkings o f o t h e r i n d i r e c t or in d u c e d s t i m u l i
t o f u r t h e r i n f l a t i o n . An exam ple o f th e l a t t e r would be
where th e p r o s p e c t o f s u b s t a n t i a l l y h ig h e r p r o f i t s becomes
an i n v i t i n g t a r g e t f o r a g g r e s s iv e l a b o r u n io n s and in d u c e s
them to e x a g g e ra te t h e i r wage demands.
The case o f s t e e l . — As i n d i c a t e d a b o v e , i t i s th e
s p e c i a l c ase o f th e e n la r g e d p r o f i t m argin o r r a t e t h a t i s
th e c h ie f con cern o f Means i n h i s s tu d y of p r i c i n g in the
s t e e l i n d u s t r y in g e n e r a l and th e U.S. S t e e l C o r p o r a tio n in
p a r t i c u l a r . Means' " a d m i n i s t r a t i v e " i n f l a t i o n i s e x p l i c
i t l y c o n cern ed only w ith th e c ase where th e i n c r e a s e d
p r i c e s c h a rg e d by f ir m s and l a b o r a r e not w a r r a n te d by any
p
p r i o r i n c r e a s e in m o netary demand o r c o s t s .
■^See a l s o F r i t z M achlup, "A no ther View of C o s t-
Push and D em and-Pull I n f l a t i o n , " The Review o f Economics
and S t a t i s t i c s . XLII (May, I 9 6 0 ) , p . 126.
2The f o l lo w in g d i s c u s s i o n i s based c h i e f l y on
M eans, P r i c i n g Power . . . , op. c i t . , pp. 6 1 -6 3 , 1 1 3-17 ,
1 3 7 -3 9 ," 1 4 3 -5 0 , 1 5 5 -6 0 .
262
A cco rd in g t o M eans, p r i c e movements a f t e r 1953 in
th e s t e e l i n d u s t r y (more p r e c i s e l y , t h e U. S. S t e e l Company)
a r e an example of t h i s ty p e o f i n f l a t i o n . For t h e p e r i o d
p r i o r t o 1953 he would a t t r i b u t e th e r i s e in s t e e l p r i c e s
m o s tly t o th e e x c e s s demand a s s o c i a t e d w ith w artim e mone
t a r y e x p a n s io n . But f o r th e p e r i o d a f t e r 1953 he s e e s no
m o n etary i n f l a t i o n n o r a g e n e r a l e x c e ss of demand. Thus
th e only e l i g i b l e c a u se s of th e p o st-1 9 5 3 s t e e l - p r i c e r i s e s
c o u ld be (a) e x c e s s i v e p r e s s u r e s by l a b o r f o r wage-
i n c r e a s e s , and (b) an e f f o r t by p ro d u c e rs t o "w iden th e
m a rg in " betw een o p e r a t i n g e x p e n se s ( l a b o r and m a t e r i a l s )
and re v e n u e s .
S in ce h i s d a t a r e v e a l t h a t th e r i s e in s t e e l l a b o r
and o t h e r o p e r a t i n g c o s ts a c c o u n te d f o r som eth ing l e s s th a n
h a l f o f th e r i s e i n s t e e l p r i c e s d u r in g 1953-1959* Means
i n f e r s t h a t th e i n c r e a s e In th e p r o d u c e r 's m argin m ust have
a c c o u n te d f o r t h e b a la n c e of th e p r i c e r i s e . T hat i s , U.
S. S t e e l ' s m arg in must have n e a r l y d o u b led in th e same
p e r i o d , from abou t e i g h t p e r c e n t t o ab out s i x t e e n p e r cent.
Was t h i s i n c r e a s e d m a rg in w a r r a n te d , i n whole o r in
p a r t , by changes i n t a x e s o r c a p i t a l equipm ent employed?
Means c o n c lu d e s t h a t only about o n e - f i f t h o f t h e I n c r e a s e d
m a rg in was so j u s t i f i e d . As betw een l a b o r and c a p i t a l , he
e s t i m a t e s t h a t i n c r e a s e d l a b o r c o s t s a c c o u n te d f o r about
o n e - f o u r t h o f th e r i s e i n s t e e l p r i c e s , and th e b a la n c e
263
was c a p i t a l ' s r e s p o n s i b i l i t y .
A u s e f u l i l l u s t r a t i o n . — I t i s n o t o u r c o n c e rn to
d e te rm in e w h e th e r ( o r t o what e x t e n t ) th e r i s e i n U. S.
S t e e l ' s p r i c e s a f t e r 1953 was j u s t i f i e d , a lth o u g h t h e
m anagem ent, a c c o rd in g to M eans, d e fe n d e d i t s markup a d j u s t
ment on two g ro u n d s: (a ) t h a t a h i g h e r r a t e o f r e t u r n was
needed t o su p p ly new c a p i t a l f o r e x p a n sio n w ith o u t h a v in g
to t a p t h e m arket f o r p r i v a t e s a v i n g s , and (b ) t h a t t h e
g e n e r a l o b j e c t i v e was t o b r i n g th e com pany's e a r n i n g s i n t o
l i n e w ith th o s e o f o t h e r f ir m s in com parable i n d u s t r i e s .
Nor n eed we be h e re co n ce rn e d w ith th e e x t e n t to
which th e r i s e i n s t e e l p r i c e s c o n t r i b u t e d t o th e r i s e in
g e n e r a l p r i c e l e v e l a f t e r 1953. Our p u rp o se has been
m erely t o i l l u s t r a t e how an e n la r g e d p r o f i t m argin m ight
se rv e t o g e n e r a t e i n f l a t i o n a r y p r e s s u r e s v i a (a ) t h e r i s e
i n p r i c e s of an im p o rta n t b a s i c commodity and (b) th e
i n c r e a s e d wage demands in d u c e d more o r l e s s by th e s p e c i a l
r i s e i n p r o f i t m arg in .
P ric in g P ra c tic e s and th e General P rice Level
S ince t h e phenomenon o f i n f l a t i o n i s e x p r e s s e d in
th e form of t h e s t a t i s t i c a l a b s t r a c t i o n c a l l e d th e " g e n e r a l
p r i c e l e v e l " — m e a su rin g th e a v e ra g e o f p r i c e s o f w h o le sa le
p r o d u c t s , consumer p r o d u c t s , o r g r o s s n a t i o n a l p r o d u c t - - i t
now behooves u s to d e s c r i b e th e m anner by w hich th e v a r i e t y
2bH
of p ric e -d e te rm in a tio n p ro cesses used in the in d iv id u a l
firm s and s e c to rs of the economy (th e main s u b je c t of
concern thus f a r ) are combined to form t h i s g e n e ra l,
average, or o v e r - a ll p ric e le v e l. That i s , how should we
d escrib e the mechanism by means of which the p ric e s se t by
in d iv id u a l firm s and s e c to rs are combined to g en erate
in c re a se s in the o v e r - a l l p ric e le v e l? In o rd er to accom
p lis h th is i t w i l l be u s e fu l to f i r s t review in o u tlin e
some of the foundations l a i d above upon which we may now
b u ild .
The Determ inants of P rices
W e may conceive of the g e n e ra l p rice le v e l as being
determ ined, in the f i r s t in s ta n c e , by a set of f a c to r s
regarded as approximate d eterm inants of the p r ic e le v e l.
These would in clu d e the same fo rc es of demand and supply
(co st) th a t are o p e ra tiv e in the case of the in d iv id u a l
firm . That i s , each firm i s , so t o speak, in the same boat
as a l l o th e r firm s in t h a t i t must contend w ith the demand
and supply fo rc e s of the market as "mediated" through t h e i r
re s p e c tiv e p r ic in g p o l i c i e s .
The se c to re d economy. —R e lated to th e s e approximate
determ inants o f p ric e s i s the in flu e n c e e x e rte d by th e
se cto red or heterogeneous n a tu re of the economy, which
comprises a v a r ie ty of market s t r u c t u r e s —from pure
265
c o m p e titio n th ro u g h m o n o p o lis tic c o m p e titio n and o lig o p o ly
t o monopoly— t o e a c h o f w hich t h e r e c o rre s p o n d s a p e c u l i a r
mode o f p r i c e - d e t e r m i n a t i o n . Thus th e key q u e s t io n h e re
becom es: a p p ro x im a te ly how do th e r e s p e c t i v e modes o f
p r i c e - s e t t i n g s e rv e t o "m ed iate " t h e f o r c e s o f su p p ly and
demand?1
V e h ic le s of p r i c i n g . — In t h i s and p r e c e d in g c h ap ters
i t was I n d i c a t e d t h a t t h e a p p ro x im a te d e te r m in a n ts o f
p r i c e s — demand (m onetary and r e a l ) and c o s t s — can a f f e c t
th e p r i c e l e v e l c h i e f l y v i a two t y p e s of p r i c i n g d e v ic e s :
( a ) th e mechanism o f pure c o m p e titio n or " f r e e " m a r k e ts ,
and (b) th e a d m i n i s t r a t i v e p r i c i n g p r a c t i c e s of l e s s - t h a n
p u r e l y c o m p e titiv e f i r m s .
In th e f i r s t m echanism , w hich we may r e f e r t o as
"m a r k e t" p r i c i n g , th e f o r c e s of demand and su p p ly a r e ex
p e c te d t o e x e r t t h e i r i n f l u e n c e s on p r i c e s i n an unim peded,
d i r e c t f a s h i o n , so t h a t p r i c e s re s p o n d i n s t a n t a n e o u s l y and
a u t o m a t i c a l l y t o changes i n demand and s u p p ly . However, in
th e second i n s t r u m e n t , w hich we may r e f e r t o as
" a d m i n i s t r a t i v e " p r i c i n g , th e f o r c e s of demand su p p ly a r e
m ed iate d th r o u g h th e p r i c i n g c a l c u l u s of t h e f i r m , w hich in
t u r n may y i e l d p r i c e and o u tp u t r e s u l t s t h a t w i l l n o t
n e c e s s a r i l y c o rre s p o n d ( a t l e a s t n o t e x a c t l y , n o r i n th e
10n t h e s e two p o in t s see Bowen, op. c i t . , pp. 298,
304.
266
s h o r t - r u n ) t o th e r e s u l t s e x p e c te d u n d e r p u re c o m p e ti t io n .
An a tte m p t was a l s o made, p a r t i c u l a r l y i n th e
p r e s e n t c h a p t e r , t o a n a ly z e th e f i n d i n g s of e c o n o m is ts on
th e im p acts o f demand and c o s t s on p r i c e s which may be
e x p e c te d u n d e r th e s e two d i f f e r e n t p r i c i n g s y s te m s . Our
main c o n cern was n o t w ith th e " w e lf a r e " or " e q u i t y " a s p e c t s
o f p r i c i n g p r a c t i c e s , b u t sim p ly w ith th e c a l c u l a b l e
im p a cts on p r i c e s and th e i n f l a t i o n p r o c e s s . At t h i s
p o i n t , t h e r e f o r e , i t may be u s e f u l t o summarize th e v a r i o u s
modes of p r i c e - s e t t i n g t h a t e c o n o m is ts r e g a r d a s c h a r a c t e r
i s t i c o f th e component s e c t o r s of t h e p r i c e i n d e x .^
The m a n u fa c tu rin g s e c t o r . — I n th e f i r s t p l a c e , much
of what h a s been s t a t e d above c o n c e rn in g a d m in is te r e d
p r i c e s i s p ro b a b ly most a p p l i c a b l e t o th e m a n u f a c tu r in g or
p r o c e s s in g segm ents o f th e economy. These i n d u s t r i e s
a c t u a l l y c o n s t i t u t e a b ro a d and h e te ro g e n e o u s c a t e g o r y ,
w hich e x p l a i n s why a v a r i e t y of a d m i n i s t r a t i v e p r i c i n g
m ethods ( r a t h e r th a n a s i n g l e one o r a few s t e r e o t y p e
m odels) m ust be r e g a rd e d as a p p l i c a b l e .
The a g r i c u l t u r a l s e c t o r . — I n th e a g r i c u l t u r a l
s e c t o r , th e m ajo r s t r u c t u r a l c h a r a c t e r i s t i c s a r e t h e p r e
dom inant hom ogeneity of th e p r o d u c t and th e l a r g e number o f
in d e p e n d e n t p ro d u c e r s o rg a n iz e d i n m a rk e ts t h a t a p p ro x im a te
^The f o l lo w in g s i x s u b - s e c t i o n s a re b a se d m ain ly
on Bowen, op. c i t . . pp. 300-303.
267
th e c l a s s i c a l c o m p e titiv e m odel, w ith th e i n d i v i d u a l fa rm e r
e x e r c i s i n g v i r t u a l l y no d i r e c t c o n t r o l o v e r h i s s e l l i n g
p r i c e . As a c o n se q u e n c e , th e b e h a v i o r o f a g r i c u l t u r a l
p r i c e s a p p ro x im a te s th e r e s u l t s e x p e c te d i n th e c o m p e titiv e
m odel. Thus t h e r e i s th e te n d e n c y o f farm p r i c e s t o be
more r e s p o n s iv e t o s h i f t s i n demand th a n t o changes i n
c o s t s , t h e l a t t e r t a k i n g e f f e c t r a t h e r i n d i r e c t l y and
s lo w ly .
However, th e w o rk ing s o f c o m p e titio n i n a g r i c u l t u r e
a re m o d ifie d by a s u b s t a n t i a l d e g re e of s p e c i a l governm ent
l e g i s l a t i o n and r e g u l a t i o n which d i r e c t l y a f f e c t i t . Of
p a r t i c u l a r n o te i s th e " f l o o r " s e t on th e p r i c e s o f a
s e l e c t e d l i s t o f p r o d u c t s . In te rm s of p r i c e e f f e c t s , t h i s
f l o o r s e r v e s t o p r e v e n t a d e p r e s s io n o f p r i c e s below i t in
case demand f a l l s o f f e x c e s s i v e l y . In th e e v e n t o f a
demand I n c r e a s e , p r i c e s w i l l n o t be r a i s e d so long as th e
governm ent g u a r a n t e e - p r i c e s rem ain above "m ark e t" p r i c e s .
W ith r e s p e c t t o c o s t c h a n g e s , s i n c e th e f l o o r
i t s e l f s h i f t s w ith changes In t h e f a r m e r 's c o s t s , I t
enhances th e a c t u a l r o l e p la y e d by c o s t s i n farm p r i c i n g .
A ls o , on th e su p p ly s i d e , governm ent crop r e s t r i c t i o n s may
a f f e c t farm p r i c e s by a l t e r i n g th e q u a n t i t y o f farm goods
p ro d u ce d .
P u b lic u t i l i t i e s -A nother segment o f t h e economy,
tho u g h somewhat n a r r o w e r , i n which governm ent s e r v e s a more
26b
p re d o m in a n tly c o n t r o l l i n g o r r e g u l a t i n g f u n c t i o n i s th e
p u b l i c u t i l i t y s e c t o r . The c h i e f consequence of t h i s c h a r
a c t e r i s t i c governm ent i n f l u e n c e i s th e u n d is p u te d prom inence
g iv e n to c o s t s i n th e p r i c e - d e t e r m i n a t i o n p r o c e s s : th e
p u b l i c a u t h o r i t i e s e x p e c t th e f i r m 's p r i c e a d ju s tm e n ts t o
conform t o changes i n c o s t s .
D i s t r i b u t i v e t r a d e s . — As n o te d abo v e, th e d i s t r i b u
t i v e t r a d e s t e n d t o employ some v a r i a n t of g r o s s -m a r g in
p r i c i n g , n o rm a lly e x p re s s e d as a p e r c e n ta g e o f f i n a l p r i c e .
The main c h a r a c t e r i s t i c i n t h i s s e c t o r i s th e i n f l u e n t i a l
r o l e p la y e d by v a r i a b l e c o s t s , which c o n s i s t m ain ly of th e
sums p a id by d i s t r i b u t o r s t o s u p p l i e r s t o a c q u ire goods f o r
r e s a l e . In g e n e r a l , v a r i a b l e c o s t s a c c o u n t f o r a h ig h
p r o p o r t i o n o f t o t a l c o s t s b u t do n o t v ary s i g n i f i c a n t l y
o v e r th e ran g e o f su p p ly h a n d le d by th e d i s t r i b u t o r . S ince
th e d i s t r i b u t o r n eeds some g e n e r a l p r i c i n g fo rm u la t h a t he
can r e a d i l y a p p ly t o th e v a r i e t y of ite m s he s e l l s , he
te n d s t o r a i s e h i s p r i c e s i n p r o p o r t i o n t o i n c r e a s e s i n h i s
v a r i a b l e c o s t s .
S e r v ic e i n d u s t r i e s . — A nother m a jo r s e c t o r o f th e
economy c o m p rise s th e " s e r v i c e s . " To th e e x te n t t h a t
s e r v i c e s a r e s o l d by i n d i v i d u a l s — such as d o m estic s e r v a n t s ,
p h y s i c i a n s , la w y e rs , t e a c h e r s , m e c h a n ic s , and o t h e r s —
r a t h e r th a n by o r g a n i z a t i o n s a s s u c h , we fa c e a p r i c i n g
p r o c e s s a k in to wage d e t e r m i n a t i o n , in which th e p r i c e
(wage) i s f o r la b o r s e rv ic e s rendered.
However, since some p ric e s paid fo r se rv ic e s may be
s e t by a s s o c ia tio n s or unions to which the in d iv id u a l
producer belongs, we have a combination of wage determ ina
tio n (w ith union in flu e n c e ) and p r ic in g p o lic y by a " firm ."
I f a g e n e ra l conclusion i s p o s s ib le , p ric e s f o r s e rv ic e s
w ill ten d to be f a i r l y responsibe to in c re a se s in demand
and (e s p e c ia lly In the case of manual workers) to wages
received by o th er wage e a rn e rs . C ost-plus would appear to
play a minimal r o l e .
E n ter c o m p lic atio n s. —Thus i t would seem th a t I f
the g e n e ra l p ric e le v e l (o r o v e r - a ll p ric e Index) could be
made s u f f i c i e n t l y r e p re s e n ta tiv e of the behavior of the
component p ric e s p re v a le n t in the economy, i t would be
reasonable to expect changes in t h i s p rice le v e l to simply
m irro r the o p eratio n of the v ario u s modes of p ric e d e t e r
m ination throughout the economy as a whole.
More p r e c i s e ly , p r i c e - l e v e l movements would seem to
depend only on (a) the c h a r a c t e r i s t i c d i s t r i b u t i o n of
market and a d m in is tra tiv e modes of p ric in g in each s e c to r
of th e economy, (b) the p r ic e - r e a c tio n s of In d iv id u a l firm s
to s p e c if ic changes in demand and co sts as "mediated" by
t h e i r re s p e c tiv e p ric in g p o l i c i e s , and (c) th e combined
impact of a l l component p r ic e - r e a c tio n s on th e p ric e Index,
c a lc u la te d according to an ap p ro p ria te w eighting scheme.
270
A c tu a lly t h i s r e l a t i v e l y g e n e r a l scheme f o r th e
I n t e r p r e t a t i o n of p r i c e changes i n te rm s of th e r e l a t i o n
s h ip betw een demand and s u p p ly , on th e one h a n d , and t h e
d i s t r i b u t i o n o f th e v a r i o u s modes o f p r i c i n g , on th e o t h e r ,
i s c o m p lic a te d by th e e x i s t e n c e o f a n o th e r l a y e r of u n d e r
l y i n g o r " a n te c e d e n t" f a c t o r s — t e c h n o l o g i c a l , s t r u c t u r a l ,
and i n s t i t u t i o n a l — which o p e r a te b e h in d th e sc e n e s to e x e r t
s i g n i f i c a n t i n f l u e n c e on th e ap p ro x im ate d e te r m in a n ts
(demand and c o s t s ) . Were t h e s e u n d e r ly in g d e te r m in a n ts o f
p r i c e s e q u a lly o r p r o p o r t i o n a l l y d i s t r i b u t e d th ro u g h o u t th e
v a r i o u s s e c t o r s o f th e economy, t h e r e would be no need h e r e
t o n o te th e s p e c i a l ( o r d i f f e r e n t i a l ) im p a cts th e y m ig ht
e x e r t on d i f f e r e n t i n d u s t r i e s . B ut, as w i l l be r e a d i l y
s e e n , such i s n o t t h e case.-*-
Rate o f p r o d u c t i v i t y . - - F o r i n s t a n c e , f ir m s and
i n d u s t r i e s may d i f f e r s i g n i f i c a n t l y i n t h e i r r a t e of
p r o d u c t i v i t y growth o r a b i l i t y t o g e n e r a te a n n u a l i n c r e
m ents of p r o d u c t i v i t y . On th e one h a n d , th e s e p r o d u c t i v i t y
g a in s se rv e t o re d u c e c o s t s (and i n c r e a s e p r o f i t s ) , w h ile
on th e o t h e r hand th e y i n v i t e l a b o r t o a b so rb a l l o r p a r t
o f th em , d e p e n d in g on t h e d e g re e of "monopoly power"
p o s s e s s e d by th e f i r m and th e r e s p e c t i v e b a r g a i n in g s tre n g th
o f u n io n and m anagem ent. As a c o n se q u e n c e , a g iv e n
^U nless o th e r w is e i n d i c a t e d , t h i s d i s c u s s i o n i s
b a se d m ainly on Bowen, op. c l t . , pp. 2 1 3 -1 4 , 310-11.
271
I n c r e a s e In demand o r wages w i l l e x e r t d i f f e r e n t i a l im p a c ts
on c o s ts and p r i c e s o f fir m s .
O th e rs have p o in te d t o d i f f e r e n t i a l r a t e s of
p r o d u c t i v i t y to e x p l a i n why p r i c e s i n th e s e r v i c e in d u s
t r i e s have te n d e d t o r i s e more r a p i d l y th a n i n m a n u f a c tu r
i n g . F or e x am p le, i t I s a rg u e d t h a t a g iv en w a g e - in c r e a s e
a f f e c t i n g b o th s e r v i c e s and m a n u f a c tu r in g would r a i s e t o t a l
c o s t s in th e fo rm er s e c t o r much more r a p i d l y .
E co n o m ists l i k e Sumner H. S l i c h t e r r e g a r d " c r e e p i n g
i n f l a t i o n " as a n e c e s s a r y c o s t of a c h ie v in g r a p i d te c h n o
l o g i c a l p r o g r e s s b e ca u se th e l a t t e r , by i n c r e a s i n g th e
demand f o r s p e c i a l t y p e s of l a b o r , h e l p s wages o u t s t r i p th e
g a in s i n p r o d u c t i v i t y . 1
S l i c h t e r Is p resu m ab ly r e f e r r i n g m ainly t o what may
be c a l l e d " i n t e r n a l " ty p e s o f t e c h n i c a l a d v an c e, in th e
se n se t h a t th e y a re g e n e r a t e d by the f i r m as a means o f
p r e s e r v i n g o r e n h a n c in g i t s c o m p e titiv e p o s i t i o n . P la c e d
on a c o n ti n u i n g b a s i s by th e f i r m , such t e c h n i c a l p r o g r e s s
h as g iven r i s e t o w hat S l i c h t e r c a l l e d th e " i n d u s t r y o f
d i s c o v e r y ." But e q u a l l y Im p o rta n t a r e th e i n f l a t i o n a r y
Im pacts o f t e c h n i c a l ad vances s t i m u l a t e d by " e x t e r n a l "
e v e n t s , such as th e d e fe n s e and s p a c e - p r o j e c t r e q u ir e m e n ts
■^Sumner H. S l i c h t e r , "On th e S id e of I n f l a t i o n , "
H arv ard B u s in e s s R ev iew , XXXV (S e p te m b e r-O c to b e r, 1957)9
p . 30. See a l s o h i s "The I n d u s t r y o f D is c o v e r y ," S c i e n c e ,
CXXVIII (December 2 6 , 1 9 5 8 ), p p . 1610-13.
272
o f th e n a t i o n w h ic h , i n t u r n , a r e i n re s p o n s e t o th e
e x t e r n a l im p acts o f th e Cold War.
R a tio o f l a b o r c o s t s . - - I n d u s t r i e s may a ls o d i f f e r
s t r u c t u r a l l y , w i t h r e s p e c t to th e r a t i o o f l a b o r c o s t s t o
t o t a l c o s t s . Thus a g iv e n p e r c e n ta g e i n c r e a s e i n u n i t
l a b o r c o s t s would r e s u l t in a much l a r g e r p r o p o r t i o n a t e
i n c r e a s e i n t o t a l c o s ts i n h i g h e r l a b o r - c o s t s e c t o r s , such
as th e s e r v i c e i n d u s t r i e s , th a n i n low er l a b o r - c o s t
s e c t o r s .
Labor o v e rh e ad c o s t s . — A r e l a t e d s t r u c t u r a l i n f l u
ence i s th e e x t e n t t o w hich i n d u s t r i e s d i f f e r ( w i t h i n and
among th e m s e lv e s ) i n t h e i r i n t r a - l a b o r r a t i o s o f "p ro d u c
t io n " w orkers ( a l s o r e f e r r e d t o as " w a g e -e a rn e rs " o r
" d i r e c t la b o r " ) t o " n o n - p r o d u c tio n " ( o r s a l a r i e d ) p e r s o n n e l
in m a n a g e r ia l, a d m i n i s t r a t i v e , s a l e s , t e c h n i c a l , s c i e n t i f i c ,
p r o f e s s i o n a l , and c l e r i c a l p o s i t i o n s .
As i n d i c a t e d by C h a rle s L. S c h u l t z e , t h i s a s p e c t
has a grow ing r e le v a n c e t o th e i n f l a t i o n problem f o r th e
f o llo w in g r e a s o n s : (a) compared t o d i r e c t l a b o r , s a l a r i e d
em ployees a re a c c o u n tin g f o r an i n c r e a s i n g p o r t i o n o f
la b o r employed i n i n d u s t r y , e s p e c i a l l y i n m a n u f a c tu r in g ,
and (b) w hereas d i r e c t l a b o r i s r e g a r d e d a s v a r i a b l e w ith
o u t p u t , s a l a r i e d w o rk e rs a r e i n c r e a s i n g l y b e in g r e g a r d e d
a s "o v e rh e a d " o r r e l a t i v e l y " f i x e d " c o s t s b e ca u se th e y a r e
h i r e d i n the c o n te x t o f lo n g e r - t e r m r e q u ire m e n ts and t h e i r
273
employment i s n o t r e a d i l y a d j u s t e d i n a c c o rd a n c e w ith
s h o r t - r u n f l u c t u a t i o n s i n o u t p u t.
The s p e c i f i c i m p l i c a t i o n o f th e grow ing r o l e o f
o v e rh e ad l a b o r f o r th e s h o r t - r u n p r i c i n g p o l i c i e s of f i r m s
i s t h a t — i n c o n t r a s t t o t r a d i t i o n a l p r i c i n g th e o r y and some
ty p e s o f c o s t - p l u s t h e o r y — f i x e d c o s t s m ust be re g a r d e d as
c a p a b le of e x e r t i n g an im pact on p r i c i n g d e c i s i o n s i n t h e
s h o r t - r u n . In th e c ase of an i n c r e a s e d employment o f o v e r
head l a b o r (and u n i t f i x e d c o s t s , t h e r e f o r e ) in a n t i c i p a
t i o n o f i n c r e a s e d s a l e s and o u t p u t — such as o c c u r r e d d u r in g
th e in v e s tm e n t boom o f 1955-57— t o th e e x te n t t h a t th e
f i r m s 1 e x p e c t a t i o n s o f h ig h e r s a l e s f a i l to m a t e r i a l i z e ,
t h e i n c r e a s e d u n i t f i x e d c o s t s t h a t have been i n c u r r e d w i l l
te n d t o red u c e p r o f i t m a rg in s . In such s i t u a t i o n s i t i s
c o n c e iv a b le t h a t p r i c e - m a k e r s , d u rin g a p e r i o d o f "su p p o sed
p r o s p e r i t y , " would be tem p ted t o r a i s e t h e i r p r i c e s in
p
o r d e r t o reco up a l l o r p a r t o f t h e i r red u c ed m a rg in s.
■kphis d i s c u s s i o n i s b a s e d m ain ly on S c h u l t z e ,
op. c i t . , pp. 1 0 -1 2 , 14, 78-96.
2The im pact o f d i s a p p o i n t i n g s a l e s volume on u n i t
v a r i a b l e c o s t s i s much s m a ll e r th a n t h e im pact on f i x e d
c o s t s inasm uch as d i r e c t l a b o r c o s t s can be a d j u s t e d t o th e
r a t e o f o u t p u t; t h a t i s , th e number o f p r o d u c tio n w o rk e rs
employed can be re d u c e d when o u tp u t f a i l s t o r i s e as
e x p e c te d ; see S c h u l t z e , i b i d . , p. 91.
274
O th e r ov erhead c o s t s . — I n t h i s c o n n e c tio n i t must
be added t h a t t h i s c y c l i c a l e f f e c t on u n i t f i x e d c o s t s i s
e x e r t e d n o t only by l a b o r o v e rh e ad b u t a l s o by o t h e r ty p e s
o f overhead c o s t s — such as p l a n t and equip m en t o u t l a y s ,
d e p r e c i a t i o n a llo w a n c e s , and r e s e a r c h and d ev elopm en t— to
th e e x t e n t t h a t th e s e a re i n c r e a s e d r e l a t i v e t o d i r e c t
l a b o r c o s t s . P o s t-w a r t r e n d s i n o v erh ead c o s t s r e v e a l t h a t
n o n - l a b o r f i x e d c o s t s have a ls o I n c r e a s e d as a p r o p o r t io n
of t o t a l c o s t s , r e f l e c t i n g n o t o n ly grow ing in v e s tm e n t in
t e c h n o l o g i c a l im provem ent— i n c l u d i n g m e c h a n iz a tio n , a u to
m a tio n , and i n s t r u m e n t a t i o n — b u t a l s o grow th o f fo rm a l
r e s e a r c h and developm ent program s as a s p e c i a l f u n c t i o n .
I n d e e d , much o f t h i s in v e s tm e n t h a s e n t a i l e d a
grow ing complement o f s p e c i a l i z e d p r o f e s s i o n a l , s c i e n t i f i c
and t e c h n i c a l p e r s o n n e l and was p ro b a b ly r e s p o n s i b l e f o r a
s i g n i f i c a n t p a r t o f t h e p o s t- w a r i n c r e a s e i n s a l a r i e d
o v e rh e ad .
F u r t h e r , w ith i n c r e a s e d p o s t- w a r c a p i t a l o u t la y s
and th e r e s u l t i n g r i s e i n the o v e r - a l l c a p i t a l / o u t p u t r a t i o
d u rin g th e 1 9 5 0 's ( c o u p le d w ith r e l a t i v e l y h i g h e r - t h a n -
a v e ra g e i n c r e a s e s i n th e p r i c e s o f new p l a n t and equipm ent),
d e p r e c i a t i o n c h a rg e s have te n d e d t o r i s e n o t only as a p r o
p o r t i o n o f t o t a l c o s t s b u t a l s o compared t o o t h e r u n i t
c o s t s . As a consequence of t h i s g e n e r a l r i s e i n r e l a t i v e l y
r i g i d overh ead c o s t s , th e b re a k -e v e n p o i n t s have been
275
p u shed s t e a d i l y h i g h e r , n o t i c e a b l y a f f e c t i n g p r o f i t s In
p e r i o d s o f re d u c e d volum e.
S p e c i a l p r i c e d e t e r m i n a n t s . — F i n a l l y , t o c o m p lic a te
m a t t e r s even f u r t h e r , t h e r e i s a h e te ro g e n e o u s c a te g o r y of
s p e c i a l o r random i n f l u e n c e s on p r i c e s t h a t may acco u n t
( i n whole o r i n p a r t ) f o r th e n a t u r e of o v e r - a l l p r i c e
changes i n p a r t i c u l a r p e r i o d s .
A c a se i n p o i n t i s th e v a r i a t i o n from tim e t o tim e
i n th e lo c u s o r s ta g e o f p r o d u c tio n a f f e c t e d by a g iv e n
change in demand or c o s t s . Thus a g iv en r i s e i n t h e w hole
s a l e p r i c e o f s t e e l p r o d u c t s may be e x p e c te d to e x e r t a
s t r o n g e r im p a ct on th e p r i c e s p a i d by p ro d u c e r s o f i n t e r
m e d ia te p r o d u c ts and p r o d u c e r s ' f i n i s h e d goods t h a n on th e
p r i c e s r e c e i v e d by p r o d u c e r s o f goods d e s t i n e d t o flow t o
consum ers th ro u g h norm al d i s t r i b u t i o n c h a n n e ls . S i m i la r
would be th e c ase of t h e im pact o f a g iv e n w a g e - i n c r e a s e . 2
In o t h e r w ords, th e m ag nitude o f c o s t s and p r i c e s
of f i n a l consum er goods a re d e te rm in e d n o t only by (a) t h e
p r i c e s of i n p u t s ( l a b o r and m a t e r i a l s ) b u t a ls o by (b) t h e
e f f e c t o f p r o d u c t i v i t y - i n c r e a s e s i n su b se q u e n t s t a g e s o f
p r o d u c tio n on th e u n i t c o s t s of p r o d u c e rs o f f i n a l consumer
^George Bookman, "The New Anatomy of B u sin e ss
P r o f i t s , " F o r t u n e , LXV (May, 1 9 6 2 ), p. 242.
2T his s u b - s e c t i o n i s b a se d m ain ly on Bowen, op. c l t n
pp. 3 1 1 -1 2 , and Chamber o f Commerce o f t h e U. S . , op. c i t . ,
pp. 15-20.
276
g o o d s, as w e l l as (c ) th e amount o f p r o f i t p e r u n i t o f
o u tp u t a c c e p te d by s e l l e r s o f f i n a l goods.
On th e o t h e r han d , i f a t th e same tim e demand
happens t o be s t r o n g enough to in d u ce p r o d u c e r s t o m a i n ta in
p r o f i t m a rg in s as a p e r c e n ta g e of t o t a l c o s ts (assum ing no
change in p r o d u c t i v i t y ) , th e n th e c o s t - i n c r e a s e s may be
a b le t o " p y ra m id ," c a u s in g th e u l t i m a t e p r i c e - r i s e r e s u l t
in g from a g iv e n c o s t - i n c r e a s e t o be l a r g e r t h e f u r t h e r
back i n t h e p r o d u c t i v e p r o c e s s th e i n i t i a l c o s t - i n c r e a s e i s
l o c a t e d .
R e la te d to t h i s a s p e c t of m agnitude o f u l t i m a t e
i n c r e a s e i n p r i c e i s t h e t im i n g of t h i s u l t i m a t e p r i c e
i n c r e a s e r e s u l t i n g from th e g iv e n i n c r e a s e i n c o s t s . Thus
a c o s t - i n c r e a s e g e n e r a te d i n a s ta g e o f p r o d u c tio n " f a r
removed" from th e co n su m er-p u rch a se s ta g e may be e x p e c te d
t o ta k e a lo n g e r tim e t o a f f e c t consumer p r i c e s th a n a
c o s t - i n c r e a s e i n th e r e t a i l i n g s t a g e .
T ra n s m is s io n Mechanism
F i n a l l y i t must be n o te d t h a t a c o s t - p r i c e o r
markup " t r a n s m i s s i o n " mechanism e x i s t s which can o p e r a t e in
a m anner com parable w ith t h e w a g e - tr a n s m is s io n ( r e f e r r e d t o
i n C h a p te rs i i i and iv ) and can se rv e t o combine th e m ic ro -
econom ic p r i c e movements of component s e c t o r s o f th e
economy i n t o a m acro -ec o n o m ic , g e n e r a l p r i c e movement.
277
I
C o s t - p l u s and m a rk u p s. — One of th e key t r a n s m i s s i o n
m echanism s, as may have become a p p a re n t by now, i s th e
f i r m 's m a in te n a n c e o f a r e l a t i v e l y f i x e d markup o r p r o f i t
m argin i n th e fa c e of c h ang es i n demand and c o s t s . Thus a
r i g i d c o s t - p l u s m argin s e r v e s t o p ro p a g a te a sequence of
p r i c e r i s e s ro u g h ly p r o p o r t i o n a t e t o t h e r i s e in c o s t s , as
one f i r m ' s p r i c e - i n c r e a s e becomes a n o th e r f i r m 's c o s t -
i n c r e a s e . In t h i s schem e, th e u l t i m a t e r i s e i n th e g e n e r a l
p r i c e l e v e l would depend p r i m a r i l y (assum ing o t h e r t h in g s
rem ain e q u a l) on how r i g i d l y th e s e r i e s o f firm s in v o lv e d
m a in ta in e d t h e i r custom ary markup l e v e l . That i s , i t would
depend on how r e s i s t a n t th e y were t o a l t e r i n g t h e i r m arg in s
i n th e fa c e o f changed demand o r c o s t s .
To say t h i s , h o w ev er, i s t o say th e o b v io u s . What
n eed s t o be added i s t h a t t h e r e e x i s t a number o f p o l ic y
c o n s i d e r a t i o n s which may i n f l u e n c e th e f i r m 's a t t i t u d e
to w ard a d j u s t i n g i t s markup in tim es of f l u x , o r even i n
th e a b sen ce of m arket c h a n g e s. In th e m ost im m ediate type
o f r e s p o n s e , th e firm c o u ld sim p ly d e c id e to a l t e r i t s
markup by a c c e p t in g an a l t e r e d p r o f i t m a rg in . F o r exam ple,
i n th e c ase of a w a g e - in c r e a s e t h a t r a i s e s c o s t s ( o t h e r
t h in g s b e in g e q u a l ) , th e f i r m c o u ld d e c id e t o a b so rb ( a t
l e a s t t e m p o r a r i l y ) a l l o r p a r t o f th e w a g e-b o o st by a cut
i n i t s p r o f i t s .
278
Key u n d e r l y i n g f a c t o r s . — Such a d e c i s i o n , how ever,
would in t u r n depend on such key " a n t e c e d e n t " f a c t o r s as
th e f i r m 's r a t e o f p r o d u c t i v i t y g ro w th , o r th e p r o s p e c t i v e
l e v e l of demand f o r i t s p r o d u c t s , b o th o f which b e a r on th e
p r o s p e c t i v e l e v e l s o f c o s ts and r e v e n u e s .
In t h i s c o n n e c tio n we may r e c a l l W e in tr a u b 's "wage-
markup" model of i n f l a t i o n i n which he assumed t h a t p ro d u c
t i v i t y in c re m e n ts and markups b oth behave as " c o n s t a n t s , "
so t h a t a w a g e - in c r e a s e would a u t o m a t i c a l l y in d u ce a p r i c e -
i n c r e a s e by th e f i r m . On th e o t h e r h a n d , in A c k le y 's view
t h e averag e l e v e l of markups w ould, i n th e s h o r t - r u n , te n d
t o f l u c t u a t e w ith th e l e v e l o f a g g re g a te demand.
The "new e n v iro n m e n t" . — In t h i s c o n n e c tio n we may
a l s o p o in t t o th e p e r v a s iv e i n f l u e n c e of th e "new e n v ir o n
m ent" of econom ic p o l i c y — c o m p risin g th e b u i l t - i n s t a b i l
i z e r s and modern m o n e t a r y - f i s c a l p o l i c y — which may s e r v e t o
b o l s t e r p e r s o n a l incom es i n p e r i o d s o f r e c e s s i o n s u f f i c i
e n t l y to in d u c e f ir m s to m a in ta in t h e i r m arkups d e s p i t e th e
o th e rw is e sa g g in g l e v e l s of a g g re g a te o u tp u t and employment.
F i n a l l y , a n o th e r d e te r m in a n t o f markup r i g i d i t y may
be t h e d e g re e o f p r i c e - l e a d e r s h i p ( o r p r i c e - f o l l o w e r s h i p )
in th e g iv e n i n d u s t r y , which i n t u r n would depend su b
s t a n t i a l l y on th e m arket s t r u c t u r e o f th e i n d u s t r y . I t
w ould seem t h a t th e more e f f e c t i v e th e p r i c e - l e a d e r s h i p ,
th e more l i k e l y a re p r i c e - f o l l o w e r s t o a d j u s t t h e i r
279
m arkups In l i n e w ith a d ju s tm e n ts i n i t i a t e d ( o r a c c e p te d ) by
t h e p r i c e - l e a d e r . However, such p a r a l l e l a d ju s tm e n ts may
be more common where t h e o b j e c t i v e i s t o p r e s e r v e m arg in s
r a t h e r th a n t o e n la r g e them.
Summary and C o n c lu sio n s
The c h i e f re a s o n f o r th e p r e s e n t c h a p t e r i s t h e
overw helm ing f a c t t h a t i n th e modern economy, in c o n t r a s t
t o t h e one e n v is a g e d by c l a s s i c a l t h e o r y , most p r i c e s a r e
" a d m i n i s t e r e d " by p r ic e - m a k e r s r a t h e r th a n a u t o m a t i c a l l y
s e t by th e unim peded o p e r a t i o n of autonomous su pply and
demand f o r c e s in a " f r e e " m a rk e t.
The m ain i m p l i c a t i o n o f t h i s f a c t i s t h a t (a ) sin c e
t h e w orld o f p u re c o m p e titio n i s th e o n ly one in w hich
e x c e s s m onetary demand can e x e r t i n f l a t i o n a r y p r e s s u r e s in
th e e x a c t m anner p o s t u l a t e d by Income t h e o r y , (b) i t i s
n e c e s s a r y t o examine how and t o what e x t e n t th e b e h a v io r of
th e a d m i n i s t e r e d p r i c e s of f ir m s would d i f f e r from t h a t of
f r e e m arket p r i c e s .
C on seq u en tly i t was n e c e s s a r y t o su rv e y (a) th e
m a jo r f a c t o r s r e s p o n s i b l e f o r , and i n f l u e n t i a l i n , t h e
a c t u a l p r i c i n g p r o c e d u r e s o f f i r m s , and (b) th e p r o b a b le
im p a c ts of t h e s e i n f l u e n t i a l f a c t o r s on p r i c e a d ju s tm e n ts
made i n th e f a c e o f changes i n demand and c o s t s .
In t h e f i r s t a r e a o f c o n c e rn , i t was se en t h a t such
b a s i c f a c t o r s as th e f i r m ' s d e s i r e t o s u r v iv e and m a in ta in
" s t a b l e r e l a t i o n s h i p s " w ith o t h e r f i r m s , as w e ll as th e
p re v a le n c e o f Ig n o ra n c e and u n c e r t a i n t y , e x p la in in good
p a r t th e emergence o f p ro d u c t d i f f e r e n t i a t i o n , th e zone of
i n d i f f e r e n c e , th e in te r d e p e n d e n c e o f f i r m s , and non-
p e c u n ia ry m o ti v a t i o n s .
I n t h e second a r e a , i t was seen t h a t (a) changes In
c o s t s te n d e d t o assume a more a c t i v e o r d i r e c t r o l e i n th e
p r i c e - d e t e r m l n a t i o n p r o c e s s t h a n changes i n demand, and (b)
i n t h e c ase of changes I n demand, re d u c e d demand would
so o n e r le a d to a p r i c e - c u t th a n I n c r e a s e d demand would l e a d
t o a p r i c e - i n c r e a s e .
In th e d e t a i l e d s e c t i o n s on a d m in is te r e d p r i c e s and
c o s t - p l u s p r i c i n g — w hich were con cern ed m ainly w ith a p o s i
t i v e a n a l y s i s o f t h i s p r i c i n g m ethod— an im p o r ta n t f i n d i n g
was t h a t p r ic e - m a k e r s must c o n s i d e r ( a t l e a s t i n d i r e c t l y )
th e s t a t e of demand a s w e ll a s c o s t s i n s e t t i n g and a d j u s t
in g t h e i r p r i c e s . In o t h e r w o rd s, p r ic e - m a k e r s do n o t deny
th e e f f e c t i v e n e s s of s h o r t - t e r m m arket f o r c e s ( a f f e c t i n g
demand and su p p ly ) b u t sim ply f i l t e r o r " m e d ia te " them I n
th e l i g h t o f lo n g - te r m c o n s i d e r a t i o n s such as t h e f i r m 's
econom ic s u r v i v a l .
The im p o rtan c e o f t h i s f i n d i n g i s t h a t a d m i n i s t e r e d
p r i c e s , l i k e w ages, a r e n o t " I s l a n d s u n to th e m s e lv e s " :
p r ic e - m a k e r s a re c o n s t r a i n e d , on th e one han d, by m arket
f o r c e s i n th e b r o a d e s t m eaning o f th e te r m , and on th e
201
o t h e r , by n o b le s s e o b l i g e , how ever t h i s may be I n t e r p r e t e d
by th e firm in s p e c i f i c c a s e s .
However, a second and more s i g n i f i c a n t f i n d i n g was
t h a t , as m e d ia to r s o f m arket demand and su p p ly ( c o s t s ) ,
p r i c e a d m i n i s t r a t o r s c o u ld p la y two t y p e s of r o l e s i n th e
i n f l a t i o n p r o c e s s : (a ) as " v e h i c l e s , " " p r o p a g a t o r s ," or
t r a n s m i t t e r s , and (b) as " g e n e r a t o r s " o r i n s t i g a t o r s o f
p r i c e movements.
In th e form er r o l e , t h e f ir m m ere ly p a s s e s along
t h e i n f l a t i o n a r y p r e s s u r e ( u s u a l l y a r i s e in c o s t s ) by
r a i s i n g i t s p r i c e s , th u s e n s u r in g th e c o n t i n u a t i o n of th e
upward s p i r a l of p r i c e s . In th e l a t t e r r o l e , how ever, t h e
f ir m s e r v e s t o i n i t i a t e an in cre m e n t o f i n f l a t i o n a r y
p r e s s u r e — even i n th e ab sen ce of e x c e s s demand— by " e n l a r g
in g " i t s p r o f i t m argin above custom ary l e v e l s . Assuming
t h a t o t h e r firm s m a in ta in r i g i d m a r g in s , an upward s p i r a l
would e n su e .
F u rth e rm o re , i t was seen t h a t B l a i r and Means con
c e n t r a t e on th e " i n s t i g a t i n g " r o l e o f th e l a r g e f ir m . But
w hereas Means, i n h i s stu d y on U. S. S t e e l , d e a l s alm o st
e x c l u s i v e l y w ith th e case o f e n la rg e m e n t of t h e t a r g e t -
p r o f i t m a rg in , B l a i r a l s o t r e a t s o f th e more s u b t l e i n f l a
t i o n a r y t e n d e n c i e s a t t r i b u t a b l e t o (a) t h e f i r m ' s assump
t i o n of i n e l a s t i c demand, (b) i t s i n c e n t i v e s t o "m agnify"
p r o s p e c t i v e c o s t s , and (c) th e p r e s s u r e on p r i c e s o f r i s i n g
282
u n i t f i x e d c o s t s d u rin g a r e c e s s i o n a r y la g i n o u tp u t.
I n t h i s c o n n e c tio n , Hansen p r o p e r l y adds a f o u r t h
i n f l a t i o n a r y b i a s : th e "new en v iro n m en t" o f economic
p o l ic y which se e k s to a s s u r e a f l o o r u n d e r a g g re g a te demand
d u rin g r e c e s s i o n and in d u c e s s e l l e r s t o m a i n t a i n p r i c e s
even i n th e f a c e o f weak demand. I n d e e d , I n H a n se n 's v ie w ,
i t i s m ainly In r e c e s s i o n t h a t a d m i n i s t e r e d p r i c e s e n t e r
th e p i c t u r e t o c r e a t e t h e " r a t c h e t e f f e c t " o v e r th e long
ru n .
Of a l l th e s e a n a l y s e s , p ro b a b ly th e m ost h e l p f u l i s
A c k le y 's markup "en g in e o f I n f l a t i o n " i n w hich b o th manage
ment and l a b o r v ie t o e n la r g e t h e i r r e s p e c t i v e income
s h a r e s . I t s s u p e r i o r i t y as a model o f th e i n f l a t i o n
p ro c e s s would a p p e a r to l i e i n i t s g r e a t e r g e n e r a l i t y . F o r
exam ple, where Means d e a ls p r i m a r i l y w ith a o n c e - f o r - a l l
c a se o f markup e n la rg e m e n t by th e f irm o n l y , Ackley i s c o n
c e rn e d w ith a p e r e n n i a l , "p rim a ry s t r u g g l e " o v e r the r e a l
income p ie by two o f th e econom y's l e a d i n g c o s t - and
p r i c e - d e t e r m i n i n g a g e n ts .
I n th e l a s t p a r t i t was n o te d t h a t th e above con
s i d e r a t i o n s r e l a t e d p r i m a r i l y to th e m ic r o - econom ic l e v e l
o f p r i c e - d e t e r m i n a t i o n , and t h a t some g e n e r a l framework
was needed to combine t h e p r i c i n g m ethods and p r i c e move
ments i n i n d i v i d u a l s e c t o r s o f th e economy i n t o one o v e r
a l l (a v e ra g e ) p r i c e movement.
283
I n t h i s c o n n e c tio n were s t a t e d a number o f g e n e r a l
i z a t i o n s on th e c h a r a c t e r i s t i c p r i c i n g p r a c t i c e s of m a jo r
s e c t o r s o f th e economy, and th e m anner in w hich th ey
m e d ia te d th e "ap p ro x im a te " d e te r m in a n ts of p r i c e s , i . e . ,
th e m arket f o r c e s o f demand and s u p p ly .
However, i t was n e c e s s a r y t o c a l l a t t e n t i o n to
u n d e r ly in g l a y e r s o f p r i c e d e t e r m i n a n t s — such as p ro d u c
t i v i t y , te c h n o lo g y , and s t r u c t u r e o f p r o d u c t i o n — which
o p e r a te th ro u g h t h e f o r c e s o f demand and c o s t s t o a l s o
a f f e c t t h e m agnitude and tim in g o f p r i c e movements.
F i n a l l y , t h e mechanism by w hich p r i c e - i n c r e a s e s a re
t r a n s m i t t e d from f ir m t o f i r m , t o g e n e r a t e a r i s e in t h e
g e n e r a l p r i c e l e v e l , was s e e n t o depend p r i m a r i l y on th e
r i g i d i t y o f c o s t - p l u s markup l e v e l s o f s e l l e r s , which in
t u r n depended on such key f a c t o r s a s th e l e v e l o f a g g r e g a te
demand and d i f f e r e n t i a l r a t e s of p r o d u c t i v i t y .
I
CHAPTER VI
THE PROCESS OF INFLATION
The p r e s e n t c h a p t e r i s a c u lm in a tin g one i n t h a t i t
se e k s t o p ro v id e a s y n t h e s i s and developm ent of th e main
id e a s of t h e p r e c e d in g f o u r c h a p t e r s on money, demand,
w ages, and p r i c i n g — f a c t o r s t h a t have come to be r e g a r d e d
as th e m a jo r " c a u s e s " o f i n f l a t i o n . ^ In t h i s w r i t e r ' s view
th e fo rth c o m in g s y n t h e s i s i s b o th n e c e s s a r y and f e a s i b l e .
As w i l l be e x p la in e d in g r e a t e r d e t a i l b elo w , t h i s
s y n t h e s i s i s made n e c e s s a r y by th e very n a t u r e o f th e
i n f l a t i o n p r o c e s s i t s e l f , which— a s has become e v id e n t by
now— n e c e s s a r i l y in v o lv e s th e c o o p e r a tio n o f more th an one
of th e f o u r m ajo r f a c t o r s . That i s , i n f l a t i o n em anates n o t
from th e w orkings o f any s i n g u l a r so u rce o r " c a u s e " but
from a t l e a s t two o r more c au se s o p e r a t in g in co m b in atio n
t o make i t a m u l t i - f a c e t e d p r o c e s s . More s p e c i f i c a l l y , we
have been d e v e lo p in g th e t h e s i s t h a t i n f l a t i o n can n o t be
*As w i l l be seen b elo w , t h e s e f o u r f a c t o r s a re n o t
th e only ones t h a t can im p e l an i n f l a t i o n a r y movement.
They were s e l e c t e d f o r a n a l y s i s p a r t l y b e ca u se th e y a re th e
m ost p o p u l a r l y d i s c u s s e d c a u s e s , and p a r t l y b e ca u se they
a r e th e m ost ap pro xim ate v a n ta g e p o i n t s f o r th e d e t a i l e d
a n a l y s i s o f p r i c e movements.
284
2 85
f u l l y u n d e rs to o d e x c e p t as an I n te r d e p e n d e n t p r o c e s s t h a t
n e c e s s a r i l y in v o lv e s th e I n t e r r e l a t i o n of such key
$
v a r i a b l e s as money, demand, c o s t s , and p r i c e s .
As a c o n se q u e n c e , any m o n is ti c th e o ry which p u r
p o r t s t o a t t r i b u t e i n f l a t i o n t o a s i n g l e dom inant f a c t o r of
th e above f o u r — such as e x c e s s iv e money su p p ly o r e x c e s s iv e
w a g e s --p ro v id e s only a p a r t i a l a n a l y s i s of a phenomenon
t h a t may a c t u a l l y be more c o m p lic a te d , a lth o u g h th e p a r t i a l
a n a l y s i s may s e r v e as a u s e f u l f i r s t a p p ro x im a tio n .
The f i r s t p a r t w i l l rev ie w argum ents showing why
th e s y n t h e s i s i s n e c e s s a r y » i . e . , i s l o g i c a l l y r e q u i r e d by
th e i n t e r d e p e n d e n t n a t u r e o f i n f l a t i o n i t s e l f . The f o llo w
in g p a r t w i l l a tte m p t t o show how t h e in te r w e a v in g of
e x i s t i n g m o n is tic t h e o r i e s can le a d us to a d e e p e r u n d e r
s ta n d in g o f th e i n f l a t i o n p r o c e s s .
I t w i l l be seen t h a t i n f l a t i o n i s n o t a sim ple
c a u s e - e f f e c t r e l a t i o n , d e ta c h e d from tim e and space ( i . e . ,
e n v ir o n m e n t) , b u t i s a dynamic p r o c e s s t r a n s p i r i n g o v e r
tim e , whose s e v e r a l components and l i n k i n g mechanism s each
p la y s a d i s t i n c t i v e I n t e g r a l r o l e in a s s u r i n g th e c o n t i n
u i t y o f p r i c e movements in an upward d i r e c t i o n w i t h in a
s p e c i a l e n v iro n m e n t.
In t h i s c o n n e c tio n , th e p r o c e s s of i n f l a t i o n w i l l
be view ed p a r t l y as a m e c h a n ic a l o p e r a t io n t h a t c o m p rises
a sequence of e v e n ts d e n o te d as " c a u s e s ” and " e f f e c t s . "
286
These e v e n t s , i n t u r n , w i l l be se en t o be lin k e d by " t r a n s
m is s io n " and " s p i r a l " mechanisms t h a t e n a b le th e component
o r s e c t o r a l e v e n ts t o g e n e r a t e b ro a d movements i n such
a g g r e g a te s as demand, c o s t s , and p r i c e s . Then th e s t r a t
e g i c im p o rtan c e of " e n v iro n m e n t" w i l l be t r e a t e d f o r th e
f i r s t tim e in a s u f f i c i e n t l y e x p l i c i t and l o g i c a l m anner.
Not a l l c o n c e iv a b le "m odels" o f th e i n f l a t i o n p r o c e s s can
o r need t o be d e a l t w ith h e r e , b u t o nly th o s e c o m p risin g
such key v a r i a b l e s as d e m a n d -p u ll and c o s t - p u s h , s i n c e they
a r e th e m ost r e l e v a n t t o r e c e n t e x p e r ie n c e i n th e U n ited
S t a t e s .
F i n a l l y , in th e t h i r d p a r t , an a tte m p t w i l l be made
t o r e l a t e th e i n f l a t i o n p r o c e s s to an u n d e r l y i n g s o c i a l -
p o l i t i c a l s t r u g g l e f o r econom ic s e c u r i t y and th e r e d i s t r i
b u t io n o f income and w e a lth o v e r th e lo ng ru n . The j u s t i
f i c a t i o n f o r t h i s a ssu m p tio n i s t h a t , r e g a r d l e s s o f any
p o s s i b l e s h o r t - r u n o r c y c l i c a l " c a u s e s " t h a t may im p e l any
p a r t i c u l a r i n f l a t i o n e p is o d e , i t i s r e a s o n e d t h a t t h e most
a c t i v e i n t e r r e l a t e d f a c t o r s making f o r , o r s u p p o r t i v e of
i n f l a t i o n over th e lon g run a re th o s e t h a t a re r e l e v a n t t o
and in v o lv e d i n th e econom ics and p o l i t i c s of r e d i s t r i b u
t i o n .
The I n te r d e p e n d e n c e o f Key V a r ia b l e s
One o f th e c h i e f b y - p r o d u c ts o f our a n a l y s i s th u s
287
k .__
f a r h as been a d e m o n s tr a tio n o f how th e " m o n is ti c " t h e o r i e s
o f i n f l a t i o n a re a c t u a l l y n o t as .m o n is tic a s th ey a p p e a r a t
f i r s t g l a n c e . The f o llo w in g a n a l y s i s w i l l a tte m p t t o show
how each o f t h e s e t h e o r i e s i s l o g i c a l l y and s i g n i f i c a n t l y
depen d en t on key e le m e n ts o f th e o t h e r m o n is ti c t h e o r i e s .
The F a c e ts o f Money
In th e c h a p t e r on money i t was se en t h a t money by
i t s e l f i s i n c a p a b le o f c a u s in g a r i s e i n p r i c e s e x c e p t
u n d e r th e u t t e r l y extrem e assu m p tio n o f a p u re -e x c h a n g e
economy (where money i s u se d o nly f o r sp e n d in g ) and
p e r f e c t l y f l e x i b l e p r i c e s .
F u r th e r m o r e , as was se e n i n th e c h a p t e r on demand,
in a n im a te money c a n n o t i t s e l f e x e r t any p r e s s u r e on p r i c e s ,
u n l e s s i t i s c h a n n e lle d in t h e form o f e f f e c t i v e m onetary
demand p a id o u t to f a c t o r s o f p r o d u c tio n a n d /o r expended
f o r th e p u rp o se o f c o n su m p tio n , i n v e s tm e n t , and governm ent
goods and s e r v i c e s .
As a c o n se q u e n c e , th e q u a n t i t y - t h e o r y ap p roach and
th e e q u a tio n of exchange a w a ite d th e c o n t r i b u t i o n s of
income th e o r y t o embody th e g e n e r a l n o t i o n o f M V
( e x p e n d i tu r e s ) i n t o th e more s p e c i f i c c o n c e p ts o f C, I , and
G, which r e p r e s e n t th e " u rg e s t o spend" i n s p e c i f i c
b e h a v i o r a l p a t t e r n s . 1
^ h i s t r a n s f o r m a t i o n may e x p l a i n why some w r i t e r s
r e g a r d income th e o r y as re m a in in g e s s e n t i a l l y a "b ra n c h "
While t h e s e e x p e n d itu r e f o r c e s came t o r e p r e s e n t
th e e le m e n ts o r components o f demand (D ), they were a ls o
shown t o be t h e s o u rc e o f income (Y) r e c e i v e d by p r o d u c tiv e
f a c t o r s . In any e v e n t , th e l e v e l of D was th en r e l a t e d t o
the c u r r e n t l e v e l of p h y s i c a l o u tp u t (0) as a means of
e x p l a i n i n g changes i n th e p r i c e l e v e l .
In t h i s manner d id th e t r u i s t i c e q u a tio n P = MV/T
d e v e lo p i n t o th e more m e a n in g fu l and o p e r a t i o n a l e q u a tio n
P = Y/0 or D /0. C o n v e rs e ly , i t was a l s o seen t h a t i n c r e a s e s
i n M a n d /o r V were e s s e n t i a l t o " p e r m it" o r " s u p p o r t" th e
e x i s t e n c e o f e x c e s s demand and e x c e s s iv e wages. The
c e n t r a l im p o rtan c e of money i n th e i n f l a t i o n p r o c e s s w i l l
be f u r t h e r e l u c i d a t e d in o t h e r c o n te x ts below .
The F a c e ts o f Demand
In t h e c h a p t e r on demand and income th e o r y i t was
seen t h a t p r i c e changes were r e l a t e d e s s e n t i a l l y t o th e
f o r c e s of demand and su p p ly . On th e one han d , demand o r
e x p e n d i tu r e s were r e l a t e d p r i m a r i l y t o income o r e a r n i n g s
from p r o d u c t i o n , w h ile on th e o t h e r hand sup ply depended
p r i m a r i l y on th e l e v e l o f o u t p u t , p r o d u c t i v i t y , and th e
shape o f c o s t c u rv e s . Thus th e answ er t o th e s p e c i a l
of th e q u a n t i t y t h e o r y ; f o r e x am p le , se e M. B la u g , Economic
Theory i n R e tr o s p e c t (Homewood, 1 1 1 . : R ic h a rd D. I r w i n , in c .
1 9 ^ 2 ), p. 557. I n d e e d , J . A. S chum peter went so f a r as t o
a s s e r t t h a t t h e Income ap p ro a ch t o e x p l a i n money p r i c e s was
" n o th in g b u t a n o th e r way o f w r i t i n g " t h e e q u a t io n o f ex
change; see h i s H is to r y o f Economic A n a ly s is (New York:
O xford U n i v e r s i t y P r e s s , 195^)» p. l l0 9
289
q u e s t i o n o f how does e x c e s s i v e demand cause p r i c e s t o r i s e
. a l s o p ro v id e d a key l i n k w ith th e c o s t- p u s h th e o r y o f i n f l a r
t i o n . As H. 6 . M oulton p u t i t , e x c e s s iv e demand c a u s e s
p r i c e s to r i s e when money-incomes (wages and o t h e r c o s t s )
i n c r e a s e f a s t e r th a n th e su p p ly of g o o d s, w hich in t u r n can
o c c u r only when th e f a c t o r s o f p r o d u c tio n r e c e i v e h i g h e r
r a t e s of pay f o r th e "same amount of s e r v i c e s .
The r o l e o f c o s t s *— Both J . M. Keynes and A. H.
Hensen a s s i g n e d a s i g n i f i c a n t r o l e to r i s i n g c o s t s as a
c o n t r i b u t i n g f a c t o r i n r i s i n g p r i c e s , as a g g re g a te o u tp u t
ap p ro ach ed fu ll-e m p lo y m e n t and f u l l - c a p a c i t y l e v e l s . In
a d d i t i o n , th e y and A. G. H a rt p o i n te d t o th e f a c t t h a t a
r i s e in wage c o s t s r a t h e r t h a n an i n c r e a s e i n o u tp u t c o u ld
be in d u c e d by th e r i s i n g demand f o r e x i s t i n g su p p ly .
I t was a l s o seen t h a t " s e c t o r a l " c a se s of e x c e s s
demand and p r i c e r i s e s in i n d i v i d u a l s e c t o r s o f th e economy
( f o r exam ple, in th e case o f C. L. S c h u l t z e ^ "demand-
s h i f t " m odel) can g e n e r a t e a g e n e r a l r i s e i n th e o v e r - a l l
p r i c e l e v e l — even i n th e a b se n c e of g e n e r a l e x c e s s demand—
by means o f " t r a n s m i s s io n " mechanisms such a s markup p r i c
in g and wage co m p a riso n s.
^H arold G. M o ulto n, Can I n f l a t i o n Be C o n t r o l l e d ?
(W ash in g to n , D. C . : Anderson Kramer A s s o c i a t e s , 1^5^)»
pp. 47-48.
290
The r o l e s o f p r i c i n g and money. — Even more im por
t a n t : th e e x i s t e n c e o f l e s s t h a n p u r e l y - c o m p e t i t i v e m a rk e t
s t r u c t u r e s p r e v e n t s demand from o p e r a t i n g d i r e c t l y on
p r i c e s . In r e a l i t y , demand i s m o stly f i l t e r e d or m e d ia te d
th ro u g h th e p r i c i n g p r a c t i c e s o f f i r m s ; t h e l a t t e r may o n ly
i m p e r f e c tl y o r i n d i r e c t l y pay homage t o th e m ark et f o r c e s
of demand and su p p ly (a s was se en in t h e c h a p t e r on
p r i c i n g ) . 1 T h u s, an i n c r e a s e i n demand would n o rm a lly have
t o w a it f o r an e n su in g ’’in d u ce d " o r " r e s p o n s iv e " i n c r e a s e
i n c o s t s b e f o r e fir m s d e c id e t o r a i s e p r i c e s .
E q u a lly im p o rta n t i s th e f a c t t h a t an "autonom ous"
o r " a g g r e s s iv e " i n c r e a s e in c o s t s in t u r n depends on th e
" p e rm is s io n " of o r " r a t i f i c a t i o n " by i n c r e a s e d m onetary
demand i n o r d e r t o be a b le t o " ca u se " a r i s e i n p r i c e s . As
s t a t e d by G. L. Bach: " . . . a c o s t - p u s h , a d m in is te r e d
p r i c e i n f l a t i o n cannot c o n tin u e long u n l e s s t h e r e i s a
grow ing t o t a l demand i n th e econom y," and e x c e s s demand i s
th e key c o n d it i o n f o r a " lo n g - r u n i n f l a t i o n a r y d r i f t . " 2
I t i s s i g n i f i c a n t t h a t A. C. L. Day and S t e r l e T.
B eza, Money and Income (New York: O xford U n i v e r s i t y P r e s s ,
I 9 6 0 ) , p . 275, i n an a n a l y s i s o f i n f l a t i o n t h a t p ro c e e d s on
th e s t r i c t l y m acro-econom ic l e v e l c h a r a c t e r i s t i c o f much
Income t h e o r y , a re com pelled to acknow ledge th e r o l e of
m icro -eco n o m ic p r i c i n g of i n d i v i d u a l co m m odities: "Changes
i n th e g e n e r a l p r i c e l e v e l a r e t h e r e s u l t of a l l th e se p a
r a t e changes In i n d i v i d u a l p r i c e s . "
2George L. B ach, " I n f l a t i o n i n P e r s p e c t i v e , "
H arv ard B u s in e s s Review . XXXVI ( J a n u a r y - P e b r u a r y , 1 9 5 8 ),
r e p r i n t e d i n A rth u r L. G rey , J r . and Joh n E. E l l i o t t ( e d s .^
Economic I s s u e s a n d , P o l i c i e s (B o sto n : Houghton M i f f l i n
com pany, ~t ?6T77 -p; 6 5:----------
291
In t h i s c o n n e c tio n i t was a l s o n o te d t h a t a g g r e g a te
demand o r p u r c h a s i n g power can i t s e l f i n c r e a s e o n ly v i a th e
s p e c i f i c p e r m is s io n of i n c r e a s e d money s u p p ly o r v e l o c i t y
of c i r c u l a t i o n , th u s e x p l i c i t l y a ckno w ledgin g th e dependence
of expanded demand upon t h e e x p a n sio n of m onetary m eans.
As P. Machlup h a s put i t : "T here can n e v e r be a p r i c e
i n f l a t i o n w ith o u t e x p a n s io n of demand and r a r e l y one w ith
out e x p a n sio n o f th e money su p p ly . "•*•
C o s ts , incom e, and demand. — P ro b a b ly most im p o rta n t
i s a p o i n t t h a t i s b e s t a p p r e c i a t e d in th e c o n te x t o f the
d i s c u s s i o n on " p r o c e s s " below : s i n c e a g g re g a te c o s t s r e p r e
s e n t and s u p p o r t th e a g g re g a te o f incom es p a id out t o
f a c t o r s o f p r o d u c t i o n , we can co n clu d e t h a t expanded c o s t s
i n t h e a g g re g a te p re s u p p o s e an e x p a n sio n o f demand. In
o t h e r w ords, " c o s t- p u s h " p r e s s u r e s c o n s t i t u t e "d em a n d -p u ll"
p r e s s u r e s as w e l l ; as n o te d by P. M achlup: i n e v e ry p r i c e
I n f l a t i o n " b o th c o s t b o o s t s and demand e x p a n s io n s must be
p r e s e n t .
The r e a d e r w i l l r e c a l l t h a t t h i s I n t e r r e l a t i o n o f
c o s t s and demand was e n c o u n te re d i n th e d i s c u s s i o n o f "wage-
p u l l . " In th e p r e s e n t c o n te x t th e n o t i o n i s g e n e r a l i z e d t o
^ F r i t z M achlup, " S t a t e m e n t ," i n U .S ., C o n g re ss,
J o i n t Economic C om m ittee, H e a r in g s , P a r t 9A, Study o f
Employm ent, G row th, and P r i c e L e v e ls (W ash ing ton:U .~ S .
Government P r i n t i n g O f f i c e , 1959)* P« 2824.
2I b i d .
292 ;
encompass a l l Income payments and to make more e x p l i c i t the!
in terd ep en d en t n atu re of the m onistic demand-pull and c o s t-
push e x p la n a tio n s of i n f l a t i o n . At t h i s p o in t i t may also
be noted t h a t i t i s p o s s ib le f o r one of these two fo rc e s j
. (to use Machlup*s phrase) to " s t a r t the p ro cessio n and th e i
: •
. other to follow and catch u p . " 1 But t h i s m a tte r of stim u- I
! lus and resp o n se , or cause and e f f e c t , w i l l be discu ssed !
! • 1
: in g r e a t e r d e t a i l below.
I t i s t h i s Hyde-Jekyl n atu re of c o s ts (income) and i
demand t h a t gives cogency to W . G. Bowen*s remark th a t " a t ■
the macro-economic le v e l the interdependence of co sts and
demand can no longer be com pletely ig n o red ." To be s u re ,
not a l l cases of excess demand n e c e s s a r ily o r ig in a te in
expanded c o sts o r payments to f a c t o r s . Leading exceptions
would be (a) expanded purchases financed out of savings or
c re d it in order to spend beyond c u rre n t incomes, and (b)
t r a n s f e r payments by government to in d iv id u a ls and groups.
N e v e rth e le s s, the co sts or incomes generated by producers
|
of goods and s e rv ic e s c o n s titu t e by f a r th e g r e a te s t p a r t
of aggregate demand and ex p e n d itu res.
I t is ap p aren tly the i n t e r r e l a t i o n s h i p of c o sts and!
I
demand t h a t S chultze had in mind when he a s s e r te d th a t " i t j
i i
' . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — — » ■ ■ ■ ■ I ■ - ■ ■ ■ ■ ■ » ■ ! ■ ■ — I . ■ ■ j
^■Ibid.
' " " " " " j
^ W illiam G. Bowen, The W age-P rice I s s u e (P rin c e to n :!
P r i n c e t o n U n i v e r s i ty P r e s s , 1960)7 P« 401. j
293
Is p r e c is e ly through the cost mechanism t h a t a demand
i n f l a t i o n i s pro p ag ated . "-* • Conversely, i t may be s a id th a t
(a) excessive monetary demand or ex p e n d itu res tu rn out to
be the means by which r e l a t i v e l y scarce f a c to r s may be
h ire d to expand the volume of o u tp u t, and (b) the u ltim a te
"cause" of p ric e r i s e s are the underlying r e la tio n s between
r e a l (p h y sica l) supply and monetary demand.
The F acets of Wages
As in the case of expanded demand, money p la y s a
key ro le as an "en ab ler" of w ag e -in c re ase s. W age-increases
cannot become e f f e c t iv e as a p re ssu re on c o sts and p ric e s
u n le ss a d d itio n a l monetary means (in c lu d in g in c re a se d
v e lo c ity of money c irc u la tio n ) are a v a ila b le to fin a n c e the
h ig h er wage payments of employers, and/or th e in c re a se d
ex p en d itu res by p u rch asers who have to pay th e h ig h e r
p r ic e s . This assumes th a t employers do n o t finance the
h ig h er wage b i l l s out of p r o f i t s , cash r e s e rv e s , or funds
saved by laying o ff m arginal w orkers.
I t a ls o assumes th a t the m o n e ta ry -fis c a l au th o r
i t i e s e x e r c is e , on b alan ce , a perm issive o r y ie ld in g policy
t h a t " r a t i f i e s " the i n f l a t i o n . That i s , they provide the
a d d itio n a l purchasing power needed to m aintain employment
■^Charles L. S c h u ltz e , P r i c e s . Costs and Output f o r
the Post War Decade: 1947-1957 (New York: Ciommittee fo r
Economic Development, 1 9 5 9 )> p. 22.
294
r a t h e r than a s s e r t a "hard money" p o lic y th a t would deny
th is purchasing power to producers and consumers. But t h i s
aspect concerns the ro le of the m o n e ta ry -fis c a l "environ
ment" in the i n f l a t i o n p ro c e s s, an a sp ec t to be d isc u sse d
in g r e a t e r d e t a i l below. Here i t s u f f i c e s to note the
underlying i n t e r r e l a t i o n s and i n t e r a c t i o n s among wages,
p r i c e s , and the m o n e ta ry -fisc a l environment.
Wages, money, and p r o d u c tiv i ty . —To p ro p e rly
a p p re c iate the c r i t i c a l r o le of perm issive m o n e ta ry -fis c a l
p o licy in wage i n f l a t i o n , i t is u s e fu l to r e c a l l an
im portant economic f a c t . Whether or not la b o r, in seeking
higher money wages, harbors any "money i l l u s i o n , " th e f a c t
remains th a t r e a l (p h y sic a l) output and income' p e r worker
can in c re a se p rim a rily as a r e s u l t of in c reased produc
t i v i t y achieved by means of in creased c a p i t a l equipment per
worker employed in p ro d u ctio n , or improved technology and
o rg a n iz a tio n , which enable a given amount of c a p i t a l and
labor to y ie ld a la r g e r o utput.
Thus th e growth of r e a l wages p er worker i s lim ite d
by th e ex ten t of the growth in p ro d u c tiv ity p e r w orker, and
th e re fo re cannot in c re a se any f a s t e r than r e a l output p er
worker. The only m o d ific atio n s to t h i s p r in c ip le occur
when th e re are " e x te rn a l" sources of improvement in the
n a t io n ’ s terms of trad e or a red u ctio n of non-wage r e a l
incomes, such as the r e a l claim s of r e c i p i e n t s o f con
t r a c t u a l incomes.
295
As a consequence o f th e above p r i n c i p l e , i f (a)
l a b o r 's money wages a re a llo w ed t o i n c r e a s e f a s t e r th a n
n a t i o n a l a v e ra g e p r o d u c t i v i t y , and (b) t h e m onetary a u th o r
i t i e s e n a b le th e money su p p ly to i n c r e a s e s u f f i c i e n t l y to
p e rm it th e i n c r e a s e d wage paym ents (and t h e r e b y a v o id
l a y o f f s ) , th e r e s u l t w i l l be a r i s e in p r i c e s s u f f i c i e n t t o
" c h i s e l away" any e x c e s s i n l a b o r ’ s income claim s and
th e re b y p r e v e n t r e a l wages from r i s i n g f a s t e r th a n p rod uc
t i v i t y . 1
Wage-pull and the s p i r a l . — As s ig n i f ic a n t as the
r e l a t i o n between wages and money supply i s the in h e re n t
r e l a t i o n between wage-push and w age-pull which, as noted
above, is but a s p e c ia l case of th e g e n e ra l interdependence
between aggregate co sts and aggregate demand.
To t h e e x t e n t t h a t i n c r e a s e d wages a re t u r n e d i n t o
expanded consumer e x p e n d i t u r e s , th e p r i c e r i s e s c a u se d by a
w age-push can be " s u p p o r t e d " ; to t h e e x t e n t t h a t t h e s e c o s t
and p r i c e i n c r e a s e s i n t u r n in d u c e a f u r t h e r round of p r i c e
and wage a d ju s tm e n t s , t h e r e e n su e s an o n -g o in g " s e l f -
f i n a n c in g " s p i r a l o f l e a p - f r o g g i n g c o s t s and p r i c e s .
I n o t h e r w o rd s, expanded wages and o th e r in co m es,
which by n a t u r e c o n s t i t u t e b o th c o s t s and demand, a r e th e
h e a r t o f th e " s p i r a l " mechanism o f c o s t s and p r i c e s .
On these points see Machlup, op. c i t . , p. 2828.
2 96
Transm ission o f w ag e -in c re ase s. — Of co nsiderable
note in our d isc u ssio n of wages was the omnipresence of
f a c to r s making fo r widespread tran sm issio n of wage a d ju s t
ments from one s e c to r o f the economy to the o th e r. This
wage tra n sm issio n is one of th e twin components o f the wage-
p ric e s p i r a l , the o th e r being th e markup p ric in g p ra c tic e s
of firm s.
Most f a m ilia r is the c o s t - o f - l i v i n g adjustm ent
invoked by la b o r as a "defensive" response whenever the
p r ic e s of consumer goods and s e rv ic e s r i s e . As we saw, the
most s i g n i f i c a n t a sp e c t of t h i s e s c a la tio n f a c to r i s th a t
i t p la y s the same " c o s t-p lu s ” ro le f o r la b o r as does the
markup p r ic in g formula fo r the firm . That i s , i t s i g n i f i e s
la b o r 1s r e f u s a l to accept any cut in i t s r e a l wages— in th e
same way th a t r ig id markup p r ic in g seeks to p r o te c t the
f ir m 's share in th e t o t a l income p ie — and hence becomes a
key "propagation" mechanism in the wage-price s p i r a l .
A c tu a lly , any number o f wage and non-wage groups
can p lay the e s c a la tio n game as a means of defending r e a l
income claims a g a in s t the "hidden tax" of r i s i n g p r ic e s .
In g e n e ra l, th e r e f o r e , e s c a la tio n emerges as a key response
mechanism which s u s ta in s the i n f l a t i o n s p i r a l of c o sts and
p r i c e s .
To the degree th a t expansionary m o n e ta ry -fisc a l
p o lic y c o n trib u te s to a r i s e in aggregate demand, which in
297
t u r n s p u r s a r i s e i n c o s t s o f m a t e r i a l s and l a b o r — hence i n
th e c o s t o f l i v i n g — we have s t i l l a n o th e r i n s t a n c e o f how
th e e n v ir o n m e n ta l f a c t o r o f governm ent econom ic p o l i c y
p la y s a k e y , a l b e i t som etim es i n d i r e c t r o l e in th e i n f l a
t i o n p r o c e s s .
A nother b a s i c t r a n s m i s s i o n mechanism i s wage
c o m p ariso n — - a l s o r e f e r r e d t o as " i m i t a t i o n " o r " e q u a l i z a
t i o n " — which we n o te d was v e ry i n s t r u m e n t a l i n conveying
th e w a g e - in c r e a s e s o b ta in e d i n "key" f ir m s and i n d u s t r i e s
to o t h e r s e c t o r s o f th e economy, e n a b l in g t h e "key wage
b a r g a in s " to s e t a p a t t e r n f o r wage a d ju s tm e n ts a t l a r g e ,
even where u n io n s were n o t i n s t r e n g t h o r were n o n - e x i s t e n t .
To t h e e x t e n t t h a t key wage b a r g a i n s a re (a) i n i t i
a te d i n th e more f a v o r a b l y s i t u a t e d s e c t o r s , c h a r a c t e r i z e d
by h i g h e r - t h a n - a v e r a g e p r o d u c t demand, p r o d u c t i v i t y g a i n s ,
and p r o f i t s , and (b ) a re d u p l i c a t e d in th e wage a d ju s tm e n ts
r e c e i v e d by l a b o r i n l e s s f a v o r a b ly a f f e c t e d s e c t o r s , th e
i n f l a t i o n p r e s s u r e s a re compounded by th e w age-com parison
t r a n s m i s s i o n mechanism.
The g a in s o f p r o d u c t i v i t y . — In c o n n e c tio n w ith t h e
grow th o f p r o d u c t i v i t y and th e f i r m 's g a in s t h e r e f r o m , i t
was n o te d t h a t s t a b i l i t y o f th e g e n e r a l p r i c e l e v e l
depended on t h e f o llo w in g b a s i c r e l a t i o n s h i p betw een wages
and p r o d u c t i v i t y in c r e m e n ts : f o r th e economy as a w hole,
th e a v e ra g e o f w a g e - in c r e a s e s must n o t ex ce ed th e a v e ra g e
298
i n c r e a s e i n p r o d u c t i v i t y of a l l f i r m s . T h u s, i f w orkers in
some s e c t o r s happen t o o b t a i n w a g e - in c r e a s e s i n e x c e s s of
th e n a t i o n a l a v erag e g a in i n p r o d u c t i v i t y ( a lth o u g h n o t in
e x c e s s of t h e p r o d u c t i v i t y r a t e a c h ie v e d in t h e i r own firm s
o r s e c t o r s , b e cau se th e y n o rm a lly e n jo y a b o v e -a v e ra g e
p r o d u c t i v i t y g ro w th ) , th e n th e o v e r - a l l p r i c e l e v e l w i l l be
f o r c e d t o r i s e , u n l e s s w o rk ers i n th e o t h e r s e c t o r s a re
w i l l i n g t o a c c e p t w a g e - in c r e a s e s s u f f i c i e n t l y below th e
n a t i o n a l p r o d u c t i v i t y r a t e t o o f f s e t th e e x c e s s i v e wage
b o o s t s .
T h is fu n d a m e n ta l r e l a t i o n betw een w ages, p ro d u c
t i v i t y and p r i c e s , w hich was e x p l i c i t l y f e a t u r e d in A. H.
H a n se n 's e f f i c i e n c y - w a g e s r a t i o and S. W e in tra u b ’ s wage-
markup e q u a t i o n , w i l l be d i s c u s s e d i n g r e a t e r d e t a i l below.
Here i t s u f f i c e s t o p o i n t o u t two im p o r ta n t f a c e t s .
1) A lready n o te d was t h e p r e v a le n c e o f wage compar
is o n o r i m i t a t i o n by means o f which key wage a d ju s tm e n ts in
th e more p r o d u c t i v e s e c t o r s , whose amount i s i n e x c e s s of
a v erag e p r o d u c t i v i t y , a re t r a n s m i t t e d ( v i a th e " s p i l l - o v e r "
e f f e c t ) t o th e r e s t o f th e economy, m aking t h e a v erag e
w a g e - in c r e a s e l a r g e r t h a n t h e a v erag e r a t e of p r o d u c t i v i t y
and t h e r e f o r e f o r c i n g p r i c e s upw ards.
As P . Machlup h as p o i n t e d o u t , th e r e a l e f f e c t o f
th e f i r s t ro u n d of " e q u a l i z i n g " w a g e - in c r e a s e s (and th e
s u p p o r t i v e demand i n f l a t i o n ) i s a r e d i s t r i b u t i o n o f some
299
o f th e p r o d u c t i v i t y g a in s of th e more f a v o r a b l y s i t u a t e d
w o rk ers t o th e l e s s f a v o r a b l y s i t u a t e d w o r k e r s , a c h ie v e d by
means o f th e c o n s u m e r -p ric e i n f l a t i o n t h a t e ro d e s away th e
r e a l g a in s o f th e f i r s t g ro u p . However, t h e r e d i s t r i b u t i o n
p r o c e s s n eed n o t s to p a t t h i s j u n c t u r e . The f i r s t group o f
w o rk ers may v e r y w e ll c a l l f o r a n o th e r ro u n d o f c o s t - o f -
l i v i n g wage a d ju s tm e n ts t o r e g a i n t h e r e a l wages c h i s e l l e d
away by i n f l a t i o n ; t h u s an a p p a r e n t l y " d e f e n s i v e " w age-
i n c r e a s e may i n e f f e c t s e r v e t o p r e s e r v e a p r e v i o u s l y
a g g r e s s iv e w a g e - i n c r e a s e . 1
2) The second f a c e t , i t may be r e c a l l e d , i s t h a t ,
i n th e c o n te x t o f p r o d u c t i v i t y - g r o w t h , w a g e - i n c r e a s e s have
g e n e r a l l y been o f two t y p e s : (a) "In d u ce d " by th e f i r m ' s
i n c r e a s e d p r o d u c t i v i t y which had s e rv e d t o i n c r e a s e i t s
p r o f i t s and whet l a b o r ' s a p p e t i t e f o r h i g h e r w ages, as w e ll
a s (b) " s t i m u l a t i n g " f u r t h e r in c re m e n ts o f p r o d u c t i v i t y by
t h e f ir m as a means o f o f f s e t t i n g t h e r i s e i n wage c o s t s .
In o t h e r w ords, t h e re d u c e d c o s t s and i n c r e a s e d
p r o f i t s y i e l d e d by h i g h e r p r o d u c t i v i t y (assum in g no low er
in g o f p r i c e s by th e f i r m ) se rv e b o th as a s a f e t y v a lv e f o r
r i s i n g wage p r e s s u r e s as w e ll as an Inducem ent f o r renewed
wage dem ands, w hich can r e s u l t in a s o r t o f l e a p - f r o g g i n g
F r i t z M achlup, "A n o th er View o f C o st-P u sh and
D em and-Pull I n f l a t i o n , " The Review o f Econom ics and
S t a t i s t i c s , XLII (May, i 9 6 0 ) , p. 135.
300
r e l a t i o n between wage and p r o d u c tiv ity increm ents. To the
degree t h a t w age-increases succeed in absorbing th e gains
of p r o d u c tiv ity , they obviously prevent th e low ering of
p r ic e s to the consumer an d /o r the in c re a se of p r o f i t s of
f ir m s .
Before pro ceed in g , i t may be added th a t produc
t i v i t y growth i s not the only source of cu rre n t and p ro s
p e c tiv e p r o f i t s which serve to arouse demands fo r h ig h er
wages. I t has a lso been seen th a t th e f i r m 's degree of
market power and the le v e l of demand and unemployment
co n d itio n s are a lso im portant in flu en c es on th e f i r m 's
p r o f i t p o s itio n .
I n f l a t i o n w ithout s p i l l - o v e r . —Now i t may also be
argued th a t i t i s n o t n ecessary to have a 1 1 s p il l- o v e r " of
the o r i g i n a l dose o f wage-push (induced by p r o d u c tiv ity -
gains in th e te c h n o lo g ic a lly p ro g re ssiv e s e c to rs ) in order
to unloose an i n f l a t i o n . I t is p o ssib le to show, as
Machlup has done, how some p r ic e i n f l a t i o n would be
in e v ita b le even in the absence of any wage s p i l l - o v e r or
im i ta t io n , so long as the follow ing co n d itio n s a p p lied :
a) In d iv id u a l w age-increases are g ran ted to the
e x te n t of p ro d u c tiv ity - g a ln s achieved in th e given
in d iv id u a l firm , so th a t i n i t i a l l y p r ic e s can remain the
same;
b) Wage r a t e s are never allowed to d e c lin e , even in
301
t h e fa c e o f unem ploym ent; and
c) Pu3lem ploym ent i s s e c u r e d , i f n e c e s s a r y , th ro u g h
e x p a n sio n o f e f f e c t i v e demand.
I n o t h e r w ords, i n t h i s case o f p r o d u c t i v i t y grow th
and accom panying t e c h n o l o g i c a l d is p la c e m e n t o f l a b o r , an
e x p a n sio n o f demand w i l l be r e q u i r e d t o re-em p lo y th e d i s
p la c e d w o rk e rs , th e re a s o n b e in g as f o l lo w s : w ith
i n i t i a l l y unchanged p r i c e s and demand, t o t a l p r o d u c t i o n o f
f ir m s had rem ain ed unchanged; hence th e need f o r a d d i t i o n a l
e f f e c t i v e demand t o ab so rb t h e t e c h n o l o g i c a l l y unem ployed,
which In t u r n w i l l cause a r i s e In consum er p r i c e s . ^
I n f l a t i o n w ith o u t w a g e - i n c r e a s e s . — To ro u n d out
t h i s d i s c u s s i o n o f p r o d u c t i v i t y (and wages and p r i c e s ) , we
may n o te M ach lu p 's re m in d e r t h a t th e same i n f l a t i o n a r y con
se q u en c es of t e c h n o l o g i c a l g a in s e x p e rie n c e d even i n th e
a b sen c e of wage s p i l l - o v e r can a l s o be v i s u a l i z e d where
t h e r e a r e no w a g e - in c r e a s e s a t a l l . T hat i s , i n f l a t i o n
would ensue so long as f i r m s , In th e ab sen ce o f w age-
i n c r e a s e s , d i d n o t u se t h e I n c r e a s e In p r o f i t s ( a c c r u i n g
from th e g a in s o f p r o d u c t i v i t y ) to b e n e f i t consum ers in t h e
form o f lo w e r p r i c e s .
The main d i f f e r e n c e betw een t h i s case and th e p r e
c e d in g ”no s p i l l - o v e r " c ase i s t h a t now t h e f ir m s and t h e i r
owners ( i n s t e a d o f w a g e -e a r n e rs ) c a p t u r e th e f u l l g a in s o f
1Ibid
302
p r o d u c tiv ity . As in the n o - s p ill- o v e r c a se , the technolog
ic a ll y - d is p la c e d workers cannot be re-employed w ithout the
aid of expanded demand, u n le s s — in the p re se n t case—the
firm s decide to convert t h e i r p ro d u c tiv ity gains in to lower
p r ic e s to consumers: a t lower p ric e s consumers would enjoy
a gain in r e a l income and an op p o rtu n ity to buy more
commodities s u f f i c i e n t to re-employ the d isp laced workers.
Without such red u ctio n of p ric e s to consumers, the r e
employment by means of a demand expansion would n e c e s s a r ily
r e s u l t in consumer-price i n f l a t i o n .
Thus i t may be sa id th a t p ro d u c tiv ity growth w ill
unfold in a g e n e ra l p ric e r i s e i f in d iv id u a l p r ic e s are
m aintained (not reduced) in the i n d u s t r ie s enjoying the
increm ents in p r o d u c tiv ity . Conversely, to prevent the
" in e v ita b le " r i s e in p r ic e s of consumer p ro d u c ts, and to
avoid unemployment as w e ll, p ric e s must be more f l e x i b l e in
the downward d ir e c tio n , p a r t i c u l a r l y in the i n d u s t r ie s in
which p ro d u c tiv ity gains accrue.
I t may be noted th a t t h i s case enables us t o p o stu
l a t e a p ric e i n f l a t i o n th a t is n e ith e r of the demand-pull
or the cost-push type. Recent i n f l a t i o n experience in th e
U nited S ta te s , however, i s known to have in c o rp o ra te d sub
s t a n t i a l degrees of b o th demand and cost expansion.^"
•^Machlup, "Statement," op. c l t . , p. 2825, and
"Another View . . . op. c l t . , pp. 13 6-38.
The F acets of P ric in g
In the c h a p ter on p ric in g our c h ie f concern was to
e v a lu ate the p r ic in g p r a c t ic e s of firm s as a "cau sa l"
f a c t o r in i n f l a t i o n . Thus we did not touch upon th e
"w elfare" q u estio n whether the p ric e and output d e c isio n s
of o l i g o p o l i s t i c and o th e r le s s -th a n -p u re ly com petitive
firm s were s i g n i f i c a n t l y d i f f e r e n t from those presumably
made under pure co m p etitio n .
Even in t h i s connection, however, i t was noted th a t
w hile competing firm s—e s p e c ia lly the la r g e r ones— tended
to e s t a b l i s h " s ta b le r e la tio n s h ip s " among th em selv es, and
re s o rte d to n o n -p ric e modes of com petition in p refe re n ce to
o u trig h t p ric e w a rfa re , t h e i r "a re a s of d is c r e tio n " in
p r ic in g could be enjoyed only w ith in c e rta in lim its se t by
market fo rc e s of supply (c o st) and demand. As G. L. Bach
has put i t : "no s e l l e r , no m a tte r how ad m inistered h is
p r i c e s , can long escape th e t e s t of the m arket."^
Our d isc u ssio n o f p r ic in g as a f a c t o r in i n f l a t i o n
rev ea led t h a t the firm can a f f e c t the g en eral p r ic e le v e l
i n e i t h e r of two ways: (a) as a p assiv e v e h ic le f o r or
r e f l e c t o r o f the o p e ra tio n of market fo rces (of c o s ts and
demand) as expressed through the f ir m 's supply and demand
cu rv es, and (b) as an i n s t i g a t o r o r g e n e ra to r of in c re ase d
■^Bach, op. c i t . , p. 6 5 .
304
c o sts and demand i n a manner t h a t im pels an autonomous or
in d e p e n d e n t upward p r e s s u r e on p r i c e s .
Demand i n p r i c i n g . — In r e g a r d i n g th e f i r m as a
" r e f l e c t o r ” i t was n o te d t h a t , f o r v a rio u s r e a s o n s , p r o
d u cers te n d to r e g a r d changes i n c o s ts a more c o n v en ien t
p r i c i n g guide th a n changes i n demand. N e v e r t h e l e s s , i t was
a ls o s e e n t h a t c o n s i d e r a t i o n s o f demand were f a r from
i n s i g n i f i c a n t i n b o th i n i t i a l p r i c e - s e t t i n g and i n s u b s e
quent a d ju s tm e n t o f p r i c e s to m arket c o n d i t i o n s .
T h is was p a r t i c u l a r l y e v id e n t i n th e w id e sp rea d
p r a c t i c e of "w orking back from p r i c e . " T h is i s c o n c e iv a b ly
th e m ost d i r e c t a p p l i c a t i o n o f m arket demand i n p r i c i n g
under any form o f c o m p e titio n , s in c e i t means t h a t th e firm
a c c e p ts th e m ark et p r i c e as " g i v e n ," and a d j u s t s th e
q u a l i t y (o r g ra d e ) o f p ro d u c t a c c o rd in g ly in o r d e r t h a t
t h i s s e l l i n g p r i c e y i e l d a "norm al" p r o f i t m argin above
c o s t s .
P o s s ib ly the most p o p u la r example of such p r i c i n g
i s the candy b a r t h a t c o n tin u e s t o s e l l f o r f i v e c e n t s ,
d e s p i te th e lo n g -r u n r i s e in c o s t s , p a r t l y b ecause th e
q u a n t i t y a n d /o r q u a l i t y o f f e r e d has d e c l i n e d , and p a r t l y
( i t may be assumed) b e ca u se of i n c r e a s e d p r o d u c t i v i t y .
T h is i s a most s i g n i f i c a n t , a l b e i t i n d i r e c t , i n d i
c a tio n o f i n f l a t i o n b e ca u se i t may become c h a r a c t e r i s t i c
of a w ide v a r i e t y o f p r o d u c ts d u rin g th e s e c u l a r i n f l a t i o n
305
p ro cess, and y e t i t cannot be d ir e c tly or e a s ily measured
by means of p ric e Indexes. To the extent th a t the indexes
which measure the progress of p rice i n f l a t i o n f a i l to take
account of changes in product q u a lity (improvements as well
as d e t e r io r a tio n ) , the f u l l extent of i n f l a t i o n is not
r e v e a le d .1
Markups and price r i s e s . —I t was also seen t h a t the
f ir m 's markup plays a twofold ro le in i n f l a t i o n . In the
u su al instance i t behaves e s s e n t i a l l y as a p re se rv e r of the
f ir m 's customary income ( p r o f it) share, and hence operates
lik e a transm ission mechanism in the c o s t-p ric e s p i r a l in
general and the wage-price s p i r a l in p a r tic u la r .
Less u su al i s the case of the "enlarged" markup
which is invoked p rim arily f o r s p e c ia l or n o n -recu rren t
reasons such as the in tro d u c tio n of research and develop
ment programs or th e adjustment to hig h er r a te s of re tu rn
enjoyed by o th e r firm s of s im ila r s ta tu s . To the ex ten t
th a t the enlarged markup i s only o ccasio n ally ap p lied , i t
w ill tend to operate as a one-time "cause" of i n f l a t i o n .
Demand arid ra tc h e t e f f e c t s . — In connection with
both of th e se cases of markup i n f l a t i o n i t i s w ell to recall
Ackley's th e s is t h a t , however the i n f l a t i o n may s t a r t ,
changes in the le v e l of demand a lso play a b asic ro le in
^For a progress re p o rt on th e measurement of qual
i t y changes in th e consumer p ric e index, see Ewan Clague,
"Computing the Consumer P rice Index," C hallenge, X (May,
306
ex p lain in g changes In th e average le v e l of markups. For
Ackley, i t i s t h i s combined p a r t i c i p a t i o n of demand and
markup elem ents th a t la r g e ly ex p lain s why even in re c e ssio n ,
when aggregate demand has slackened, th e p ric e le v e l may
continue to inch upwards (so long as co sts continue to
r i s e ) , a l b e i t a t a l e s s e r pace than i f demand.had been more
exuberant.
The consequence of t h i s phenomenon has become known
as the " r a tc h e t e f f e c t . " In Hansen's view, th e r a tc h e t
e f f e c t is re in fo rc e d by government b o ls te r in g of sagging
demand in th e "new environment" of economic p o lic y , which
induces firm s to h e s i t a t e b efore c u ttin g co sts and p r i c e s .
This i s another in sta n c e of how the m o n e ta ry -fis c a l e n v i r
onment plays an i n d ir e c t but key ro le in the s e c u la r r i s e
of p r ic e s .
F in a ll y , as Machlup has .reminded u s, an i n f l a t i o n
of e f f e c t iv e demand i s a n ecessary co n d itio n n o t only f o r a
demand-pull i n f l a t i o n of consumer p r ic e s but a ls o fo r a
cost-push i n f l a t i o n , f o r w ithout i t th e r i s e in costs would
r e s u l t in reduced production and employment r a t h e r than a
continuing r i s e in consumer p r i c e s . 1
1962), pp. 13-16.
M achlup, "Another View . . . ," op. c i t . , p. 129.
P r i c e S t a b i l i t y and th e
"Cause*1 of I n f l a t i o n : A Summary
I n sum m arizing t h e p r e c e d in g d i s c u s s i o n , we may
p ro c e e d on two l e v e l s : (1) u n d e r which g e n e r a l c o n d i t i o n s
can th e p r i c e l e v e l r i s e , r e g a r d l e s s o f th e s p e c i f i c
1 1 c a u s e " o f th e i n f l a t i o n , and (2) u n d e r which c o n d it i o n s
can each o f th e f o u r key v a r i a b l e s — money, demand, wages,
and p r i c e s — be re g a r d e d as t h e " c a u s e " o f i n f l a t i o n ,
r e g a r d l e s s o f th e s i z e o f i t s im p act on th e i n f l a t i o n
p r o c e s s , s i n c e i t s im pact may be s m a l l e r o r l a r g e r th a n th e
im p act of th e o t h e r p a r t i c i p a t i n g f a c t o r s on th e u l t i m a t e
p r i c e r i s e .
C o n d itio n s o f p r i c e s t a b i l i t y . — In th e f i r s t
m a t t e r , we may s t a r t w ith th e s ta te m e n t t h a t s t a b i l i t y o f
th e o v e r - a l l p r i c e l e v e l depends e s s e n t i a l l y on th e g e n e r a l
r e l a t i o n s h i p o r b a la n c e betw een a g g re g a te demand ( i n c l u d
in g income and e x p e n d i t u r e s ) and a g g re g a te s u p p ly ( i n c l u d
in g c o s t s and p r o d u c t i v i t y ) . To t h e e x te n t t h a t e i t h e r
demand becomes e x c e s s iv e i n r e l a t i o n t o a g iv e n s u p p l y , o r
a g iv e n demand i s accom panied by re d u c e d su p p ly o r p ro d u c
t i v i t y o r h i g h e r u n i t c o s t s , t h e r e e n s u e s a r i s e i n p r i c e s
t h a t i s known as " open i n f l a t i o n . " I t m a t t e r s n o t a t t h i s
p o i n t what f a c t o r ( s ) " c a u se d " e x c e s s i v e demand o r demand-
p u l l , on th e one h a n d , o r d e f i c i e n t su p p ly o r c o s t - p u s h , on
th e o t h e r ; s u f f i c e i t t o n o te t h a t a v e ra g e p r i c e s t a b i l i t y
308
depends on the balance of demand and supply in g e n e r a l .1
To the e x ten t t h a t demand and supply remain in
approximate b a la n c e , b u t r is in g co sts induce q u a lity
d e t e r io r a tio n as a means of m aintaining e x is tin g p r i c e s ,
then the r e s u l t may be termed “hidden i n f l a t i o n , " in con
t r a s t to the more f a m ilia r " suppressed" or "rep ressed "
types of i n f l a t i o n not discussed in t h i s study. The d i f f e r
ence between th e two i s th a t whereas the former r e p re s e n ts
a "complete" adjustm ent to the i n f l a t i o n a r y p ressu re (in
th i s case, r i s i n g c o s t s ) , in the l a t t e r the p ric e a d j u s t
ment to in f la t io n a r y p re s s u re s (o f r is in g demand and/or
co sts) has merely been te m p o rarily prevented or postponed
and i s expected to be "completed" by a p ric e r i s e at some
l a t e r d ate.
D e fin itio n of "cau ses" . — Once p ric e s t a b i l i t y has
been s h a tte re d and, in the case of i n f l a t i o n , p r ic e s s t a r t
to r i s e , we begin to search fo r the c u l p r i t who s t a r t e d i t
(the "cause") and su sp ect the e x iste n c e of e i t h e r excess
demand o r co st-p u sh , or various combinations th e re o f. But
not a l l types of excess demand or cost-push are e l i g i b l e to
serve as "causes" of th e i n f l a t i o n . In the case o f demand,
ip o r a d e ta ile d a n a ly s is of the co n d itio n s of p r ic e
s t a b i l i t y , deraand-pull and co st-p u sh , see F rie d ric h A.
Lutz, "C ost- and Demand-Induced I n f l a t i o n , " Banca N azlonale
Del Lavoro—Q u arterly Review, No. (March, 1 9 5 8 ),
pp. 3 -1 8 .
309
i t was noted t h a t only "autonomous1 1 or "spontaneous" excess
demand— g en erated e i t h e r by consumers, p ro d u cers, or
government "independently" of any p r io r expansion o f costs
or incomes ( th a t i s , i t could be expected to occur even i f
co sts had remained the same)— could be e l i g i b l e as a "cause"
of i n f l a t i o n .
A ll o th e r cases of demand expansion were regarded
as " d e r iv a tiv e ," being e ith e r (a) "induced" by a p r i o r r i s e
in c o s ts , such as wages and p r i c e s , or (b) " su p p o rtiv e "
or "com pensatory," expanding demand with th e aid of the
m o n e ta ry -fis c a l a u t h o r i t i e s as a means of minimizing the
unemployment th a t would tend to r e s u l t from the c o st (wage
and p r ic e ) in c re a s e s .
S im ila rly in the case of c o s t s ; a wage o r p ric e
in c re a se could be deemed "autonomous" only i f i t occurred
independently of demand, th a t i s , i f i t could be expected
to occur even in th e absence of an in c re a se in demand,
because of "monopoly" or market powers and the absence of
pure c o m p e titio n .1
I t was also n o te d , in th e chapter on demand, th a t
such " d is e q u ili b r a tin g " autonomous c o s t-in c re a s e s would
1The' follow ing d isc u ssio n i s based mainly on Machlup
"S tatem en t," op. c i t . , pp. 2824, 2826, 2 8 3 6 , 2 8 4 4 -4 5 , and
"Another View . . . ," op. c i t . . pp. 130-31.
310
have to be "absorbed” or " liq u id a te d " by an in c re a s e in
monetary demand s u f f i c i e n t to perm it or " r a t i f y " the p ric e
in c re a s e s . This p o in t may be e la b o ra te d a b i t a t t h i s
ju n c tu re .
According to Machlup, autonomous wage or p ric e
in c re a se s may e x e rt th ree p o s s ib le e f f e c t s , in s in g u la r or
combined fa sh io n : (a) a red u ctio n in production and
employment, (b) an "induced" expansion of p r iv a te demands,
and/or (c) a "su p p o rtiv e " expansion of demand by means of
m o n e ta ry -fis c a l measures.
For example, the in c re ase d unemployment th a t is
th re a te n e d or re a liz e d by the given c o s t-in c re a s e s may be
o f f s e t by an expansion of demand: to the e x te n t th a t the
induced demand expansion ( e . g . , w age-pull) i s i n s u f f i c i e n t
to re-ab so rb th e excess supply of labor cre a te d by the wage
and p ric e in c re a s e s , government a u t h o r it ie s may supplement
the d e fic ie n c y with a su p p o rtiv e in je c t io n of demand.
Other cost i n c r e a s e s .--What about o th e r types of
cost (wage and p ric e ) in c re a se ? In the case of wages
th e re were, in a d d itio n to the autonomous c ateg o ry , two
o th e r c a te g o rie s : (1) " induced" w age-increases stim u la te d
by surrounding economic f a c t o r s , such as em ployers'
p r o f i t s ( " p r o f it- in d u c e d " ) , or w age-rates in o th er
i n d u s tr ie s ( " s p ill - o v e r " or " i m i t a t i v e " ) , or the w orkers'
own c o s t- o f - liv in g (" d e fe n s iv e " ); (2) " resp o n siv e " or
311
"com petitive" w age-increases which, in response to an excess
demand f o r a given type of la b b r, could be expected to
occur even under co n d itio n s of pure com petition, in the
absence of any union monopoly power and unemployment.
I t may be noted t h a t , according t o Machlup, the
"d e fe n s iv e " w age-increase— seeking to compensate only fo r
the r i s e in c o s t - o f - l i v i n g — a c tu a lly q u a l i f i e s as an
autonomous ty p e , although i t is designed merely to r e s to r e
r e a l wages to the group’ s customary le v e l. The reason i s
th a t i t re q u ire s the e x e rc is e of b arg a in in g power to
r e a l i z e i t ; hence i t d i f f e r s from the responsive type which
is merely a response to an excess demand f o r the given type
of lab o r re c e iv in g the r a i s e . N e v e rth e le s s, as we have
n o te d , d efen siv e w age-increases do play a key r o le in
determ ining th e pace of the wage-price s p i r a l .
Aggressive versus immoderate. — Of a l l the types of
w ag e -in c re ase s, Machlup b e lie v e s th a t mainly the autonomous,
p r o fit-in d u c e d , and s p i l l - o v e r types w i l l tend t o be
" a g g re s s iv e " in the sense t h a t they seek t o ra is e r e a l wage
r a te s above the g ro u p 's customary le v e l (and thereby give
impulse to an in f l a t i o n a r y process) in c o n tra s t t o the
d efen siv e-ty p e r a i s e (which serves merely to "propagate"
the i n f l a t i o n ) .
This does not mean th a t a l l aggressive wage-
in c re a se s are n e c e s s a r ily i n f la t io n a r y : only wage-
312
i n c r e a s e s t h a t are " im m oderate”— which r a i s e wages in
e x c e s s of th e n a t i o n a l averag e r a t e o f p r o d u c t i v i t y g ro w th —
a re i n f l a t i o n a r y ; b u t only an autonomous I n c r e a s e i s t o be
r e g a r d e d as th e "c a u se " o f a p r i c e r i s e .
One f u r t h e r im p o r ta n t p o i n t may be added. As n o te d
i n th e c h a p t e r on w a g es, a seem in g ly " d e f e n s iv e " wage-
i n c r e a s e may a c t u a l l y r e p r e s e n t a s t e p t o p r e s e r v e a r e c e n t
" a g g r e s s i v e " w a g e - in c r e a s e t h a t had been p a r t l y e ro d e d by
t h e r e s u l t i n g c o s t - p u s h i n f l a t i o n . In such a c a s e , th e
d e f e n s i v e - l o o k i n g c o s t - o f - l i v i n g a d ju s tm e n t t o r e s t o r e r e a l
wages cannot be re g a r d e d as a l t o g e t h e r d e f e n s i v e .
The case of p r i c e s . — I n th e case of a d m in is te r e d
p r i c e s , a p r i c e - i n c r e a s e by th e firm may be " autonom ous"
i n th e se n se n o te d i n th e case o f w ag es, i . e . , i f th e y a r e
a t t r i b u t a b l e t o th e f i r m ' s m arket power r a t h e r th a n t o
c o m p e titiv e demand and supply c o n d i t i o n s . In a d d i t i o n ,
a c c o rd in g t o M achlup, a d m in is te r e d p r i c e s may be p u r e ly
r e s p o n s iv e ( c o m p e ti t iv e ) i f th e y would have o c c u rr e d even
i n th e absen ce o f any p ric e -m a k in g p o w e rs, such as when
e x c e s s demand r e q u i r e s p l a n t s t o work a t c a p a c ity and
r i s i n g s a l e s r e s u l t m ain ly i n an a c c u m u la tio n of o r d e r s .
C o n v e rs e ly , a " r e s p o n s iv e " p r i c e i n c r e a s e would be
in c o n c e i v a b l e i f t h e r e was much unused c a p a c i t y . However,
an a d m in is te r e d p r i c e - i n c r e a s e may be " in d u c e d " by an
expanded demand even i n th e f a c e o f e x c e s s c a p a c i t y , i f
313
such i n c r e a s e s m ight n o t have o c c u rre d i n th e absen ce o f
the demand e x p a n s io n .
F i n a l l y , as i n th e c ase o f w ages, p r i c e - i n c r e a s e s
are deemed d e f e n s iv e when d e s ig n e d m erely t o r e s t o r e and
m a in ta in th e custom ary r e a l p r o f i t r a t e , coming s o l e l y in
r e a c t i o n to i n c r e a s e d c o s t s o f p r o d u c t i o n . I f th e p r i c e -
i n c r e a s e se e k s t o e n la r g e th e custom ary p r o f i t r a t e , as i n
th e c a se o f t h e " e n la r g e d " p r o f i t m a rg in , th e n i t would be
deemed " a g g r e s s i v e ."
I n f l a t i o n as a P ro c e ss
Having d i s c u s s e d , in t h e p r e c e d in g p a r t , th e main
i n t e r r e l a t i o n s betw een th e f o u r most p o p u la r " c a u s e s " o f
i n f l a t i o n , and why i t i s d i f f i c u l t t o f u l l y e x p l a i n th e
i n f l a t i o n p r o c e s s by a p u r e ly m o n is ti c t h e o r y , we can now
p ro ceed t o a more g e n e r a l i z e d d i s c u s s i o n of i n f l a t i o n as a
" p r o c e s s " or "sy stem " i n o p e r a t i o n .
In d o in g so , we w i l l d e a l p r i m a r i l y w ith th e mean
in g o f such term s as " p r o c e s s , " " r e s p o n s e ," " t r a n s m i s s i o n , "
and " e n v ir o n m e n t," f i r s t as p a r t s of l o g i c a l r e l a t i o n s
betw een econom ic v a r i a b l e s , th e n in term s of t h e i r s o c i a l -
p o l i t i c a l c o n te x t.
One n o te w o rth y a s p e c t o f t h i s g e n e r a l a p p ro a ch t o
the i n f l a t i o n p r o c e s s i s th e f a c t t h a t , l i k e i n d i v i d u a l
b u s i n e s s c y c l e s , no two i n f l a t i o n e p is o d e s may be a l i k e
314
e x c e p t i n th e f a c t t h a t , i n g e n e r a l , each w i l l p o s s e s s a
cause o r s t i m u l u s , re s p o n s e o r e f f e c t , t r a n s m i s s i o n and
s p i r a l m echanism s, and an e n v iro n m e n t, a l l i n t e r r e l a t e d and
i n t e r a c t i n g in a l o g i c a l an d, p o s s i b l y , p r e d i c t a b l e p a t t e r n .
I t i s th e s e g e n e r a l e le m e n ts o r i n g r e d i e n t s of th e i n f l a t i o n
p r o c e s s , common to a l l c a s e s , which i t i s u s e f u l t o i d e n
t i f y f o r u se i n th e a n a l y s i s and i n t e r p r e t a t i o n o f p a r t i c
u l a r e p is o d e s .
A number o f w r i t e r s have r e f e r r e d t o and a n a ly z e d
i n f l a t i o n as a p r o c e s s , s t a t i n g e x p l i c i t l y or m ere ly im p ly
in g t h a t i t c o n s t i t u t e s a sequ en ce o r p a t t e r n o f e v e n ts
i n t e r r e l a t e d and i n t e r a c t i n g i n s p e c i f i c ways. P ro b a b ly
th e most s u c c i n c t s ta te m e n t i s A. G. H a r t ' s d e f i n i t i o n t h a t
i n f l a t i o n i s a " p r o c e s s t h a t r a i s e s p r i c e l e v e l s . " ^ F o r
o u r p u r p o s e s , how ever, a more a d e q u a te s t a r t i n g p o i n t i s
th e d e f i n i t i o n g iv e n by A. C. L. Day and S. T. B eza. F o r
them i n f l a t i o n i s :
a p r o c e s s o f r i s i n g p r i c e s ; i t i s i n i t i a t e d by some
change which makes i t im p o s s ib le t o s a t i s f y t h e
whole of th e demand which I s fo rth c o m in g a t e x i s t
in g p r i c e s , so t h a t i n i t i a l p r i c e r i s e s o c c u r ; and
i t i s p r o p a g a te d by th e r e a c t i o n s o f t r a n s a c t o r s o r
g ro u p s o f t r a n s a c t o r s t o th e i n i t i a l p r i c e r i s e , so -
t h a t f u r t h e r p r i c e r i s e s a re in d u c e d . [ I t a l i c s m in e .]
^ A lb e rt G a ilo r d H a r t , "What I s I n f l a t i o n ? " Challenge.
VI (December, 195 7 ), p . 8.
2Day and Beza, op. c i t . , p. 291.
315
W ith two p o s s i b l e e x c e p t i o n s , t h i s d e f i n i t i o n i s
a s s a t i s f a c t o r y a s any as a s t a r t i n g p o i n t . F o r one, i t
a t t r i b u t e s i n f l a t i o n t o d e m a n d -p u ll e x c l u s i v e l y . The o t h e r
e x c e p ti o n i s th e o m issio n o f " e n v iro n m e n t” as a key
I n g r e d i e n t of th e p r o c e s s , about w hich more w i l l be s a i d
below .
The R esponses t o I n f l a t i o n
The ob vio u s s t a r t i n g p o in t o f th e f o l lo w in g
a n a l y s i s sh o u ld be th e p h r a s e " r i s i n g p r i c e s " which i s th e
k e r n e l o f most d e f i n i t i o n s o f i n f l a t i o n f o r th e sim ple
re a s o n t h a t t h i s i s a p p a r e n t l y what i n f l a t i o n i s a l l a b o u t.
(Some e c o n o m ists would i n c l u d e s u p p r e s s e d o r r e p r e s s e d
i n f l a t i o n , in w hich th e p r i c e r i s e does n o t o c c u r immedi
a t e l y b u t i s p o s tp o n e d , b u t t h i s s p e c i e s has n o t been our
d i r e c t c o n c e r n .)
E n t e r th e r e s p o n s e s .- - T h e term " r i s i n g p r i c e s "
i m p l i e s th e e x i s t e n c e o f a " s p i r a l ," t h a t i s , a s e r i e s o r
s u c c e s s io n o f p r i c e r i s e s , as i n d i c a t e d by t h e word
" f u r t h e r " used by Day and B eza. T h is c o n ce p t i n t u r n
i m p l i e s a m echanism by w hich th e s p i r a l can o p e r a t e , t h a t
i s , whereby each p r i c e r i s e i s " c a u s a l l y " l i n k e d t o a
s u c c e e d in g p r i c e r i s e .
I n t h i s c o n n e c tio n th e d e f i n i t i o n r e f e r s to a
l i n k i n g mechanism c o n s i s t i n g o f " r e a c t i o n s " ( o r r e s p o n s e s )
in d u c e d i n t r a n s a c t o r s by p r i c e r i s e s and s e r v i n g to
316
" p r o p a g a te " o r t r a n s m i t th e i n i t i a l p r i c e r i s e i n t o
s u c c e s s iv e rou nds of p r i c e r i s e s and i n f l a t i o n a r y r e s p o n s e s .
L et us t h e r e f o r e t a k e a c l o s e r lo o k a t t h e s e re s p o n s e s t o
p r i c e r i s e s .
One ty p e o f r e s p o n s e t o p r i c e r i s e s a lr e a d y met i s
th e i n s t i t u t i o n of wage com parison by which th e i n i t i a l
w a g e - in c r e a s e i n a key s e c t o r of t h e economy in d u c e s a
t r a n s m i s s i o n o r s p i l l - o v e r o f i m i t a t i v e w a g e - i n c r e a s e s .
As n o te d a b o v e , t h i s ty p e o f re s p o n se may be
" a g g r e s s iv e " i n t h e se n se t h a t i t s e e k s to r a i s e r e a l wage-
r a t e s above custom ary l e v e l s and i s more t h a n m erely
d e f e n s i v e . Itmay be added t h a t th e r a i s i n g o f p r i c e s by
f ir m s may be s i m i l a r l y i m i t a t i v e , p a r t i c u l a r l y where f ir m s
f a c e s i m i l a r changes in m ark et c o n d it i o n s o r a re c h a r
a c t e r i z e d by i n te r d e p e n d e n c e .
In any e v e n t , th e p o i n t h e re i s t h a t th e I m i t a t i v e
ty p e o f r e s p o n s e s h o u ld be r e g a r d e d more a s an im p u lse
f a c t o r — s e r v i n g to augment o r enhance the i n i t i a l s tim u lu s
t o i n f l a t i o n — th a n as a d e f e n s iv e r e a c t i o n t o a p r i c e r i s e
(su ch as t h e c o s t - o f - l i v i n g a d ju s tm e n t) t h a t s e r v e s only
t o " p r o p a g a te " t h e i n f l a t i o n . N e v e r t h e l e s s , b e ca u se o f th e
b a s i c im p o rta n c e o f th e p r o p a g a t iv e a s p e c ts o f d e fe n s iv e
and r e l a t e d r e s p o n s e s , most o f th e f o llo w in g w i l l be
d e v o te d t o th e c h a r a c t e r i s t i c s o f d e f e n s iv e r e s p o n s e s in
g e n e r a l .
317
D e fen siv e v e r s u s p a s s i v e . — Day and Beza c l a s s i f y
r e a c t i o n s to p r i c e r i s e s i n t o two g e n e r a l t y p e s : (1)
" p a s s iv e " and (2) " d e f e n s i v e . " ! P a s s iv e r e a c t i o n s a re e x
p r e s s e d by t r a n s a c t o r s a d j u s t i n g t h e i r sp end ing p la n s ,
whereby th e y sim ply a c q u ie s c e t o th e p r i c e r i s e (and th e
drop in r e a l income) and a l t e r t h e i r e x p e n d itu r e s in th e
l i g h t o f t h e i r g iv e n money incom es. I f t h e i r money incomes
a l s o i n c r e a s e a t th e same t i m e , th e n t h e i r sp e n d in g p la n s
w i l l a ls o be a l t e r e d a c c o rd in g ly , depending on the p ro p e n
s i t i e s t o spend and sav e.
Whereas i t i s a p p a re n t t h a t p a s s iv e r e a c t i o n s w i l l
te n d to slow down th e pace of i n f l a t i o n — assum ing incomes
rem ain th e same a t th e tim e of the p r i c e r i s e — d e fe n s iv e
r e a c t i o n s can be e x p e c te d t o c o n t r i b u t e s u b s t a n t i a l l y t o
th e p ro p a g a tio n and s p i r a l l i n g of p r i c e r i s e s . The re a s o n
i s t h a t t h i s type o f re sp o n se r e p r e s e n t s a r e f u s a l t o
a c c e p t th e w orsened s i t u a t i o n ( i . e . , th e drop in r e a l
income) caused by th e p r i c e r i s e . T h is r e f u s a l may ta k e
e i t h e r o f two fo rm s, one a f f e c t i n g t h e c o n d itio n s o f mone
t a r y demand, the o t h e r a f f e c t i n g th e c o n d itio n s of s u p p ly *
Two d e fe n s iv e r e s p o n s e s .--T h e f i r s t ty p e o f d e fe n
s i v e re s p o n se i s e x p re s s e d by a tte m p ts to r e s t o r e th e
•^The fo llo w in g d i s c u s s i o n on r e s p o n s e s i s based
m ain ly on Day and B eza, op. c i t . . pp . 295-325.
318
a d v e rs e e f f e c t of th e p r i c e r i s e on t h e r e a l v a lu e o f goods
p u r c h a s e d . T his i s a c h ie v e d by th e t r a n s a c t o r i n c r e a s i n g
h i s m o n etary e x p e n d i t u r e s — by r e s o r t i n g t o c r e d i t , draw ing
on r e s e r v e s , o r r e d u c in g s a v i n g — a s a means of c o m p en satin g
f o r the p r i c e r i s e and r e s t o r i n g th e custom ary l e v e l o f
r e a l ( p h y s i c a l ) e x p e n d i t u r e s . In o t h e r w ords, t r a n s a c t o r s
sim p ly s e e k to m a in ta in th e l e v e l of r e a l demand by sp en d
in g more money.
The u n d e r l y i n g a ssu m p tio n i n t h i s case i s t h a t
t r a n s a c t o r s a r e s t r o n g l y m o tiv a te d to m a in ta in t h e i r r e a l
sp e n d in g . Examples in c lu d e p ro d u c e rs who a re b e n t upon
m o d e r n iz a tio n of p l a n t and equipm ent b e ca u se o f c o m p e titio n
and who may t h e r e f o r e p e r s i s t i n f u l f i l l i n g p la n n e d l e v e l s
o f r e a l ( p h y s i c a l ) i n v e s tm e n t; o r governm ent a g e n c ie s
i n s i s t i n g upon m a in ta in in g t h e i r own r e a l e x p e n d i tu r e s a t
a f i x e d p e r c e n ta g e o f n a t i o n a l incom e.
The second ty p e o f d e fe n s iv e r e s i s t a n c e t o i n f l a
t i o n ta k e s th e a l t e r n a t i v e p a th of m e e tin g th e d rop in r e a l
income by a tt e m p ts t o i n c r e a s e th e s e l l i n g - p r i c e s o r money
incom es o f t r a n s a c t o r s . F a m i l i a r exam ples a re c o s t - o f -
l i v i n g a d j u s t m e n t s , th e r e t e n t i o n of m arkups and p r o f i t
m arg in s by f ir m s , and th e p r e s e r v a t i o n o f r e a l t a x re v e n u e s
by g o v ernm ent. The a t t r a c t i o n of t h i s method o f r e s i s t a n c e
t o i n f l a t i o n i s t h a t th e r e s t o r a t i o n o f r e a l incom es t o
fo rm e r l e v e l s a l s o means an a u to m a tic r e s t o r a t i o n o f r e a l
sp e n d in g power as w e l l .
319
D e fe n s iv e n e s s and th e s p i r a l . — The c o n c lu s io n t h a t
can be drawn, a c c o rd in g t o Day and B eza, i s t h a t t h e v e ry
c o n t i n u i t y o f th e i n f l a t i o n p r o c e s s depends on t h e n a t u r e
o f d e f e n s iv e r e s p o n s e s — t h a t once an i n f l a t i o n h a s been
i n i t i a t e d , " e f f e c t i v e ” d e f e n s i v e a c t i o n s a g a i n s t eac h p r i c e
r i s e ( s u f f i c i e n t t o r e s t o r e fo rm e r l e v e l s o f r e a l sp e n d in g
a n d /o r incom e) may be a b le to keep t h e p r o c e s s g o in g
" i n d e f i n i t e l y . "
T h is does n o t mean t h a t a l l t r a n s a c t o r s o r t r a n s
a c t o r grou ps must be a b l e and w i l l i n g to p la y th e game o f
l e a p f r o g g in g d e f e n s iv e r e s p o n s e s t o th e h i l t . C on tinu ous
i n f l a t i o n would o c c u r n e c e s s a r i l y even i f no more th a n two
g ro u p s were t r y i n g to r e s t o r e t h e i r r e a l incom es o r spend
i n g , w ith a l l o t h e r g ro u p s r e a c t i n g " p a s s i v e l y , " b e in g
u n a b le o r u n w i l l i n g to d e fe n d th e m s e lv e s ; as soon as
group A r e s t o r e d i t s own p o s i t i o n i t would be harm ing group
B, p ro v o k in g th e l a t t e r to r e a c t d e f e n s i v e l y , and so on.
The e n su in g p r i c e s p i r a l would r e p r e s e n t a s t r u g g l e f o r
" in c o m p a tib le ends" (w hich rem in ds u s o f A c k le y 's markup
" e n g in e o f i n f l a t i o n " ) , b u t i t c o u ld p r o c e e d o nly so long
a s b o th g ro u p s A and B ( f o r e x am p le, w a g e - e a r n e rs and
p r o f i t - r e c e i v e r s ) c o u ld s a t i s f y th e m s e lv e s a t t h e exp en se
o f th e p a s s i v e g r o u p s , such as f ix e d -in c o m e p e o p le .
F u r th e rm o r e , an i n f l a t i o n s p i r a l c o u ld o c c u r even
i f one group a lo n e p la y e d th e game o f r e a c t i n g d e f e n s i v e l y .
320
An exam ple I s where th e d e f e n s iv e grou p c o n s i s t e d o f p r o
d u c e rs b e n t upon r a i s i n g t h e l e v e l of t h e i r r e a l ( p h y s i c a l )
in v e s tm e n t e x p e n d i t u r e s , w hich in v e s tm e n t cau sed r i s i n g
incomes f o r th e o t h e r ( p a s s i v e ) g r o u p s , which i n t u r n
in d u ced r i s i n g e x p e n d i tu r e s by th e l a t t e r , and th e r e s u l t
in g p r i c e r i s e s s t i m u l a t e d p r o d u c e r s i n t o a n o th e r ro u n d of
d e f e n s iv e r e a c t i o n s i n o r d e r to m a i n ta in th e l e v e l o f
in v e s tm e n t in r e a l te r m s .
In any e v e n t , th e c o m b in a tio n of ways in w hich th e
i n f l a t i o n p r o c e s s c o u ld d e v e lo p a re v a r i e d and num erous.
S u f f i c e i t to n o te t h a t i n a d d i t i o n t o th e above e x am p le s,
(a) i n t h e s i n g l e - g r o u p c a s e , th e group may be bent upon
d e fe n d in g i t s r e a l income ( r a t h e r th a n i t s r e a l sp e n d in g ,
a s i n t h e above e x a m p le ), and (b) in th e tw o -g ro u p l e a p
f r o g g i n g , both g ro u p s may s im u lta n e o u s ly d e fe n d t h e i r r e a l
incomes o r t h e i r r e a l e x p e n d i t u r e s , o r one may d e fe n d i t s
r e a l income w h ile t h e o t h e r d e fe n d s i t s r e a l sp e n d in g .
The pace and bu rd en o f i n f l a t i o n . — In g e n e r a l ,
a c c o rd in g to Day and B e za , t h e pace o r momentum of i n f l a
t i o n ( i . e . , th e p e r c e n ta g e r i s e i n p r i c e s p e r tim e p e r i o d )
and t h e burden o f l o s s i t im poses on th e r e a l income and
sp e n d in g power o f g ro u p s w i l l te n d t o be a f f e c t e d by t h e
speed and s t r e n g t h o f re s p o n s e s t o p r i c e r i s e s . Thus th e
f a s t e r t h e re s p o n s e and th e ” s t r o n g e r ” th e t r a n s a c t o r s
( t h a t i s , th e more a b le th e y a re t o f u l l y r e s t o r e t h e i r
321
p o s i t i o n t o fo rm er l e v e l s ) , th e q u i c k e r th e pace of th e
i n f l a t i o n and th e s m a ll e r th e b urden of l o s s .
C o n v e rs e ly , th e " i n t e r n a l " momentum o f th e i n f l a
t i o n would a p p e a r to be w eaker and slo w e r th e g r e a t e r t h e
p a s s i v i t y o f t r a n s a c t o r s who a llo w e d t h e i r money Incomes
and e x p e n d i tu r e s t o rem ain c o n s t a n t , f o r exam ple, b e ca u se
of ( a ) th e "money i l l u s i o n " o r "P ig o u e f f e c t , " or (b) th e y
b e lo n g to g ro u p s whose incom es a r e more o r l e s s f i x e d in
d o l l a r term s ( e . g . , r e n t i e r s , p e n s i o n e r s , some s a l a r i e d
p e r s o n n e l ) , o r (c) th e a c c o u n tin g c o n v e n tio n s employed by
f ir m s in v a lu e in g t h e i r a s s e t s ( e . g . , a t o r i g i n a l c o s t )
y i e l d " p a p e r p r o f i t s " b u t i n a d e q u a te l i q u i d r e s e r v e s f o r
re p la c e m e n t p u rp o s e s a t th e h i g h e r p r i c e s .
The e x i s t e n c e o f p a s s i v e g ro u p s weakens th e i n f l a
t i o n p r o c e s s by p r o v i d in g a " le a k a g e " o r o f f s e t ( s i m i l a r t o
th e le a k a g e i n th e m u l t i p l i e r p r o c e s s ) t h a t e n a b le s one o r
a few g ro u p s t o p r e s e r v e t h e i r own r e a l p o s i t i o n s a t t h e
e x pense o f t h e p a s s i v e g r o u p s , t h e r e b y p r e v e n tin g t h e p r i c e
r i s e from b e in g h i g h e r th a n o t h e r w is e .
S i m i l a r i n e f f e c t t o p a s s i v i t y i s t h e "co m pleteness"
w ith which t r a n s a c t o r s a re a b le t o r e s t o r e r e a l income and
e x p e n d i t u r e s . The l e s s com plete t h e r e s p o n s e , th e g r e a t e r
th e d ra g on th e i n f l a t i o n p r o c e s s and th e g r e a t e r th e
b u rd en i t im p o ses.
The E nvironm ent of I n f l a t i o n
B ecause th e sp e e d and s t r e n g t h o f t h e r e s p o n s e s t o
r i s i n g p r i c e s a re so c r u c i a l t o t h e e x i s t e n c e of t h e i n f l a
t i o n ^ s p i r a l m echanism , i t i s im p o rta n t t o n o te more
e x p l i c i t l y a n o th e r b a s i c d im ensio n i n th e i n f l a t i o n pro cess:
th e r o l e s t h a t c e r t a i n u n d e r ly in g o r " e n v iro n m e n ta l" f o r c e s
p la y i n i n f l u e n c i n g th e r e s p o n s e s d is c u s s e d above.
T h is b r i n g s t o mind I r v i n g F i s h e r ' s acknowledgment
of th e " i n d i r e c t " o r " a n t e c e d e n t " i n f l u e n c e s ( i n s t i t u t i o n a l
and s t r u c t u r a l ) which a c t th ro u g h M, V, and T to I n f l u e n c e
P. But we have a lr e a d y seen t h a t , w hereas F i s h e r r e g a r d e d
P as e s s e n t i a l l y " a b s o l u t e l y p a s s i v e " and no more t h a n an
" e f f e c t , " we now r e g a r d changes in P in t h e i r own r i g h t s a s
a c t i v e p a r t i c i p a n t s i n th e i n f l a t i o n p r o c e s s p r e c i s e l y
b ecause th e y te n d t o evoke ( in d u c e ) r e s p o n s e s by t r a n s a c t o r s
W e w i l l a l s o now see t h e r o l e p la y e d by some " i n d i r e c t " o r
e n v iro n m e n ta l i n f l u e n c e s upon t h e s e same r e s p o n s e s , some o f
which F i s h e r h im s e lf acknow ledged ( e . g . , " a n t i c i p a t i o n s " o r
e x p e c t a t i o n s ) . But w h ereas F i s h e r r e g a r d e d them a s "out*-
sid e " i n f l u e n c e s , we s h a l l see t h a t th ey a r e an I n t e g r a l
p a r t - o f i n f l a t i o n as a p r o c e s s .
F o r th e purp o se o f th e f o l lo w in g d i s c u s s i o n th e
e n v iro n m e n ta l i n f l u e n c e s on r e s p o n s e s may be c o n v e n ie n tly
d iv id e d i n t o two c a t e g o r i e s : th e f i r s t o r " i n t e r n a l " grou p
of i n f l u e n c e s i s l a r g e l y o f a p s y c h o l o g i c a l n a t u r e ,
323
I n c lu d in g such f a c t o r s as th e money i l l u s i o n and e x p e c ta
t i o n s ; t h e second o r "e x t e r n a l " group o f i n f l u e n c e s a re
l a r g e l y i n s t i t u t i o n a l or s t r u c t u r a l and in c lu d e such key
i n g r e d i e n t s as money su p p ly , unem ploym ent, and governm ent
economic p o l ic y .
B efore p ro c e e d in g to th e d i s c u s s i o n of th e s e
e n v iro n m e n ta l i n f lu e n c e s on r e s p o n s e s , i t i s im p o rta n t to
n o te t h a t th e v a r i o u s re s p o n s e s d is c u s s e d above o p e ra te a s
p r e s s u r e s on P v ia e i t h e r of t h e two key dim en sio n s o f th e
p r i c e l e v e l : th e c o n d itio n s o f demand ( e . g . , sp en d in g
p l a n s , e t c . ) and t h e c o n d itio n s of supply ( e . g . , c o s t s ,
s e l l i n g p r i c e s , e t c . ) This p e r s p e c t i v e w i l l a ls o be r e l e
v a n t to much of th e f o llo w in g d i s c u s s i o n .
Some p s y c h o lo g ic a l f a c t o r s . — The i n t e r n a l psy ch o
l o g i c a l i n f lu e n c e s come i n t o prom inence once th e i n f l a t i o n
has p ro ce ed e d f o r any le n g th o f tim e s u f f i c i e n t to make
t r a n s a c t o r s i n c r e a s i n g l y aware of th e c o n tin u o u s n a tu r e o f
the p r i c e r i s e s . These p s y c h o l o g ic a l f a c t o r s may e v e n tu
a l l y a f f e c t th e c h a r a c t e r o f r e s p o n s e s s u f f i c i e n t l y t o
a c c e l e r a t e th e pace o f the i n f l a t i o n i t s e l f . ^
1See i b i d . , pp. 3 2 2 -2 5 , f o r th e f o llo w in g d i s
c u s s io n on p s y c h o lo g ic a l f a c t o r s . See a l s o W illa r d L.
Thorp and R ichard E. Quandt, The New I n f la - tio n (New York:
M cGraw-Hill Book Company, 1 9 5 9 ), pp. 7 7 -7 8 , f o r a d i s
c u s s io n o f the " p s y c h o lo g ic a l m u l t i p l i e r , "
324
F o r one t h i n g , th e money I l l u s i o n (s e e C h a p te r iv )
which was o p e r a t i v e in t h e e a r l i e r s t a g e s when p r i c e r i s e s
were r e l a t i v e l y s m a ll may b e g in to s h a t t e r when p r i c e r i s e s
become n o t i c e a b l y l a r g e , in d u c in g p e o p le t o spend more to
m a in ta in r e a l e x p e n d itu r e s *
C onnected w ith t h i s developm ent i s th e te n d e n c y of
t r a n s a c t o r s t o make i n c r e a s i n g a llo w a n c e f o r f u t u r e
e x p e c te d p r i c e r i s e s . T h is i s e x p r e s s e d by a tte m p ts t o
f o r e s t a l l e f f e c t s o f f u t u r e p r i c e r i s e s on income and
sp e n d in g t h a t have th e e f f e c t o f s p e e d in g up th e d e f e n s iv e
r e a c t i o n s . In o t h e r w ords, d e f e n s i v e r e a c t i o n s b e g in t o
se e k o v e r- c o m p e n s a tio n : s i n c e i t i s r e a l i z e d t h a t
d e f e n s iv e r e s p o n s e s th e m s e lv e s o n ly b r in g on f u t u r e p r i c e
r i s e s , t r a n s a c t o r s t r y to s e c u re s t i l l l a r g e r a d ju s tm e n ts
now t h a t w i l l a llo w f o r th e f u t u r e p r i c e b o o s t s .
R is in g p r i c e e x p e c t a t i o n s a l s o s t i m u l a t e a " hedging*1
a t t i t u d e t o th e h o ld in g o f w e a l t h , f o s t e r i n g (a) an u n w i l l
in g n e s s to s a v e , (b) th e a v o id a n c e o f h o ld in g w e a lth whose
v a lu e o r y i e l d i s f i x e d i n term s o f money ( e . g . , money
i t s e l f , b o n d s ), and (c) a s h i f t t o h o ld in g w e a lth i n " r e a l "
o r p h y s i c a l fo rm s, such a s a n t i q u e s and b u i l d i n g s . In t h e
extrem e case t h e u n w i l l i n g n e s s t o sa v e and s p i r a l l i n g
demand p r e s s u r e s w i l l r e s u l t i n " h y p e r - i n f l a t i o n . "
F i n a l l y , h e d g in g a c t i o n s t e n d t o be i n c r e a s i n g l y
accom panied by o u t r i g h t s p e c u l a t i o n , which r e p r e s e n t s an
325
a c t i v e t a k in g - a d v a n ta g e o f e x p e c te d p r i c e r i s e s .
In g e n e r a l , t o t h e e x t e n t t h a t t h e s e a c c e l e r a t i o n
t e n d e n c i e s a re s t r o n g enough t o o f f s e t t h e e x i s t e n c e of
l a r g e p a s s i v e g r o u p s , t h e r e b y in d u c in g f u r t h e r i n f l a t i o n a r y
f o r c e s , th e y can f o r c e t h e i n f l a t i o n t o c o n tin u e i n d e f i n
i t e l y .
"E x t e r n a l " e n v iro n m e n ta l i n f l u e n c e s . — Among t h e
" e x t e r n a l " e n v ir o n m e n ta l i n f l u e n c e s on th e sp eed and
s t r e n g t h o f r e s p o n s e s , some have a lr e a d y been d i s c u s s e d in
p r e c e d in g c h a p t e r s , and n e e d o n ly b r i e f m en tio n h e r e .
T hese i n c l u d e t h e p o s s i b i l i t y o f p u b l i c s p o n s o r s h ip o f
r e d i s t r i b u t i o n o f incom es from g ro u p s p o s s e s s i n g lo w er mar
g i n a l p r o p e n s i t i e s to consume t o th o s e w ith h ig h e r MPC's,
which would t e n d to q u ic k e n th e p ace of i n f l a t i o n . On th e
o t h e r h a n d , o p e r a t io n o f th e p r o g r e s s i v e income t a x and th e
b u i l t - i n s t a b i l i z e r s c o u ld se rv e a s a d r a g on r i s i n g p r i c e s ,
a s would a la g in governm ent e x p e n d i t u r e s b e h in d th e r a t e
of p r i c e r i s e .
Also v e ry im p o rta n t i s t h e f a c t t h a t i n f l a t i o n can
p ro c e e d o n ly so lo n g as t h e r e i s " s u f f i c i e n t " money to
s u p p o r t i t . ^ More p r e c i s e l y , i t h a s been seen t h a t th e
m o n e t a r y - f i s c a l p o l ic y o f g ov ernm en t— e x p r e s s e d by th e
■^On t h i s p o i n t s e e Day an d Beza, o p . c i t . , p . 3 1 9 #
and Thorp and Q uand t, o p . c i t . , p p . 84-87.
326
C o n g re ss, t h e F e d e r a l R eserve System , and t h e T r e a s u r y —
c o m p rise s an im p o r ta n t i n f l u e n c e on th e " d i r e c t " d e t e r
m in a n ts o f p r i c e s , i . e . , demand, w ages, and p r i c i n g
p r a c t i c e s . 1 These f i n a n c i a l powers of governm ent were
p a r t i c u l a r l y r e l e v a n t t o : (a ) th e f i n a n c i n g o f expanded
e x p e n d i t u r e s o f an "autonom ous" n a t u r e o f co nsum ers, p r o
d u c e r s , and governm ent a g e n c i e s ; (b) th e a b i l i t y o f f ir m s
t o g r a n t w a g e - i n c r e a s e s and f i n a n c e th e w a g e -p u ll p r e s s u r e s
g e n e r a t e d th e r e b y ( i . e . , " th e demand s id e o f c o s t
i n c r e a s e s " ) ; and (c) t h e p u b l i c ' s need f o r a d d i t i o n a l
p u r c h a s in g power t o buy up goods and s e r v i c e s a t th e h i g h e r
w a g e -c o s ts and p r i c e s .
W ithout f i n a n c i a l f a c i l i t i e s f o r th e i n j e c t i o n o f
a d d i t i o n a l p u r c h a s in g pow er— v i a i n c r e a s e d money supply
a n d /o r i n c r e a s e d v e l o c i t y o f c i r c u l a t i o n — in o r d e r t o
f in a n c e t h e s e t h r e e a c t i v i t i e s and p e rm it th e d o l l a r
volume o f e x p e n d i tu r e s t o r i s e i n l i n e w ith p r i c e s , t h e r e
would r e s u l t a drop in s a l e s and o u t p u t , p r i c e s c h a r g e d ,
em ploym ent, o r a c o m b in a tio n o f t h e s e , and t h e p r o p a g a tio n
o f an o n -g o in g p r i c e s p i r a l c o u ld be p r e v e n t e d .
The "m onetary e n v iro n m e n t" . — I t i s v i a t h e s e
c h a n n e ls o f expanded sp e n d in g t h a t th e r o l e o f th e
^ u c h o f th e f o llo w in g d i s c u s s i o n i s b a se d on Bowen,
op. c l t . . p p . 3 1 7 -2 1 , 3 ^6, 354, 369 .
327
m o n e t a r y - f i s c a l system s i s p e rfo rm ed and f e l t th ro u g h o u t
th e economy. That i s , i t i s th r o u g h th e more o r l e s s d ire c t
c o n t r o l o v e r money s u p p ly i t s e l f , and th e i n d i r e c t i n f l u
ence o v e r t h e v e l o c i t y of money, t h a t t h e "m on etary e n v i r
onment" becomes an i n t e g r a l f a c t o r i n th e i n f l a t i o n
p r o c e s s .
In a s e n s e , to speak o f th e " i n t e g r a l " r o l e of t h e
m o netary en v iro n m en t i n I n f l a t i o n i s t o r e f e r t o o n ly one
f a c e t o f a more g e n e r a l phenomenon: t h e f a c t t h a t th e
m o netary e n v iro n m en t I s in te r d e p e n d e n t and i n t e r a c t i n g w ith
econom ic a c t i v i t i e s a t a l l tim e s ( in r e c e s s i o n a s w e ll a s
i n i n f l a t i o n ) , r e s p o n d in g to t h e "n eed s o f t r a d e " and th e
d e fe n s e o f sound c u rre n c y v a l u e , on th e one h a n d , and
" l e a n i n g a g a i n s t th e econom ic w inds" i n o r d e r t o f a c i l i t a t e
c o u n t e r - c y c l i c a l p o l i c y , on th e o t h e r hand.
T h u s, f o r e x am p le , th e m o n e t a r y - f i s c a l a u t h o r i t i e s
canno t r e a d i l y p u rsu e a p e r m i s s i v e , p r o - i n f l a t i o n p o l ic y
w ith r e s p e c t t o w a g e - I n c r e a s e s w ith o u t r e g a r d f o r th e
d i r e c t i o n o f economic t r a d e - w in d s in o t h e r s e c t o r s , such as
a boom in c a p i t a l In v e s tm e n t o r a d e f i c i t in th e b a la n c e o f
I n t e r n a t i o n a l paym ents. In a d d i t i o n , th e o p e r a t i o n of
m o n e t a r y - f i s c a l p o l i c y — and hence th e i n f l a t i o n p r o c e s s
i t s e l f — c a n n o t be com prehended a p a r t from th e b e h a v io r of
th e s e v e r a l f i n a n c i a l i n t e r m e d i a r i e s t h a t a re o u t s i d e th e
d i r e c t I n f l u e n c e of t h e F e d e r a l R eserve a u t h o r i t i e s .
32 8
C o n v e rse ly , th e f a c t t h a t governm ent a u t h o r i t i e s
can p r e v e n t an i n f l a t i o n by a s u f f i c i e n t l y r e s t r i c t i v e
m o n e t a r y - f i s c a l p o l ic y does n o t n e c e s s a r i l y im ply t h a t t h e y
w i l l alw ays do s o , s in c e such s t r i n g e n t a c t i o n may b r in g on
s u b s t a n t i a l i n c r e a s e s in unemployment, an outcome t h a t i s
p o l i t i c a l l y u n d e s ira b le ., so lo ng as th e a l t e r n a t i v e of
w a g e -c u ts i s a v o i d e d . 1
P e r m is s iv e n e s s v e r s u s d e te r r e n c e . — At t h i s j u n c t u r e
th e q u e s tio n o f main concern i s n o t how or w h eth er th e
m o n e t a r y - f i s c a l i n s tr u m e n ts can a c t e f f e c t i v e l y a s p e r
m is s iv e a g e n ts o r as d e t e r r e n t s in i n f l a t i o n . I t s u f f i c e s
to r e c a l l t h a t , w ith r e s p e c t t o p e r m is s iv e n e s s , i t was
n o te d ( p a r t i c u l a r l y in th e d i s c u s s i o n o f w a g e -p u ll) t h a t no
m a t t e r how p e rm is s iv e th e m onetary e n v iro n m e n t, i n c r e a s e d
money su p p ly does n o t a u to m a t i c a ll y c au se i n c r e a s e d
e f f e c t i v e demand. Much depends on th e b e h a v io r o f th e p r o
p e n s i t i e s to consume, th e money i l l u s i o n , and th e o th e r
p o s s i b l e d ra g s on e x p e n d i tu r e s .
As f o r d e t e r r e n t a s p e c t s , i t was n o te d t h a t not
on ly would th e money su p p ly have t o be l i m i t e d , b u t the
v e l o c i t y o f c i r c u l a t i o n would a ls o have to be slowed down.
The main re a s o n i s t h a t th e i n f l a t i o n p r o c e s s , c h a r a c t e r
i z e d by r i s i n g p r i c e s and i n t e r e s t r a t e s , i n h e r e n t l y
A c c o r d i n g t o L u tz , op. c i t . , p . 11, one o f th e
aim s of r e s t r i c t i v e money p o l ic y in th e fa c e of e x c e s s iv e
wage demands may be t o s t i f f e n em ployer r e s i s t a n c e t o such
demands.
329
p r o v id e s numerous i n c e n t i v e s to (a) le n d e rs t o circ u m v e n t
th e f r u s t r a t i o n s o f r a t i o n e d c r e d i t and money and f i n d
a l t e r n a t i v e ways to e x p l o i t t h e i r e x i s t i n g le n d in g c a p a c i t y
more f u l l y , s a y , by more a c t i v e le n d in g p o l i c i e s , and t o
(b) h o l d e r s o f i d l e cash b a la n c e s t o m inim ize them i n o r d e r
t o make more funds a v a i l a b l e t o le n d in g i n s t i t u t i o n s a t
r i s i n g i n t e r e s t r a t e s . To t h e e x t e n t t h a t v e l o c i t y can
i n c r e a s e , s i g n i f y i n g a r i s e i n a g g r e g a te s p e n d in g , th e
i n f l a t i o n a r y p r e s s u r e on p r i c e s re m a in s u n r e s t r i c t e d .
The main q u e s t i o n , r a t h e r , a p p e a rs t o b e : would
th e means u se d t o r e s t r i c t m onetary demand, i n t h e a tte m p t
t o p r e v e n t a r i s e i n p r i c e s , n e c e s s a r i l y a s s u r e p r i c e
s t a b i l i t y w ith o u t a r e d u c t i o n in th e r a t e o f p r o d u c t i o n as
w e ll? Or i s i t p o s s i b l e t h a t th e s t a b i l i t y o f p r i c e l e v e l
would p ro v e d e c e p t i v e — a m ix tu r e o f r i s i n g p r i c e s and
d e c l i n i n g p h y s i c a l o u tp u t?
P r i c e s t a b i l i t y a t a c o s t . — I t i s p o s s i b l e t o l i s t
s e v e r a l r e a s o n s why p r i c e s t a b i l i t y co u ld be o b t a i n e d o n ly
a t th e c o s t o f some r e d u c t i o n i n p r o d u c tio n and em ploym ent.1
F o r one t h i n g , as w i l l be e l a b o r a t e d below ( I n th e d i s
c u s s io n on unem ploym ent), a mere t h r e a t of re d u c e d o u tp u t
and em ploym ent, o r a modest d e c lin e In a g g re g a te demand i n
s e l e c t e d s e c t o r s o f t h e economy, a r e n o t l i k e l y t o be
1T h is s u b - s e c t i o n I s b ased p a r t l y on Bowen, o p .
c i t . , pp . 3 69-71 . See a l s o a s i m i l a r d i s c u s s i o n o f t h i s
problem i n Thorp and Q uandt, o p . c i t . , pp. 167-73.
330
s u f f i c i e n t d e t e r r e n t s t o upward wage p r e s s u r e s or t o o f f s e t
a r i s e i n u n i t l a b o r and u n i t t o t a l c o s t s . This i s p a r t i c
u l a r l y th e case where f irm s a re a b l e and s t r o n g l y i n c l i n e d
to p a s s a lo n g h i g h e r c o s t s i n th e form o f h ig h e r p r i c e s .
I t was a l s o s e e n , i n our d i s c u s s i o n of p r i c i n g ,
t h a t even i f c o s t s h e ld s te a d y i n c e r t a i n s e c t o r s , many
f irm s may ( a t l e a s t i n i t i a l l y ) be r e l u c t a n t t o cut p r i c e s
i n re s p o n s e t o a m odest d e c l i n e in demand e f f e c t e d by a
r e s t r i c t i v e m onetary p o l i c y . As a conseq uence of t h i s
s h o r t - t e r m i n f l e x i b i l i t y o f c o s ts and p r i c e s in th e down
ward d i r e c t i o n , th e i n i t i a l im pact o f th e r e s t r i c t i v e mone
ta r y p o l i c y w i l l l i k e l y be on th e volume o f p r o d u c t i o n ,
h ours o f w ork, and employment i n th o s e s e c t o r s most
d i r e c t l y a f f e c t e d by th e r e s t r i c t i o n of m onetary demand.
To th e e x t e n t t h a t m o n etary r e s t r i c t i o n d e p r e s s e s
o u tp u t and employment more th an c o s t s and p r i c e s , t h i s
p o l ic y n o t only f a i l s t o a c h ie v e i t s o b j e c t i v e ( p r i c e s t a b
i l i t y ) b u t a l s o In d u c e s u n d e s i r a b l e s id e e f f e c t s i n o u tp u t
and employm ent. Pew e c o n o m is ts d o u b t t h a t u l t l m a t e l y a
s u f f i c i e n t l y d e te rm in e d r e s t r i c t i v e p o l ic y would y i e l d an
a c c e p t a b l e d e g re e o f p r i c e s t a b i l i t y ; b u t how much o f a
drop i n o u tp u t and employment would be r e q u i r e d t o a c h ie v e
t h i s (and w h e th er t h i s would be an a c c e p t a b l e c o st t o pay)
rem ain a m u ch-debated m a t t e r .
331
Unemployment t o t h e f o r e . — I n any e v e n t , th e p o i n t
i s t h a t u n d er p r e s e n t i n s t i t u t i o n a l a rra n g e m e n ts and
p r a c t i c e s , th e em ergence of unemployment as a b y - p r o d u c t of
th e r e s t r i c t i o n o f demand and i n f l a t i o n a r y p r e s s u r e s con
s t i t u t e s a c e n t r a l problem f o r governm ent i n i t s own r i g h t .
In th e c o n te x t o f ch an g in g p o l i t i c a l a d m i n i s t r a t i o n s and
d i v e r g e n t p u b l i c p h i l o s o p h i e s , th e e x te n t t o which any
s p e c i f i c group o f o f f i c i a l s w i l l p u r s u e th e g o a l of p r i c e
s t a b i l i t y a t th e c o s t o f red u c ed demand and employment w i l l,
of c o u r s e , depend c o n s i d e r a b ly on t h e i r s e n s i t i v i t y t o and
t o l e r a n c e of unemployment and on t h e n a tu r e o f t h e i r
c o u n te r - m e a s u r e s , as w e l l as on t h e i r d e v o tio n to th e g o a l
of p r i c e s t a b i l i t y .
I n o t h e r w ords, we must e x p l i c i t l y acknow ledge two
a d d i t i o n a l key e n v ir o n m e n ta l f a c t o r s t h a t may I n f l u e n c e th e
r e s p o n s e s o f t r a n s a c t o r s t o i n f l a t i o n : (1) th e e x t e n t of
unem ploym ent. w h e th er o r n o t d i r e c t l y c o n n e c te d w ith th e
i n f l a t i o n p r o c e s s , and (2 ) th e r o l e of governm ent p o l i c y t o
c o u n te r unemployment and i t s p o s s i b l e r e l a t i o n s t o th e
I n f l a t i o n p r o c e s s .
As a m a t t e r o f f a c t , m o n etary p o l ic y t o a s s u r e
p r i c e s t a b i l i t y c o n s t i t u t e s only one a s p e c t o f governm ent
p o l ic y t h a t b e a r s d i r e c t l y upon I n f l a t i o n . The o t h e r m a jo r
a s p e c t i s f i s c a l p o l i c y , c o m p risin g b ro ad e x p e n d i t u r e , t a x ,
and d e b t program s w hich— w h ile o f t e n n e c e s s a r i l y i n t e r
332
r e l a t e d w ith m on etary p o l i c y in t h e a r e a o f s t a b i l i z a t i o n
p o l i c y — may in t h e i r own r i g h t e x e r t im p o rta n t r e d i s t r i b u
t i v e e f f e c t s o f a p r o - i n f l a t i o n a r y c h a r a c t e r .
In s i n g l i n g out t h e phenomenon of unemployment a s
an e n v iro n m e n ta l f a c t o r w orthy o f s p e c i a l t r e a t m e n t , we may
b r i e f l y r e c a l l i t s a p p ea ra n c e in c o n n e c tio n w ith two o t h e r
d e te r m in a n ts o f t h e p r i c e l e v e l . I n c o n n e c tio n w ith p r o
du c t i v i t y g ro w th , f o r i n s t a n c e , i t was seen t h a t th e d i s
p la c e m e n t o f l a b o r by t e c h n o l o g i c a l advances co u ld be o f f
s e t only by (a) th e e x e r c i s e of i n c r e a s e d p r i v a t e demand
( o r r e a l incom e) a c c r u in g t o p u r c h a s e r s e i t h e r i n t h e form
o f i n c r e a s e d wages o r lo w e r consum er p r i c e s (b o th in d u ce d
by the i n c r e a s e i n p r o d u c t i v i t y ) , e n a b l in g th e r e a b s o r p t i o n
of th e unem ployed, and (b) i n j e c t i o n s o f s u p p o r t i v e demand
w ith t h e a i d o f m o n e t a r y - f i s c a l a u t h o r i t i e s s u f f i c i e n t t o
re -e m p lo y the w o rk e rs r e l e a s e d by te c h n o lo g y .
I n c o n n e c tio n w ith e x c e s s i v e w a g e - in c r e a s e s t h a t
cause a r i s e i n u n i t l a b o r and t o t a l c o s t s , to th e e x te n t
t h a t p ro d u c e rs can n o t o r do n o t r a i s e t h e i r p r i c e s t o m ain
t a i n t h e i r m ark u p s, o r do n o t c u r t a i l p r o f i t s , e x i s t i n g
wage b i l l s and p r i c e s can be m a in ta in e d o n ly by means o f
l a y o f f s a n d /o r c u r t a i l m e n t o f h i r i n g . To t h e e x t e n t t h a t
em p lo y ers a re a b le to r a i s e p r i c e s only s l i g h t l y , t h a t i s ,
s u f f i c i e n t to com pensate f o r only p a r t of th e h i g h e r wage
b i l l , th ey w i l l s t i l l be f o r c e d t o red u ce t h e i r p a y r o l l s .
333
As a co n seq uence we have an example of unemployment and
some i n f l a t i o n .
Unemployment and w ag es. — Now th e s p e c t e r o f
unemployment a p p e a rs i n a n o th e r wage c o n te x t: th e e x t e n t
t o which ( a ) t h e e x i s t i n g l e v e l o f unemployment o r (b) th e
p r o s p e c t i v e unemployment t h r e a t e n i n g to r e s u l t from
e x c e s s i v e w a g e - in c r e a s e s a c t u a l l y w i l l se rv e t o re d u c e or
m o d era te t h e l e v e l of wage demands and a d ju s tm e n t s .
T here i s a w id e s p re a d te n d e n c y , a t f i r s t th o u g h t
n o t u n r e a s o n a b l e , t o b e l i e v e t h a t th e r a t e a t which wage
r a t e s change i s p o s i t i v e l y r e l a t e d to th e l e v e l o f employ
m ent and I n v e r s e l y r e l a t e d t o th e l e v e l o f unemployment.
The c h i e f a ssu m p tio n i s t h a t as th e l e v e l of
unemployment i n c r e a s e s , wage demands w i l l be Ind uced to
m o d e ra te , and a t some " c r i t i c a l " p o i n t of r i s i n g unem ploy
ment l a b o r m ig h t even be w i l l i n g t o a c c e p t a cut i n wage
r a t e t o f o r e s t a l l any f u r t h e r d rop i n em ploym ent. T h is in
t u r n i m p l i e s t h a t changes i n wage r a t e s a re e x c l u s i v e l y o r
p re d o m in a n tly e x p la in e d by movements in th e l e v e l of
unem ploym ent.
An o u t s t a n d i n g exam ple o f t h i s l i n e o f t h i n k i n g i s
t h e a tte m p t t o d e te rm in e f u n c t i o n a l r e l a t i o n s h i p s betw een
wage movements and unemployment l e v e l s and t o a s c e r t a i n th e
334
" c r i t i c a l " volume o f unemployment a t which wage p r e s s u r e s
w i l l cea se to be e x c e ssiv e ." ^
The case o f l o c a l unem ploym ent. — In t h e c h a p te r on
wages i t was n o te d t h a t t h e r e i s s u b s t a n t i a l agreem ent t h a t
demand and su p p ly c o n d i t i o n s I n th e l a b o r m ark et a re a s i g
n i f i c a n t d e te r m in a n t of wage movem ents, even i n t h e case o f
n o n - u n io n iz e d f i r m s . I t was a l s o n o te d t h a t t h e p o s i t i o n
o f th e I n d i v i d u a l em ployer— h i s p a r t i c u l a r need f o r l a b o r
and h i s a b i l i t y to r e s i s t wage demands— a ls o p la y e d an
Im p o rta n t r o l e . I t i s now n e c e s s a r y t o show more e x p l i c
i t l y t h a t th e r e l a t i o n betw een wages and employment c o n d i
t i o n s must be view ed d i f f e r e n t l y in (a) th e c a se of th e
i n d i v i d u a l f irm and l o c a l l a b o r m a r k e t, th an i n (b) th e
case of th e economy as a whole and th e n a t i o n a l employment
in d e x .^
I n th e case of th e i n d i v i d u a l f ir m , t h e case o f t h e
n o n -u n io n iz e d f ir m may be d i f f e r e n t i a t e d from t h e case o f
c o l l e c t i v e b a r g a i n i n g . I n t h e fo rm e r, th e c a se o f e x c e ss
su p p ly o f l a b o r (due t o unem ploym ent, e t c . ) n e e d n o t be
p e r f e c t l y s y m m e tric a l w ith t h e case o f e x c e s s demand
m en tio n ed i n C h a p te r I v . F o r one t h i n g , th e sudden
a p p e a ra n c e o f e x c e s s supply where em ployers have d e cid ed
^ o w e n , i b i d . , p . 392.
^The f o l lo w in g d i s c u s s i o n on t h e r o l e o f unemploy
ment i s b a se d p r i m a r i l y on Bowen, i b i d . , pp. 93, 101-12,
224, 392.
335
t o h i r e l e s s l a b o r th a n th e q u a n t i t y a v a i l a b l e a t th e g iv e n
wage i s n o t a p t t o e x e r t as much d i r e c t wage p r e s s u r e on
th e f ir m as was th e c ase w ith th e a p p e a ra n c e o f e x c e s s
demand f o r l a b o r .
S econd, th e e x t e n t o f p r e s s u r e e x e r t e d by e x c e s s
su p p ly w i l l depend l a r g e l y on th e f i r m 's o v e r - a l l s i t u a t i o n
a t th e t i m e , p a r t i c u l a r l y i t s p r o f i t s and w o rk -fo rc e
q u a l i t y : t h e more s a t i s f i e d th e firm i s w ith t h e s e f a c t o r s ,
t h e s m a lle r th e wage p r e s s u r e i t f e e l s .
T h i r d , th e f i r m may have a v a r i e t y o f r e s p o n s e s o r
a d ju s tm e n ts t o e x c e s s supply from which to p i c k , th e m ost
ob vio u s b e in g a r e d u c t i o n i n wage r a t e . Yet s t u d i e s r e v e a l
t h a t wages i n g e n e r a l seem to be l e s s f l e x i b l e i n th e
downward th a n i n th e upward d i r e c t i o n , even i n th e ab sen ce
o f u n io n s , m ain ly b e c a u se o f management h e s i t a n c y o u t of
h u m a n i t a r i a n , m o r a le , o r p r o d u c t i v i t y c o n s i d e r a t i o n s .
W hatever th e d i r e c t e f f e c t o f e x c e s s l a b o r su p p ly
on wage r a t e s may b e , i t i s v e ry l i k e l y t h a t non-wage
a d ju s tm e n ts w i l l ta k e p l a c e . These w i l l ran g e from a c u t
i n w orking h o u rs and l a y o f f s t o th e r a i s i n g o f h i r i n g
s p e c i f i c a t i o n s , t i g h t e r work s t a n d a r d s , and t o u g h e r promo
t i o n p o l i c y - - t h e r e v e r s e o f non-wage a c t i o n s t a k e n in t h e
c a se o f e x c e s s demand— and t h e i r e x t e n t w i l l depend on th e
f i r m ' s i n i t i a l s t a n d a r d s w ith r e s p e c t t o s e l e c t i o n and
d i s c i p l i n e .
336
In t h e c ase o f c o l l e c t i v e b a r g a i n i n g , i t was n o te d
in C h a p te r iv t h a t demand and s u p p ly c o n d it i o n s i n t h e
l o c a l la b o r m ark et e x e r t th e e x p e c te d e f f e c t s on th e b a r
g a in i n g power o f u n io n s and, h e n c e , on th e d i r e c t i o n o f
im p a c t on w ages. What re m a in s v e ry much a t i s s u e i s th e
e x t e n t t o which u n io n wage p o l i c y i s i n f l u e n c e d by t h e
p o s s i b l e e f f e c t s o f w a g e - in c r e a s e s on employment o p p o rtu n
i t i e s ( i . e . , by p o t e n t i a l unem ploym ent).
On t h e one h a n d , i t h as been s t r o n g l y arg ued t h a t ,
as f a r as u n io n p o l i c y i s c o n c e rn e d , u n io n l e a d e r s c an n o t
c o n s i d e r p o t e n t i a l employment e f f e c t s i n f o r m u la tin g wage
demands. On th e o t h e r hand i t h a s been a s s e r t e d t h a t t h i s
p r o p o s i t i o n i n no way i m p l i e s t h a t wage demands a re form u
l a t e d w ith o u t any r e f e r e n c e t o e x i s t i n g employment and
econom ic c o n d i t i o n s . 1 F u r th e rm o r e , a lth o u g h th e p r o s p e c t
of unemployment may n o t a t f i r s t in d u ce a m o d e ra tio n of
wage dem ands, i f unemployment a c t u a l l y m a t e r i a l i z e s a s a
r e s u l t of t h i s u n c o n c e rn , th e u n io n may be f o r c e d t o low er
i t s s i g h t s i n su b s e q u e n t n e g o t i a t i o n s . T here i s some
e v id e n c e t o s u g g e s t t h a t f e a r s o f p o t e n t i a l unemployment
a re more l i k e l y t o d e f l a t e wage demands when t h e r e e x i s t s
an e x c e s s l a b o r su p p ly th an when t h e r e i s a l a b o r s h o r t a g e .
^The e c o n o m ist L u tz , op. c i t . , p . 12, p u t i t some
what m i l d e r by' r e g a r d i n g th e p r o p o s i t i o n t h a t u n io n wage
p o l i c y i s s e n s i t i v e t o th e volume o f unemployment a
" p e rh a p s n o t u n i v e r s a l l y v a l i d s u p p o s i t i o n . "
337
Prom th e employer* s s id e I t was seen t h a t th e
g r e a t e r h i s own e x c e s s demand f o r l a b o r , t h e more w i l l i n g
i s he l i k e l y to be t o g r a n t c o n c e s s io n s . C o n v e r s e ly , i n
s l a c k tim e s th e em ployer may have l e s s to l o s e from a s t r i k e
s in c e i t may a c t u a l l y p ro v id e him t h e o c c a s io n t o s h u t down
f o r in v e n to r y d e p l e t i o n .
The case o f a g g re g a te unem ploym ent. - - I f l i t t l e more
th a n t h e above can be s a i d w ith c e r t a i n t y a b o u t l o c a l l a b o r
m arket c o n d it i o n s on wage a d j u s t m e n t s , what can be s a i d
a b o u t th e p o s s i b l e s i g n i f i c a n c e o f th e n a t i o n a l employment
s i t u a t i o n — as m easured by t h e unemployment in d e x — on such
wage a d ju s tm e n ts ? A ccording t o Bowen t h e r e a r e s e v e r a l
cogent r e a s o n s why a c lo s e c o r r e l a t i o n betw een th e s e two
m ag n itu d es sh o u ld n o t be expected.'*'
F i r s t o f a l l , th e unemployment in d e x does n o t
m easure th e n a t i o n a l " e x c e s s demand f o r l a b o r " --o n e o f th e
m ajor econom ic d e te r m in a n ts o f w ages— in th e se n se u s e d
h i t h e r t o , as th e e x c e s s of demand o v e r su p p ly a t th e g o in g
wage; and t h i s would be t r u e even i f each l o c a l m arket were
b u t a m i n i a t u r e r e f l e c t i o n o f th e economy a s a whole. The
unemployment in d ex only ( a ) d e p i c t s th e number of p e o p le
c la im in g i n a b i l i t y t o f i n d a jo b and t h e r e f o r e (b) t e l l s
l i t t l e a b o u t th e number o f jo b s re m a in in g u n f i l l e d con
c u r r e n t l y w ith p e o p le s e e k in g jo b o p e n in g s . In d e e d , i n
■^See a l s o „ t h e d i s c u s s i o n i n Thorp and Quandt,
op. c i t . , pp. 7 9 -8 2 .
33 8
p e r i o d s o f low unem ploym ent, when i t i s p o s s i b l e t o
e x p e r ie n c e a s u b s t a n t i a l i n c r e a s e i n demand f o r l a b o r w ith
l i t t l e o r no change i n th e number o f " f r i c t i o n a l l y "
unemployed (n o r i n t h e t o t a l ) , th e in d ex number o f
unem ployed would be p a r t i c u l a r l y i n a p p r o p r i a t e and i n a c c u r
a te as a m easure o f th e e x c e s s demand f o r l a b o r .
S eco n d , i t a l s o a p p e a rs t h a t th e tim e i t t a k e s f o r
a change i n demand and s u p p ly c o n d i t i o n s t o e x e r t an i n f l u
ence on wage a d ju s tm e n ts may n o t be v e ry r a p i d . E xcep t i n
th e case o f a m a jo r change i n l a b o r m arket c o n d i t i o n s , t h e
em ployer may be a b l e t o p o stp o n e a change in wage r a t e f o r
a c o n s i d e r a b l e tim e owing t o (a) t h e e x i s t e n c e o f im per
f e c t i o n s i n t h e l a b o r m arket and (b) t h e v a r i e t y o f c o s t
l e s s and non-wage a d ju s tm e n ts he may be a b le t o choose
from .
On th e u n io n s i d e , d e la y e d r e a c t i o n i n t h e i r wage
demands may be due t o th e p o s s i b i l i t y t h a t p o t e n t i a l
unemployment i s a r e l a t i v e l y l e s s s i g n i f i c a n t d e t e r r e n t to
wage demands th a n a c t u a l l y r e a l i z e d unem ploym ent. In
a d d i t i o n , t h e r e i s th e im p o r ta n t r e t a r d i n g e f f e c t on wage
movements due to t h e i n c r e a s i n g l y lo n g -te r m n a t u r e of wage
c o n t r a c t s and th e grow ing a p p l i c a t i o n o f c o s t - o f - l i v i n g
e s c a l a t o r s . 1
1I b i d . , p. 81
339
T h ird , one can n o t r e a l l y speak o f a " n a t i o n a l ”
la b o r m arket i n th e se n s e t h a t , i n the s h o r t r u n , w orkers
can be e x p e c te d t o move from one job m arket t o a n o th e r w ith
any d e g re e of r a p i d i t y o r w i l l i n g n e s s . As a consequence of
im m o b ility n o t a l l l o c a l i t i e s can e x p e rie n c e th e same degree
of e x c e s s demand f o r l a b o r . I n d e e d , i t i s even p o s s i b l e
f o r e x c e ss demand and e x c e s s su p p ly to c o e x i s t w ith in th e
same l o c a l i t y . Thus even i f changes i n th e o v e r - a l l
unemployment in d e x could be t r a n s l a t e d I n t o changes in
o v e r - a l l e x c e ss demand, i t c o u ld n o t be a u to m a t i c a ll y
assumed t h a t th e same change was being e x p e rie n c e d by any
s p e c i f i c la b o r m ark e t, l e t a lo n e by any s p e c i f i c firm
w ith in t h a t m a rk e t.
F o u r th , th e e x i s t e n c e o f o th e r wage d e te r m in a n ts
(n o te d e s p e c i a l l y in C h a p te r iv ) as w e ll as th e r e l a t i v e
a t t r a c t i v e n e s s o f some non-wage a d ju s tm e n ts a ls o make th e
l i n k between l a b o r m ark et p r e s s u r e s and wage a d ju s tm e n ts
f a i r l y lo o se .
F i f t h , n o t m entioned by Bowen i s th e f a c t t h a t j u s t
as unemployment i s n o t th e s o le o r m ajor d e te rm in a n t o f
wages, n e i t h e r a r e wage r a t e s th e so le o r m ajor d e t e r
m inant o f unemployment. T his i s p a r t i c u l a r l y so because of
the growing r o l e of governm ent w hich, by means of t r a n s f e r
pay m en ts, c o u n t e r - c y c l i c a l p o l i c y , l a r g e - s c a l e p u rc h a se s
from p r i v a t e I n d u s t r y , and the d i r e c t employment of
3^0
num erous w o rk e r s , a l s o c o n t r i b u t e s s u b s t a n t i a l l y t o move
m ents i n th e l e v e l of employment and unem ploym ent, as w e ll
a s to t h e l e v e l of a g g re g a te demand which i n t u r n a f f e c t s
employment c o n d i t i o n s and wage demands, a p o i n t r e t u r n e d t o
below .
More p r e c i s e l y , th e d i r e c t l i n k betw een changes i n
employment and wages i s broken t o the e x t e n t t h a t compensa
t o r y o r s t a b i l i z i n g a c t i o n s by governm ent make t h e t h r e a t
o f l a y o f f s by em ployers l e s s o f a d e t e r r e n t t o demands f o r
e x c e s s i v e w a g e - i n c r e a s e s .
F i n a l l y , i n c o n n e c tio n w ith governm ent econom ic
p o l i c y i t sh o u ld a l s o be n o te d t h a t where unemployment and
r e l i e f b e n e f i t s a re i n c r e a s e d i n tim e s of r i s i n g employment
and p r i c e s ( i n o r d e r t o keep p ace w ith t h e r i s i n g c o s t of
l i v i n g ) , and where th e d i f f e r e n t i a l betw een such b e n e f i t s
and r e g u l a r wage paym ents h as n o t been to o g r e a t , we may
f i n d th e number o f unemployed re m a in in g s u b s t a n t i a l l y
u n changed . As a consequence we have t h e parado x of r i s i n g
wage l e v e l s unaccom panied by any drop i n unemploym ent.
Some c o n c lu s io n s . — The m ain g e n e r a l c o n c lu s io n one
may i n f e r from t h e above i s t h a t , w ith r e s p e c t t o th e firm 's
demand f o r l a b o r and i t s o v e r - a l l p o s i t i o n , t h e l o c a l
s i t u a t i o n i s c e r t a i n l y more d i r e c t l y s i g n i f i c a n t f o r
i n d i v i d u a l wage a d ju s tm e n ts th a n th e n a t i o n a l s i t u a t i o n .
341
T here rem ains th e very p e r s u a s i v e c o n t e n t i o n t h a t
h ig h l e v e l s o f employment are g e n e r a l l y more conducive to
l a r g e w a g e - in c r e a s e s t h a n are low l e v e l s , and t h a t a
" s u f f i c i e n t l y ” la rg e d e g re e o f unemployment (th e " c r i t i c a l "
l e v e l ) i s l i k e l y to m o d era te t h e m agnitude o f wage a d j u s t
m e n ts. However, as Bowen w a rn s, i t sh o u ld be re c o g n iz e d
t h a t a l l t h i s may be t r u e b e c a u se of th e a s s o c i a t e d
e f f e c t s o f th e l e v e l o f employment r a t h e r t h a n b e ca u se of
th e d i r e c t e f f e c t s of la b o r m a rk e t c o n d i t i o n s . 1
For exam ple, i n c r e a s e d wage demands and a d ju s tm e n ts
may be a t t r i b u t e d more t o high p r o f i t s a n d le s s e n e d p r i c e
c o m p e titio n i n the p r o d u c t m a r k e t— both i m p o r t a n t wage
d e te r m i n a n ts — which a r e l i k e l y t o accompany h ig h employment
l e v e l s . These two wage i n f l u e n c e s may a l s o be r e i n f o r c e d
t o t h e e x t e n t t h a t w o rk e rs e x e r c i s e high e f f e c t i v e demand
a lo n g w ith t h e high l e v e l s of em ploym ent. I n t h i s c o n t e x t ,
th e volume o f unemployment s e r v e s only as a "v ery rough"
index o f a n o th e r m a jo r wage d e te r m i n a n t, t h e p r o s p e c t i v e
p r o f i t a b i l i t y o f f i r m s , which i n t u r n i s g r e a t l y d e p e n d e n t
on th e l e v e l of a g g r e g a te demand.
F i n a l l y , i t i s Bowen’s judgm ent t h a t th e a c t u a l
s i g n i f i c a n c e of unemployment as a d e te r m in a n t of wage
movements may be o v e re m p h a siz e d . T his d o e s n o t mean, he
■^This d i s c u s s i o n i s b a s e d m ainly on Bowen, op. c i t .,
pp. 2 2 4 -2 5 , 393-94.
342
a d d s , t h a t t h e r e may n o t a c t u a l l y e x i s t an "exchange"
r e l a t i o n s h i p betw een changes i n unemployment and changes i n
wage r a t e s and p r i c e s , a r e l a t i o n s h i p t h a t may be w orthy of
f u r t h e r s t u d y , from econom ic and non-econom ic v i e w p o i n t s . 1
Nor does Bowen deny t h a t "enough" unemployment w i l l in d u c e
m o d e ra tio n i n th e s i z e o f wage demands and a d ju s tm e n t s . He
m ere ly co n te n d s t h a t th e p o s s i b i l i t y of an i n t e r r e l a t i o n
betw een unemployment and i n f l a t i o n does n o t w a r r a n t th e
em phasis on unemployment as a d e te r m in a n t of wage and p r i c e
movements and as a fu lcru m o f p o lic y - m a k in g .
N e v e r t h e l e s s , i t s h o u ld be n o te d Bowen i s r e f e r r i n g
only t o th e " d i r e c t " i n f l u e n c e o f unemployment on w ages;
b u t , as w i l l be shown below , t h e r e a r e " i n d i r e c t " i n f l u
e n ces em an atin g from governm ent a n ti-u n em p lo y m en t a c t i o n s
t h a t may a f f e c t th e g e n e r a l l e v e l of demand and hence o f
wages.
Unemployment and econom ic p o l i c y . — Our n e x t c o n cern
i s th e r e l a t i o n of governm ent econom ic p o l i c y t o unem ploy
m ent. Under th e Employment Act of 1946 governm ent h as
become m o tiv a te d by a "commitment" t o prom ote "maximum"
l e v e l s of em ploym ent, p r o d u c tio n and p u r c h a s in g power.
^Bowen h i m s e l f i s v e ry s k e p t i c a l t h a t a p r e c i s e
r e l a t i o n s h i p can e x i s t betw een a d ju s tm e n ts of wages and
any s i n g l e w a g e -d e te rm in in g f a c t o r ; he r e a s o n s t h a t t h e r e
e x i s t s e v e r a l im p o r ta n t wage d e te r m i n a n t s ; see i b i d . ,
P. 392.
343
T h is commitment i s i n t e r p r e t e d by some as c a l l i n g f o r "higH*
l e v e l s of em ploym ent, w h ile o t h e r s say i t means " f u l l
employment a t any c o s t , " r e g a r d l e s s o f e f f e c t s on p r i c e s . ^
One r e l e v a n t q u e s t i o n i n t h i s r e g a r d i s t h e e x t e n t
t o which governm ent "fu11-em p loy m en t" p o l i c y h as a c t u a l l y
been im plem ented i n a manner c a u s in g o r in d u c in g more or
l e s s i n f l a t i o n . An answ er m ight be sought i n th e r e c o r d
o f e x p e r i e n c e , b u t th e r e c o r d i s n o t a l t o g e t h e r unambiguous
on t h i s s c o r e . On t h e one hand i s t h e view t h a t our
e x p e rie n c e i n c o u n t e r - c y c l i c a l p o l i c y s in c e 1946 was r e l a
t i v e l y t i m i d . Thus i t has b een a s s e r t e d t h a t g o v e rn m e n t's
w i l l i n g n e s s and a b i l i t y t o c o u n t e r a c t unemployment d u r in g
m ost of t h i s p e r i o d h a s been a f f e c t e d by (a ) f e a r s o f infHaj-
t i o n as w e l l a s unem ploym ent, and (b ) a r e l u c t a n c e t o
a c c e p t a r i s i n g n a t i o n a l d e b t . As a c o n se q u e n c e , i t i s
a d d e d , in m ost p o s t - w a r r e c e s s i o n s t h e a d m i n i s t r a t i o n ^
p o l i c i e s have r e a c t e d r a t h e r " c a u t i o u s l y " t o m o d erate
d e c l i n e s i n b u s in e s s a c t i v i t y : C on gress h a s been r e l u c t a n t
t o e n a c t t a x c u ts e x c e p t i n th e c ase o f s e r i o u s d o w n tu rn s,
and p a s s i v e d e f i c i t s have b een i n c u r r e d as a consequence o f
d e c l i n i n g re v e n u e s and o n ly m o d era te i n c r e a s e s in sp e n d in g .
•J-The f o l lo w in g d i s c u s s i o n i s b a se d m a in ly on Bowen,
i b i d . , pp. 3 7 7 -8 1 , and Thorp and Q u a n d t, op. c l t . . p . 82.
344
On th e o t h e r h a n d , i t would be h a rd t o m a in ta in
t h a t unemployment p o l i c i e s i n no way c o n t r i b u t e t o i n f l a
t i o n a r y p r e s s u r e s . On s e v e r a l o c c a s io n s above i t was n o te d
t h a t governm ent employment p o l i c y in th e s h o r t ru n does
s e rv e t o a t l e a s t m i t i g a t e th e downward p r e s s u r e s on
employment and demand, t h e r e b y r e d u c in g t h e downward
p r e s s u r e s on c o s t s and p r i c e s . F or e x am p le, i n C h ap ter v
i t was n o te d t h a t f o r Hansen t h i s a s p e c t o f employment
p o l ic y in d u c e d p r i c e a d m i n i s t r a t o r s t o r e s i s t p r i c e c u ts
and w a g e -e a rn e rs t o r e s i s t wage c u t s , th e r e b y f o s t e r i n g th e
"r a t c h e t e f f e c t " o v e r s u c c e s s iv e r e c e s s i o n s .
With r e s p e c t t o th e problem a t h a n d , e c o n o m ists
W. L. Thorp and R. E. Quandt p o i n t out t h a t governm ent
a n t i - r e c e s s i o n p ro g ra m s, p l u s th e l a r g e r p e r s o n a l r e s e r v e s
made p o s s i b l e a t r i s i n g wage l e v e l s , s e rv e t o c r e a t e a more
even flow o f consum er sp e n d in g and an income " i n s e n s i t i v i t y
t o r e c e s s i o n t h a t th e y b e l i e v e i s " l a r g e l y r e s p o n s i b l e " f o r
th e deep c o n ce rn w ith i n f l a t i o n even i n r e c e s s i o n p e r i o d s .
F or them t h i s e x p l a i n s why t h e once " i r r e c o n c i l a b l y
a n t a g o n i s t i c " phenomena o f unemployment and i n f l a t i o n can
a c t u a l l y c o e x i s t " p e a c e f u l l y . " When th e d e g re e o f
unemployment becomes so " u n d e s i r a b l y l a r g e " t h a t s p e c i f i c
governm ent a c t i o n i s r e q u i r e d t o r e l i e v e i t , t h i s r e l i e f
may se rv e t o f u r t h e r enhance th e i n f l a t i o n a r y p r e s s u r e s .
345
L on g-run a s p e c t s . — With r e s p e c t t o th e lo n g -r u n
e f f e c t s o f employment p o l i c y upon i n f l a t i o n , i t has been
a s s e r t e d t h a t th e s e r i e s of governm ent d e f i c i t s and th e
"ea sy money" p o l ic y im plem ented as p a r t o f i t s a n t i
unemployment program s may te n d t o b e q u e a th a " le g a c y of
l i q u i d i t y " o r , more p r e c i s e l y , (a) a s t r e n g t h e n i n g o f th e
l i q u i d i t y p o s i t i o n o f t h e economy i n g e n e r a l , and (b) a
s u b s t a n t i a l i n c r e a s e i n th e e x p a n s io n a ry p o t e n t i a l o f th e
bank ing system in p a r t i c u l a r .
For exam ple, i n c o n n e c tio n w ith governm ent d e f i c i t s .
T re a su ry f i n a n c i n g m ethods can y i e l d an i n c r e a s i n g volume
of governm ent o b l i g a t i o n s o u t s t a n d i n g . To th e e x t e n t t h a t
th e new o f f e r i n g s a re p u rc h a se d by th e F e d e r a l R eserve
System , th e r e s u l t w i l l be an i n c r e a s e i n b o th th e money
su p p ly and member bank r e s e r v e s .
On t h e o t h e r h a n d , th e F e d e r a l R e serv e* s easy-m oney
p o l i c y i s v e ry l i k e l y t o become an even more d i r e c t so u rc e
o f i n c r e a s e d r e s e r v e s f o r th e b an k in g sy ste m . Here th e
F e d e r a l R eserv e may s e e k t o expand bank r e s e r v e s by engag
in g in o pen-m arket p u r c h a s e s o f T re a s u ry o b l i g a t i o n s from
p r i v a t e bond h o l d e r s . A l t e r n a t i v e l y i t can lo w e r r e s e r v e
re q u ire m e n ts t o in d u ce an improvement i n bank r e s e r v e p o s i
t i o n s s u f f i c i e n t to p e r m it them t o expand t h e i r h o ld in g s o f
•J-This d i s c u s s i o n of lo n g -r u n a s p e c t s i s based
p a r t l y on Bowen, op. c i t . , pp. 3 5 6 , 3 8 1 -8 3 , 407.
3 46
governm ent s e c u r i t i e s and t h e r e b y s t o r e up l i q u i d i t y f o r
f u t u r e u s e .
T h is s t o r e of l i q u i d i t y may p e rm it (a ) an I n c r e a s e
i n money su p p ly d u rin g s u b s e q u e n t e a r l y re c o v e ry s ta g e s and
(b) an "ec o n o m iz in g 1 1 of t h i s i n c r e a s e d money su p p ly v i a
i n c r e a s e d v e l o c i t y o f c i r c u l a t i o n d u rin g th e peak s t a g e s o f
o u tp u t and employm ent. As a c o n se q u e n c e , th e l a r g e cash
b a la n c e s o r le g a c y o f l i q u i d i t y endowed by s u c c e s s iv e a n t i
r e c e s s i o n program s may s e rv e t o i n c r e a s e th e d i f f i c u l t y o f
im p lem en tin g r e s t r i c t i v e m onetary p o l i c y d u rin g s u b s e q u e n t
p r o s p e r i t y p h a s e s : i t would f i r s t be n e c e s s a r y t o a b so rb
s u f f i c i e n t l i q u i d i t y t o p e rm it m onetary r e s t r a i n t s to
e f f e c t i v e l y l i m i t le n d in g a c t i v i t i e s and slow down th e
v e l o c i t y o f c i r c u l a t i o n .
I n t r a c t a b l e unemployment . — The p r e c e d in g d i s c u s s i o n
o f t h e c o n f l i c t f a c e d by a governm ent s e e k in g t o m inim ize
unemployment w ith o u t i n f l a t i o n a r y e f f e c t s i s o n ly a f i r s t
a p p ro x im a tio n t o th e q u e s t io n of p r i c e s t a b i l i t y and
unem ploym ent. I t has been co n cern ed more w ith th e g e n e r a l
problem o f th e c o m p a t i b i l i t y o f th e ful1-em ploy m en t commit
ment and p r i c e s t a b i l i t y . On t h e one h a n d , i t was seen
t h a t governm ent m o n e t a r y - f i s c a l a c t i o n s p e r se can s e rv e to
s u p p o r t o r in d u c e i n f l a t i o n a r y p r e s s u r e s from t h e sid e o f
demand and c o s t s . On t h e o t h e r hand, i t f a i l e d t o r a i s e
th e d e e p e r and more a p ro p o s q u e s t io n o f w h e th er th e ty p e
347
of unemployment caused by i n f l a t i o n p e r se i s s u f f i c i e n t l y
t r a c t a b l e t o m o n e t a r y - f i s c a l p o l i c y . T h is ty p e o f ■
unem ploym ent, as i n d i c a t e d ab o v e, i s b ro u g h t on by
e x c e s s i v e wage demands and s t r i n g e n t m onetary c u rb s on th e
f i n a n c i n g o f e x c e s s iv e w a g e - in c r e a s e s and o t h e r r i s i n g
c o s t s .
In o t h e r w ords, f o r th e p u rp o se o f o u r s t u d y ,
unemployment may be s e p a r a t e d i n t o two b ro a d c a t e g o r i e s :
(a) th e more t r a d i t i o n a l " c y c l i c a l ’1 ty p e r e s u l t i n g from
r e c e s s i o n s i n demand and p r o d u c t i o n , and (b) th e "ex -
i n f l a t i o n " ty p e em an atin g p r i m a r i l y from th e e x c e s s i v e n e s s
o f wage demands and th e r e s t r i c t i v e n e s s of a n t i - i n f l a t i o n
p o l i c y . I t i s th e fo rm e r ty p e o f unemployment f o r which
m o n e t a r y - f i s c a l p o l i c y — g e a r e d t o th e s t a b i l i z a t i o n o f
a g g re g a te demand— was d e s ig n e d ; to what e x t e n t i t can a l s o
s e r v e t o remedy t h e seco nd ty p e i s more p r o p e r l y d is c u s s e d
u n d e r th e h e a d in g o f p o l i c y . Here i t s u f f i c e s to n o te
t h a t , i n th e c o n te x t o f t h e "new i n f l a t i o n " and "new
unem ploym ent," any in ad e q u ac y in m o n e t a r y - f i s c a l p o l i c y as
an a n t i - i n f l a t i o n d e v ic e may l i e l e s s i n i t s i n f i r m i t y th a n
i n th e i n t r a c t i b i l i t y o f t h e a ilm e n t.
I n f l a t i o n ’ s s a f e t y v a l v e s . — In a d d i t i o n t o th e p r e
c e d in g e n v ir o n m e n ta l i n f l u e n c e s , which may be view ed as
b e in g m o stly o f th e " a c t i v e " ty p e in th e se n se t h a t t h e
p a r t i c i p a n t s in v o lv e d may have th e o p t io n o f d e c id in g
348
w h e th e r to f e e d or check th e i n f l a t i o n p r o c e s s , we s h o u ld
n o te s e v e r a l " i n e r t " o r s t r u c t u r a l f a c t o r s t h a t may a f f e c t
th e pace of I n f l a t i o n i n s p e c i a l ways. T hese f a c t o r s may
se rv e as " s a f e t y v a lv e s " o r e sc a p e h a tc h e s f o r th e demand
and c o s t p r e s s u r e s on p r i c e s ; by o f f s e t t i n g t h e p r i c e r i s e s
in s e l e c t e d s e c t o r s th ey may h e lp m oderate t h e o v e r - a l l
r i s e i n p r i c e s . 1
The r o l e of e x c e s s c a p a c i t y . — E xcess o r unused
c a p a c ity in p l a n t and equipm ent has t r a d i t i o n a l l y been
r e g a r d e d as a s a f e t y v a lv e f o r th e p r e s s u r e s cau sed by
r i s i n g demand and o u tp u t on c o s t s i n much th e same way t h a t
unemployment had been view ed as a s a f e t y v a lv e f o r
e x c e s s iv e wage demands. The r e a s o n I s t h a t t h e e x c e s s
c a p a c ity was presum ed t o com prise f a c i l i t i e s a b le t o p r o
duce a d d i t i o n a l o u tp u t a t p r e v a i l i n g c o s t s , p r i c e s , and
p r o f i t s . T h u s, as was se e n In th e c h a p t e r on demand,
Keynes d id n o t e x p e c t p r i c e s t o r i s e u n t i l demand drove
o u tp u t to n e a r - f u l l l e v e l s o f employment and c a p a c i t y ,
where u n i t c o s t s began t o r i s e f a s t e r t h a n o u t p u t.
^ h e f o llo w in g d i s c u s s i o n i s b ased m ain ly on Thorp
and Q uandt, op. c l t . . pp . 8 2 -8 4 , 88; F e d e r a l R eserv e Bank
of P h i l a d e l p h i a . B u s in e s s Review (A u g u st, 1 9 6 2 ), pp. 14-5 ;
and P a t r i c k M. Boarman, S. F o re ig n T rade P o l i c y — A Dec
l a r a t i o n o f P r i n c i p l e s By a Committee o f E c o n o m is ts ," P r i
v a te R e p rin t o f I n s e r t by Congressman H. T. S c h n e e b e li i n
U .S ., C o n g r e s s io n a l R eco rd , 87th C ong., 2d S e s s . , A p r i l 17,
1962, pTt.
3^9
U nder w hich c o n d i t i o n s i s i t p o s s i b l e t h a t e x c e s s
c a p a c ity w i l l n o t s e rv e to o f f s e t th e p r e s s u r e s o f r i s i n g
demand and c o s t s ? F or one t h i n g , th e more d i v e r s i f i e d th e
l i n e o f p r o d u c ts and th e more s p e c i a l i z e d t h e eq u ip m en t,
th e l e s s l i k e l y w i l l p r o d u c t i v e c a p a c i ty f o r one p ro d u c t be
s u b s t i t u t a b l e f o r t h a t o f a n o th e r .
Second, s u b s ta n d a rd o r o b s o le s c e n t m ach in ery a l s o
l i m i t s th e a b i l i t y of e x t r a c a p a c i ty to add o u tp u t a t th e
same c o s t s as t h e more modern c a p a c i t y . Then, t h e su p p ly
and e f f i c i e n c y o f l a b o r as w e ll as i t s c o n t i n u i t y on t h e
jo b (w ith o u t work s to p p a g e s ) a l s o a f f e c t th e p r o d u c t i v i t y
o f g iv en c a p a c i t y . T h is p r o d u c t i v i t y would a l s o depend on
. th e q u a l i t y o f f a c t o r y o r g a n i z a t i o n and m a n a g e r ia l a b i l i t y .
F i n a l l y , as was n o te d in th e c h a p t e r on p r i c i n g , a
r e c e s s i o n in demand and o u tp u t and th e r e s u l t i n g r i s e in
unused c a p a c ity do n o t n e c e s s a r i l y in d u ce a d ro p in u n i t
c o s t s and p r i c e s . T h is i s p a r t l y due t o downward r i g i d
i t i e s of c o s t s . a n d th e p r o t e c t i o n o f m a rg in s , and p a r t l y t o
g r e a t e r c o n fid e n c e t h a t governm ent w i l l n o t p e r m it th e
s l i d e i n demand and o u tp u t t o g e t out o f hand.
The r o l e o f i m p o r t s . — F o r e ig n t r a d e h as a l s o t r a d
i t i o n a l l y p r o v id e d an im p o r ta n t o u t l e t f o r d o m e s t i c a l l y -
g e n e r a te d i n f l a t i o n p r e s s u r e s : th e p o s s i b i l i t y f o r p u r
c h a s e r s t o o b t a i n im p o rte d goods and s e r v i c e s a t low er
p r i c e s th a n th o s e o f f e r e d by d o m e stic s e l l e r s . T h is o f f s e t
350
t o d o m e s tic i n f l a t i o n i s o p e r a t i v e so lo ng as d o m estic
p r i c e s ( a t f i x e d exchange r a t e s ) a re r i s i n g f a s t e r t h a n
s i m i l a r p r i c e s a b r o a d , and would depend s u b s t a n t i a l l y on
th e n a t i o n * s d e g re e o f dependence on im p o rte d com m odities
and th e p r o p e n s i t y t o im p o rt.
In d e e d , th e a v a i l a b i l i t y of c h e a p e r im p o rts may
e n a b le t h e n a t i o n n o t o nly to c o u n te r a c t d o m e stic p r i c e
r i s e s s u f f i c i e n t l y t o a c h ie v e a p p ro x im ate s t a b i l i t y in i t s
p r i c e in d e x e s b u t a l s o t o c r e a t e th e d e c e p tiv e im p re s s io n
t h a t d o m e stic i n f l a t i o n p r e s s u r e s a re n o n - e x i s t e n t . I n .
o t h e r w o rd s, low er p r i c e s f o r p u rc h a s e d f o r e i g n goods may
e n a b le t h e c o e x i s t e n c e o f s t a t i s t i c a l p r i c e s t a b i l i t y and
d o m estic i n f l a t i o n p r e s s u r e s .
T h is r a i s e s a b a s i c q u e s t i o n a b o u t w h e th e r s t a t i s
t i c a l p r i c e s t a b i l i t y (a s m easured by an in d e x ) i s p e r se
an a d e q u a te I n d i c a t o r o f th e e x t e n t o f i n f l a t i o n . We have
a lr e a d y n o te d t h a t q u a l i t y d e t e r i o r a t i o n of p r o d u c ts and
s e r v i c e s , and unemployment can se rv e a s e sc a p e v a lv e s t h a t
o f f s e t p r i c e - r a i s i n g p r e s s u r e s and dampen t h e r i s e i n th e
p r i c e in d e x . Now we n o te a n o th e r im p o rta n t f a c e t o f i n f l a
t i o n t h a t i s n o t m e a su ra b le by t h e o v e r - a l l p r i c e in d e x .
In t h i s c o n n e c tio n i t sh o u ld a l s o be n o te d t h a t th e
c o n s t r u c t i o n o f th e p r i c e in d e x i t s e l f may d i s g u i s e th e
o c c u rre n c e o f p r i c e i n f l a t i o n i n s p e c i f i c s e c t o r s ( e . g . , i n
i n d u s t r y and s e r v i c e s ) when accom panied by p r i c e d e c l i n e s
351
i n o t h e r s e c t o r s ( e . g . , farm p r o d u c t s ) t h a t o f f s e t th e
s e c t o r a l p r i c e r i s e s s u f f i c i e n t l y t o y i e l d an o v e r - a l l
a p p e a ra n c e of p r i c e s t a b i l i t y , a s happened i n th e U n ite d
S t a t e s i n th e e a r l y 1 9 5 0 's .
To r e t u r n t o t h e r o l e o f im p o r ts : as i n th e case
o f e x c e s s c a p a c i t y , t h e r e may be s p e c i a l c irc u m s ta n c e s p r e
v e n ti n g t h i s o u t l e t from s e r v i n g i t s t h e o r e t i c a l f u n c t i o n
as a s a f e t y v a l v e . An im p o rta n t example i s th e s e r i e s of
d e f i c i t s i n t h e U n ite d S t a t e s b a la n c e of paym ents s in c e
1950. In t h i s s i t u a t i o n , t o th e e x t e n t t h a t im p o rts a re
a llo w e d to i n c r e a s e f a s t e r t h a n e x p o r t s , th e o v e r - a l l
d e f i c i t i s w orsened and th e b a s i s f o r f u r t h e r outw ard flo w s
o f g o ld i s s t r e n g t h e n e d . C o n v e rs e ly , t o th e e x te n t t h a t
o u tflo w s o f g o ld must be c h ec k ed , th e e x p e n d i tu r e s on
im p o rts w i l l a l s o be s u b j e c t t o r e s t r i c t i o n s .
The I m p l i c a t i o n s o f A n a ly s is
To c u lm in a te th e d i s c u s s i o n i t i s p o s s i b l e t o draw
a number o f i m p l i c a t i o n s from th e p r e c e d in g c o n s i d e r a t i o n s
and t h e r e b y a l s o la y th e f o u n d a tio n s o f th e f i n a l p o r t i o n
o f t h i s c h a p t e r i n which an h y p o t h e s is i s drawn on th e
b a s i s o f a l l t h a t h as p re c e d e d .
The Meaning o f "C ause"
I n th e f i r s t p l a c e , th e p r e c e d in g c o n s i d e r a t i o n s
r a i s e a b a s i c q u e s t i o n about th e m eaning and s i g n i f i c a n c e
of th e terra " c a u s e ." A cco rd ing to th e d i c t i o n a r y , th e wordj
"c a u se " has been d e f in e d n o t only i n th e more f a m i l i a r !
se n se as (a) so m eth in g "w hich o c c a s io n s o r e f f e c t s a
r e s u l t , " b u t a l s o as (b) " t h a t w ith o u t w hich th e r e s u l t
would n o t have b e e n ," o r "any c ir c u m s ta n c e , c o n d i t i o n ,
e v e n t , e t c . , o r . . . any co m b in atio n t h e r e o f t h a t n e c e s
s a r i l y b r in g s about o r c o n t r i b u t e s to a r e s u l t .
In o t h e r w o rd s, th e te rm "c a u se " r e f e r s n o t o n ly toi
th e s tim u lu s o r im p u lse f a c t o r , as i n th e common-sense con
c e p t , b u t a ls o t o th e mechanisms o f re s p o n s e and e n v ir o n
m e n ta l f a c t o r s t h a t may p r o p a g a t e , i n d u c e , o r p e rm it th e
o p e r a t i o n of th e s t i m u l i .
T h is i n t e g r a t e d c o n ce p t o f " c a u se " rem inds us o f
M a ch lu p 's comment on i n d u c t i v e l o g i c ( i n th e c h a p t e r on
demand) a c c o rd in g t o which a " n e c e s s a r y c o n d itio n " or
" p e r m is s iv e " a g e n t i s deemed th e cause o f a p r i c e - i n c r e a s e
so lo ng as th e i n i t i a l s tim u lu s c o u ld n o t a lo n e a c h ie v e the;
p r i c e r i s e . ^
These i n t r o d u c t o r y rem arks a re n o t a mere q u ib b le
o v e r w o rd s; th ey a re h ig h ly a p ro p o s to th e u n d e r s ta n d in g of;
^•W e b ste r’ s C o l l e g i a t e D ic ti o n a r y ( 5 th e d . ; S p r in g
f i e l d : G. & C. M erriam C o ., 194*1), p . l o l , and W e b s te r’ s
New C o l l e g i a t e D i c ti o n a r y (2d e d . ; S p r i n g f i e l d : G. & C. |
Merriam C o ., 1 9 b 0 ), p . 132.
^For a s i m i l a r v ie w p o in t se e Dennis H. R o b e rts o n ,
L e c tu r e s on Economic P r i n c i p l e s (London: S t a p l e s P r e s s ,
1 9 5 9 ), I I I , 96.
353
a p r o c e s s t h a t i s i n h e r e n t l y m u l t i - f a c e t e d , whose key
v a r i a b l e s and components c o o p e ra te i n a manner t h a t i s
i n t e r r e l a t e d , i n t e r d e p e n d e n t , and i n t e r a c t i n g . There seems
l i t t l e doubt t h a t i n f l a t i o n q u a l i f i e s as such an i n t e r
dependent p r o c e s s .
The p r o p e r stu d y o f i n f l a t i o n . — In th e c o n te x t of
th e i n f l a t i o n p r o c e s s , a com plete r a t h e r th a n a p a r t i a l
u n d e r s ta n d in g o f th e phenomenon r e q u i r e s t h a t a t t e n t i o n be
d e v o te d to th e a n a l y s i s of th e r e s p o n s e and e n v ir o n m e n ta l
f a c t o r s as much a s t o th e i n i t i a l o n e s: b e c a u se t h e fo rm er
a re c a p a b le o f d e te r m in in g th e scope ( d i s t r i b u t i o n ) , m agni
t u d e , and sp e ed o f p r i c e m ovem ents, th e y a re a s c r u c i a l t o
th e o p e r a t io n o f th e i n f l a t i o n p r o c e s s as a r e th e i n i t i a l
s t i m u l i . I t i s t h i s b a s i c c o n ce p t o f "mechanism as cau se"
t h a t J . A. S chum peter may have had i n mind when he n o te d i t
made l i t t l e se n se t o q u a r r e l "w h e th e r i t i s t h e b u l l e t o r
th e m u r d e r e r 's i n t e n t i o n t h a t 'c a u s e s ' t h e d e a th o f t h e
v i c t i m . "1
T h is may a l s o e x p l a i n why t h e l i t e r a t u r e on i n f l a
t i o n h a s d e v o te d much a t t e n t i o n t o t h e re s p o n s e and e n v i r
onm ental mechanisms as w e ll as t o th e " a p p ro x im a te " d e t e r
m in a n ts ( i . e . , money, demand, c o s t s , and p r i c i n g ) and o t h e r
p o s s i b l e s t i m u l i o f p r i c e c h a n g e s . T hus, i n a d d i t i o n t o
such h e a d in g s as " d e m a n d -p u ll" and " c o s t- p u s h " i n f l a t i o n ,
S c h u m p e te r , op. c l t . , p. 1110.
354
we f i n d su c h l a b e l s as " o v e r h e a d - c o s t- p u s h " I n f l a t i o n and
" r a t c h e t " i n f l a t i o n — b o th r o o te d in an en v iro n m en t o f
s t r u c t u r a l and i n s t i t u t i o n a l " r i g i d i t i e s " i n c o s t s and
p r i c e s — t h e " v e l o c i t y " mechanism b a s e d on e x p e c t a t i o n s and
r e s p o n s e p s y c h o lo g y , and " l o g - r o l l i n g " i n f l a t i o n i n which
t h e p o l i t i c a l e n v iro n m en t c a t e r s t o th e in c o m e -c la lm s o f
p r e s s u r e g r o u p s , t o name b u t a few.
I n t h i s c o n n e c ti o n , th e p r e s e n t stu d y has a lr e a d y
r e f e r r e d t o t h e o r i e s in w hich re s p o n s e and e n v ir o n m e n ta l
f a c t o r s p l a y c r u c i a l r o l e s . These i n c l u d e , f o r exam ple,
F r ie d m a n 's t h e o r y t h a t th e "p erm an en t" e x p a n sio n o f g o v e rn
ment b u d g e ts p r o v i d e s an e n v iro n m en t t h a t n o u r i s h e s s tr o n g
u n i o n s ; S c h u l t z e ' s " d e m a n d - s h if t" model i n w hich th e down
ward r i g i d i t y and c o s t - o r i e n t e d n a t u r e o f p r i c e s and wages
a r e th e d e c i s i v e e n v ir o n m e n ta l f a c t o r s ; and A c k le y 's
"markup" i n f l a t i o n i n w hich th e r i g i d markup r e s p o n s e s o f
b o th l a b o r and management com prise th e h e a r t o f th e wage-
p r i c e s p i r a l .
In t h i s c o n te x t i t may be n o te d t h a t th e r i g i d i t y
o r " i n f l e x i b i l i t y " of p r i c e s and wages in t h e downward
d i r e c t i o n even i n th e p r e s e n c e o f s l a c k demand— which
c o n s t i t u t e s th e i n s t i t u t i o n a l and s t r u c t u r a l b a s i s of
" r a t c h e t " i n f l a t i o n — w i l l r e - a p p e a r below a s a more
g e n e r a l phenomenon c h a r a c t e r i s t i c o f " p r e s s u r e g ro u p "
i n f l a t i o n . In b o th of t h e s e c a s e s , th e f a c t t h a t p r i c e s
355
and incom es in g e n e r a l do n o t d e c l i n e in r e c e s s i o n p e r i o d s
(w h ile t h e y i n v a r i a b l y r i s e i n u psw in g s) means t h a t o v e r
th e long ru n th e p r i c e in d ex can o n ly move upw ards.
C auses a t w ork. — The u n d e r l y i n g i n t e r r e l a t i o n and
in te r d e p e n d e n c e of t h e key v a r i a b l e s o f th e i n f l a t i o n
p r o c e s s a l s o e n a b le s u s t o e x p l a i n why even M a c h lu p 's
"autonom ous" c a u s e s — i . e . , e x c e s s demand and c o s t - i n c r e a s e s
i n th e a b se n c e o f e x c e s s demand— a re a c t u a l l y n o t3 o n e -w o lf
c a u s e s , so t o sp e a k , a b le t o e f f e c t a p r i c e r i s e w ith o u t
t h e c o o p e r a tio n o f o t h e r e s s e n t i a l e le m e n ts .
In th e case o f e x c e s s demand, f o r e x am p le, i t was
se e n t h a t (a ) i n c r e a s e d money su p p ly a n d /o r v e l o c i t y were
r e q u i r e d as p e r m is s iv e a g e n ts i n t h e f i n a n c i n g o f t h e excess
demand; (b) t h e e f f e c t s o f most ty p e s o f demand on p r i c e s
were "m e d ia te d " th ro u g h th e p r i c i n g p r a c t i c e s o f f ir m s and
would t h e r e f o r e not in d u ce p r i c e r i s e s u n t i l s c a r c i t y and
r i s i n g c o s t s came i n t o p la y ; and c o n s e q u e n tly (c ) demand
i n f l a t i o n would a c t u a l l y be e x p r e s s e d and p r o p a g a te d
th ro u g h th e c o s t and p r i c i n g m echanism s o f th e economy in
t h e form o f e x p e n d i tu r e s on paym ents f o r f a c t o r s of p r o
d u c ti o n .
In th e case o f e x c e s s i v e c o s t s (w ages, p r o f i t s ,
e t c . ) , an I n c r e a s e d M o r V i s r e q u i r e d to " r a t i f y " o r
s u p p o rt th e i n c r e a s e d c o st-p a y m e n ts to p r o d u c tio n f a c t o r s ,
o r to f i n a n c e th e p u b l i c ' s p u r c h a s e s a t t h e h i g h e r p r i c e s .
356
To th e e x te n t t h a t h i g h e r wages a re fin a n c e d out o f re d u c e d
p r o f i t s a n d /o r s a v in g s in d u c e d by l a y o f f s o f l a b o r , th e
p r e s s u r e on p r i c e - i n c r e a s e s may be m i t i g a t e d . To the
e x t e n t t h a t p r i c e s a r e f o r c e d t o r i s e somewhat i n i t i a l l y ,
th e r e s u l t i n g unemployment in d u ce d by re d u c e d p r o f i t s and
l a y o f f s co uld be e x p e c te d t o dampen demand and a b o r t t h e
i n i t i a l p r i c e r i s e s .
In o t h e r w ords, th e i m p l i c a t i o n i s t h a t , w h ile i t
i s p o s s i b l e t o s i n g l e out an " i n i t i a l " im pulse t o a s e r i e s
o f p r i c e - r i s e s , i t would be Im p o ssib le t o r e g a r d i t as
" th e " cause o f t h e i n f l a t i o n i n th e se n se t h a t i t a lo n e was
r e s p o n s i b l e f o r ( o r c o n t r i b u t e d t o ) th e u l t i m a t e r i s e in
p r i c e l e v e l .
" Causes" v e rs u s " P a r t i c i p a n t s . " — R e la te d t o t h i s
c o n s i d e r a t i o n i s th e f a c t t h a t even i f i t were p o s s i b l e
e m p i r i c a l l y t o i d e n t i f y which o f a l l th e p a r t i c i p a t i n g
e le m e n ts o f t h e i n f l a t i o n p r o c e s s — in c l u d i n g t r a n s m i s s i o n
and s p i r a l m echanism s—may have " i n i t i a t e d " th e p r i c e
s p i r a l , th e m ag nitude o f th e u l t i m a t e p r l c e - I n c r e a s e would
depend n o t o n ly on th e s i z e o f th e i n i t i a l s tim u lu s b ut
a l s o on th e s i z e and s t r e n g t h o f r e s p o n s e s t o I t . 1
^ o r a d i s c u s s i o n o f t h i s p o in t se e Bowen, op. c i t . ,
pp . 412-15.
357
A f u r t h e r i m p l i c a t i o n o f th e s e c o n s i d e r a t i o n s i s
t h a t M achlup*s c l a s s i f i c a t i o n o f demand and c o s t i n f l a t i o n
does n o t mean t h a t "autonom ous" c a u se s a r e n e c e s s a r i l y
r e s p o n s i b l e f o r a l l o r most o f th e u l t i m a t e r i s e in p r i c e s .
On t h e c o n t r a r y , i t i s p o s s i b l e t h a t an autonomous i n c r e a s e
could make a s m a lle r c o n t r i b u t i o n to t h e i n f l a t i o n p r o c e s s
( i . e . , a c c o u n t f o r a s m a l l e r s h a r e of th e " u l t i m a t e " r i s e
in p r i c e s ) t h a n fo llo w - o n r e s p o n s e s .
To t a k e a case i n a d v e r t e n t l y o f f e r e d by Machlup
h i m s e l f , an autonomous demand e x p a n s io n may a c t u a l l y be
fo llo w e d by a d m i n i s t r a t i v e p r i c e and wage i n c r e a s e s "more
d r a s t i c " th a n the m e re ly r e s p o n s iv e ( c o m p e t i t i v e ) i n c r e a s e s
t h a t c o u ld have been e x p e c te d u n d e r p u re c o m p e titio n . Then,
in o r d e r t o a v o id any r e s u l t i n g unem ploym ent, t h e s e
i n c r e a s e s w ould r e q u i r e a su b seq u e n t e x p a n s io n o f demand of
the in d u c e d o r s u p p o r t i v e t y p e s .
I n a n o th e r i l l u s t r a t i o n p r e s e n t e d by M achlup:
autonomous wage and p r i c e i n c r e a s e s may g iv e r i s e to an
■^•These r e f e r e n c e s to Machlup a r e t o h i s "S ta te m e n t,"
op. c i t . . p p . 2825-27. Somewhat r e l a t e d t o t h i s case i s
the presum ed l e a p f r o g g in g r e l a t i o n betw een h i g h e r wages and
h i g h e r p r i c e s In th e p o s t - w a r s t e e l I n d u s t r y , a c c o rd in g t o
which ( u n t i l 1959) I t was th e i n d u s t r y 1s " r e g u l a r p r a c t i c e "
to g r a n t a b o v e -a v e ra g e I n c r e a s e s In wages and f o llo w them
w ith "even b ig g e r " p r i c e - i n c r e a s e s ; sep A. H. R a s k in , "The
Squeeze On t h e U n io n s," The A t l a n t i c M o n th ly . CCVII ( A p r i l
1 9 6 1 ), p . 5 8 . T his l e a p f r o g g i n g phenomenon may be
e x p la in e d by r i s i n g e x p e c t a t i o n s ; s u p r a , p . 17 7.
. 358
e x c e s s i v e demand e x p a n s io n i f " e x c e s s i v e l y n e rv o u s" g o v e rn
ment o f f i c i a l s r u s h t o i n j e c t an o v erdo se o f s u p p o r tiv e
p u r c h a s in g pow er. I n t h i s c a s e some o f th e e f f e c t i v e
demand c r e a t e d by governm ent would c o n s t i t u t e an autonomous
a d d i t i o n t h a t c o u ld th e n r e s u l t i n f u r t h e r ( r e s p o n s i v e )
upw ard a d ju s tm e n ts o f c o s t s .
Machlup a l s o p o i n t s to an " e x c e p t i o n a l " c ase where
f i r m s f o r some r e a s o n have been c h a r g in g lo w e r p r i c e s th a n
a re "good f o r t h e i r p r o f i t s , " and th e n move t o overcompen
s a t e f o r t h i s s i t u a t i o n by t a k i n g th e o c c a s io n of a wage-
i n c r e a s e t o r a i s e p r i c e s more th a n i s j u s t i f i e d by th e
I n c r e a s e in c o s t s .
A q u e s t i o n o f d a t i n g . — I f i t i s p o s s i b l e f o r th e
c u m u la tiv e im p act o f th e r e s p o n s e s p e r se on t h e " u l t i m a t e "
p r i c e r i s e to f a r e x ce ed t h a t which I s w a rra n te d by t h e
s i z e o f th e i n i t i a l im p u ls e , th e n th e s i g n i f i c a n c e of a
s e a r c h f o r " c a u s e s " o f i n f l a t i o n would seem t o l i e n o t in
l o c a t i n g th e " o r i g i n a l " c u l p r i t (a s thoug h o n ly a s i n g l e
autonom ous c au se were r e s p o n s i b l e f o r t h e e n t i r e p r i c e
r i s e ) . R a th e r , i t would seem more p r o p e r and f r u i t f u l to
d e te rm in e t h e s i z e o f th e r e s p e c t i v e c o n t r i b u t i o n s t o t h e
r i s e In p r i c e s made by each o f t h e s e v e r a l e le m e n ts t h a t
p a r t i c i p a t e d i n th e s p i r a l , and d e s i g n a t e t h e l a r g e s t
c o n t r i b u t o r ( s ) a s th e " c r u c i a l " e l e m e n t ( s ) , w h e th er th e y be
I n i t i a l o r r e s p o n s e f a c t o r s .
359
Such a p r o j e c t , how ever, would r a i s e a b a s i c
m e th o d o lo g ic a l p ro b lem : how t o s i n g l e out t h e s i z e o f th e
^ 'u ltim a te " p r i c e r i s e ? T hat i s , how to s e l e c t th e r e s p e c
t i v e d a t e s f o r (a ) th e i n i t i a l ( o r b a s e ) p r i c e w hich i s t o
be compared w ith t h e l a t e r h i g h e r p r i c e , and f o r (b) th e
h i g h e r p r i c e which i s to be compared w ith th e i n i t i a l
p r i c e ? F o r any g iv e n s e l e c t i o n of b e g in n in g - a n d - e n d ln g
d a t e s , and f o r w hich th e r e s p e c t i v e c o n t r i b u t i o n o f each
p a r t i c i p a t i n g e le m e n t t o t h e e v e n t u a l p r i c e r i s e i s d e t e r
m ined, th e r e s u l t m ig h t be h ig h ly r e l a t i v l s t i c i n th e se n se
t h a t an a l t e r n a t e s e t o f s t a r t i n g d a t e s ( s a y , 19*10 i n s t e a d
of 19*17) would y i e l d r e s p e c t i v e c o n t r i b u t i o n s t h a t were
s i g n i f i c a n t l y d i f f e r e n t .
T h u s, f o r exam p le, one s e t o f d a te s m ight y i e l d
f i n d i n g s v e ry a c c e p t a b l e t o u n io n l e a d e r s b e cau se th e y
showed management as th e l a r g e r c o n t r i b u t o r to th e g iv e n
p r i c e r i s e , but a n o t h e r p a i r o f d a t e s m ight p l e a s e manage
ment more th a n th e u n io n s . In e i t h e r c a s e , th e p a r t y p u t
on th e d e f e n s iv e m ig h t n e v e r t h e l e s s a rg u e t h a t i t s i n f l a
t i o n r o l e was " j u s t i f i e d " f o r one o r a n o th e r r e a s o n , such
as t h e n e ed to " c a t c h up" w ith r i s i n g c o s t s o r to m atch th e
g a in s o f a r i v a l u n io n o r f i r m .
A Long-Run P ro c e s s
As an i n t r o d u c t i o n t o th e f o llo w in g s e c t i o n i t
sh o u ld be n o te d t h a t a n o th e r im p o r ta n t i m p l i c a t i o n o f th e
360
above d e l i b e r a t i o n s i s t h e lo n g - r u n c h a r a c t e r w hich th e
g e n e r a l i z e d i n f l a t i o n p r o c e s s assum es in o u r a n a l y s i s .
I n f l a t i o n i s assumed to be more t h a n a s h o r t - r u n , c y c l i c a l ,
or p a r t i a l sequence of e v e n ts t h a t m ight (a ) encom pass to o
s h o r t a span o f tim e and hence (b ) embrace too few o f th e
v a r i a b l e s d i s c u s s e d a b o v e , o m it t in g some t h a t may be r e l e
v a n t to th e p a r t i c u l a r i n f l a t i o n e p is o d e .
In t h i s c o n c e p t, f o r exam p le, th e p o s t- w a r a tt e m p t s
of l a b o r u n io n s to " c a t c h up" on t h e i r wage a d ju s tm e n ts
f o l lo w in g w artim e c o n t r o l s , o r th e a tte m p t o f th e U. S.
S t e e l C o rp o ra tio n to " e n la r g e " i t s p r o f i t m argin d u r in g th e
1950Ts could b o th be view ed as lo n g - r u n a d ju s tm e n t s as w e ll
as s h o r t - r u n s t i m u l i t o i n d u s t r y - w i d e wage and p r i c e move
m e n ts , even th ou gh th e s i z e of t h e i n i t i a l i n c r e a s e s m ight
be r e g a r d e d a s " e x c e s s i v e " or " u n j u s t i f i e d " f o r o t h e r
r e a s o n s . Thus i t i s th e lo n g - r u n c o n te x t t h a t p e r m i t s more
key v a r i a b l e s t o e n t e r i n t o th e p i c t u r e when th e y a r e r e l e
v a n t t o th e s p e c i f i c e p is o d e .
S i m i l a r l y , th e g e n e r a l p o s t- w a r r i s e in p r i c e s of
consum er s e r v i c e s may be i n t e r p r e t e d as a " c a t c h i n g up"
p r o c e s s , f o l lo w in g y e a r s of " r e s t r a i n t " by firm s h o ld in g
back t h e i r p r i c e s d e s p i t e r i s e s i n c o s t s . 1
■'•Arthur F. B u rn s, "The P roblem o f I n f l a t i o n , " Read
in g s i n E co n o m ics, e d s . P a u l A. S am u elson, R obert L, Bishop
ana Joh n R. Coleman (3d e d . ; New York: M cGraw-Hill Book
Company, 1 9 5 8 ), p . 124.
361
F i n a l l y , i t i s th e lo n g -ru n view o f th e i n f l a t i o n
p r o c e s s t h a t seems t o be im p lie d by th e u se of such term s
a s " s p i r a l " and " c r e e p i n g ," b o th o f which subsume a p a t t e r n
o f c o o p e ra tio n and I n t e r a c t i o n among s t i m u l i , r e s p o n s e s ,
and e n v iro n m e n ta l f a c t o r s i n a r e p e t i t i v e m anner.
I n f l a t i o n and R e d i s t r i b u t i o n
P rob ab ly th e most com prehensive and s i g n i f i c a n t
i m p l i c a t i o n t o be drawn from th e p r e c e d in g a n a l y s i s rem ains
t o be s t a t e d . T h is i m p l i c a t i o n c o n ce rn s th e u l t i m a t e
e sse n c e o r meaning of t h e g e n e r a l i z e d i n f l a t i o n p r o c e s s ,
i n v o lv in g an a tte m p t to answ er th e f o llo w in g q u e s tio n :
can th e i n f l a t i o n p r o c e s s as a whole be e x p la in e d by an
a ll- e m b r a c in g con cep t t h a t i s l o g i c a l l y d e d u c lb le o r
i n f e r a b l e from th e a r r a y of b a s ic i n g r e d i e n t s ( s t i m u l i ,
r e s p o n s e s , environ m en t) a n a ly z e d above?
The re a s o n f o r t h i s q u e s tio n i s a s f o llo w s : i f i t
i s t r u e t h a t i n f l a t i o n i s th e i n h e r e n t l y in te r d e p e n d e n t and
i n t e r a c t i n g p ro c e s s assumed above— a l o n g - r u n , c o n tin u in g
phenomenon u n f o ld in g i n s e v e r a l d im en sio n s (econom ic,
t e c h n o l o g i c a l , p s y c h o l o g i c a l , s o c i a l , and p o l i t i c a l ) ,
th e re b y encom passing a l l group s a s a c t i v e o r p a s s iv e
p a r t i c i p a n t s — th e n i t may be p o s s i b l e to e x p la in th e
re a so n f o r i t s e x i s t e n c e by a s i n g l e b road h y p o th e s is t h a t
em braces th e key v a r i a b l e s and components of th e I n f l a t i o n
362
p r o c e s s w ith in a p a r a l l e l in te r d e p e n d e n t and i n t e r a c t i n g
scheme.
Seeds o f t h e h y p o t h e s i s .- - S e e d s o f a p o t e n t i a l
h y p o t h e s is were a c t u a l l y stre w n th ro u g h o u t p r e c e d in g
c h a p t e r s , in th e c o n te x t of d i s c u s s i o n s on t h r e e m ain
a s p e c t s o f th e i n f l a t i o n p r o c e s s : i t s c a u s e s , t r a n s m i s s i o n
and s p i r a l m echanism s, and e n v ir o n m e n ta l i n s t i t u t i o n s and
s t r u c t u r e s .
T hus, i n t h e c o n te x t of th e c a u se s of i n f l a t i o n ,
p a r t i c u l a r l y wage and p r i c e a g g r e s s i o n , s e v e r a l m o d e ls—
such a s L e r n e r 's " s e l l e r s ' i n f l a t i o n " and A c k le y 's "markup"
i n f l a t i o n — a p p e a r t o s h a re th e n o t io n o f an u n d e r l y i n g tu g
o f war betw een wage and non-wage income g ro u p s o v e r l a r g e r
p o r t i o n s o f th e income p i e a s th e p rim a ry "e n g in e " o f
i n f l a t i o n . That i s , when th e r e s p e c t i v e in c o m e -c la im s of
w a g e -e a rn e rs and p r o f i t - r e c e i v e r s p ro v e " i n c o m p a t i b l e ," in
th e se n se t h a t t o g e t h e r th e y add up t o more th a n 100 p e r
cen t o f th e p r o d u c t 's s e l l i n g p r i c e , t h e s e ’ c la im s can n o t be
s a t i s f i e d u n l e s s s e l l i n g p r i c e s a l s o i n c r e a s e . But sin c e
th e p r i c e r i s e re d u c e s r e a l in c o m e s , i t w i l l le a v e b o th
p a r t i e s no b e t t e r o f f th a n b e f o r e , s p a r k in g a re s u m p tio n o f
th e t u g o f war o v e r income s h a r e s i n an a tte m p t t o a c h ie v e
t h e im p o s s ib le (assum ing no i n c r e a s e s i n p r o d u c t i v i t y ) .
I m p l i c i t i n t h i s tu g o f war i s th e r e f u s a l t o
a c c e p t l e s s th a n t h e d e s i r e d (p resu m ab ly " f a i r " ) s h a r e of
363 !
incom e. I n s e v e r a l c o n te x ts i t was n o te d t h a t t h i s a t t i -
i
tude was a t th e h e a r t o f t r a n s m is s io n and s p i r a l mechanisms1
by which i n i t i a l i n c r e a s e s i n wages, and o th e r c o s t s and
j
p r i c e s a re t r a n s m i t t e d i n waves of c o s t - i n c r e a s e s to o t h e r i
s e c t o r s , which in t u r n induce c o s t - p r i c e s p i r a l s from
p e r io d t o p e r i o d .
F o r exam ple, la b o r may invoke n o t only a r i s e i n
c o s t - o f - l i v i n g as th e excuse f o r r e s t o r a t i v e w a g e -in c re a s e s '
b u t a ls o th e wage com parison and " h a b i t u a l " w a g e - r a is e , i n
o rd e r t o e r a d i c a t e d i f f e r e n t i a l s and t o " c a tc h up" w ith
o th e r g ro u p s . Labor may a ls o p o i n t t o th e f i r m ’ s " a b l l i t y -
t o - p a y " ~ b a s e d on p r o d u c t i v i t y in c r e m e n ts , i n c r e a s e d
demand, o r m ark et power— as th e so u rc e f o r i n c r e a s e d r e a l
w ages.^ T his in d e p e n d e n t a t t i t u d e c o n c e rn in g th e wage
sh a re i s a ls o r e f l e c t e d in l a b o r 's r e f u s a l to a c c e p t r i g i d
form u las o r " g u i d e l i n e s " f o r wage a d ju stm e n ts (su ch as th e
" p r o d u c t i v i t y p r i n c i p l e " ) t h a t m ight be viewed as sa n c tio n -:
in g th e e x i s t i n g wage s t r u c t u r e and income d i s t r i b u t i o n .
---------------------------------- i
^■This r e c a l l s th e g e n e r a l p r i n c i p l e t r a c e d back t o '
th e days o f Samuel Gompers: " R a ise wages in p ro s p e ro u s
tim e s , and peg them a g a i n s t d e c l in e i n d e p r e s s i o n s ," which
along w ith s i m i l a r b e h a v io r i n p r i c e s c r e a t e s th e b a s i s o f |
" r a t c h e t " i n f l a t i o n ; q u o t a t i o n from Jo h n M. C l a r k , "On
Economic Problems of th e Next Twenty Y e a rs ," I n Committee
f o r Economic D evelopm ent, Problem s of U n ited S t a t e s
Economic Development (New York: Committee f o r Economic
D evelopm ent, 19 58), I , 133.
,364
I t may a l s o be n o te d t h a t w ith in t h e l a b o r group
r i v a l r y o v e r income s h a r e s may p r e v a i l among v a r i o u s seg
m e n ts , w ith th e m o re -fa v o re d w a g e -e a rn e rs s e e k in g t o
p r o t e c t o r e n la r g e t h e i r r e l a t i v e sh a re s a g a i n s t th e l e s s -
f a v o r e d seg m en ts.
S i m i l a r l y , on th e f i r m 1s s i d e , t h e r e f u s a l t o
a c c e p t l e s s t h a n i t s d e s i r e d markup or p r o f i t m arg in may
a ls o be more o r l e s s o p e r a t i v e a s a key e le m e n t i n t r a n s
m is s io n and s p i r a l m echanism s, d epending on how r i g i d l y
p r ic e - m a k e r s adhere t o t h e i r m a r g in s . I f t h e firm a g re e s
t-o pay the i n c r e a s e d wages o r o t h e r c o s t s , th e o n ly way i t
can m a in ta in i t s m argin i s t o com pensate f o r th e c o s t -
i n c r e a s e s by su b se q u e n t p r i c e i n c r e a s e s a n d /o r i n c r e a s e d
p r o d u c t i v i t y .
In th e f i r s t c a s e , th e co m pen sato ry p r i c e - i n c r e a s e
would presum e an a b i l i t y - t o - p a y by th e com m unity. n o u r is h e d
by h ig h l e v e l s o f employment and demand, o r a s u f f i c i e n t
d e g re e of "m arket p o w e r." On t h e o th e r h a n d , i f t h e f i r m 's
p r o d u c t i v i t y cannot be i n c r e a s e d a n d , f o r some r e a s o n , th e
f ir m weakens i t s r e s i s t a n c e t o c o s t e n cro ac h m en ts and
a c c e p ts re d u c e d m a r g in s , to t h a t e x te n t t h e r e s o r t t o com
p e n s a t o r y p r i c e - i n c r e a s e s i s l e s s e n e d and i n f l a t i o n a r y
i
p r e s s u r e s a r e re d u c e d .
1Thus P aul A. S am uelson, i n s t a t i n g h i s " t e n t a t i v e "
h y p o t h e s is t h a t th e " c r e e p i n g i n f l a t i o n " o f th e m id d le
365
F o r o u r p r e s e n t p u r p o s e , t h e m ost im p o rta n t i m p l i
c a t i o n o f th e tu g o f war betw een w a g e -e a rn e rs and p r o f i t -
r e c e i v e r s i s th e a p p a r e n t i r r e c o n c i l a b i l i t y of v iew s over
t h e " f a i r n e s s " o f r e s p e c t i v e income s h a r e s . As summed up
by J . M. C l a r k , t h e " q u e s t io n of who i s c a u s a l l y r e s p o n
s i b l e f o r i n f l a t i o n becomes m erged w ith t h e q u e s t i o n of th e
r e a s o n a b l e n e s s o f t h e d i s t r i b u t i o n of in c o m e s ." 1
F o r t h i s r e a s o n , C la rk a d d s , th e " c h ic k e n o r th e
egg" q u e s t io n of w h e th e r l a b o r o r management i n i t i a t e d t h e
s p i r a l can n e v e r be s e t t l e d : e a c h p a r t y would blame th e
o t h e r f o r th e " l e a p f r o g g in g " r e s p o n s e , and n e i t h e r would
a g re e t o a " c l e a r l y n e u t r a l b a s e - d a t e " f o r th e s t a r t of
th e s p i r a l s in c e t h a t m ight c a s t i t i n t h e r o l e o f th e
v i l l a i n of th e p i e c e .
C la rk c o n c lu d e s t h a t as lo n g as th e p a r t i e s
in v o lv e d do n o t a l t e r t h e i r custom ary b e h a v io r i n t h i s
dram a, and do n o t r e s o l v e t h e i s s u e betw een t h e m s e lv e s , th e
e n t i r e burden of " c u r in g " th e i n f l a t i o n may be throw n upon
th e s h o u ld e r s o f p u b l i c a g e n c ie s .
1950*s was a t t r i b u t a b l e t o th e "much l e s s h a rd " r e s i s t a n c e
o f f ir m s t o wage dem ands, a l s o acknow ledges t h a t th e
accom panying " h ig h employment" and i n c r e a s e d " t o l e r a t i o n "
o f p r i c e and wage i n c r e a s e s by s o c i e t y a t l a r g e p resu m ab ly
p e r m i t t e d f ir m s t o r a i s e p r i c e s i n t u r n ; se e h i s "A m eric a 1s
Most Im p o r ta n t Economic P ro b lem s: The T h r e a t of I n f l a t i o n , "
i n Committee f o r Economic D evelopm ent, op. c i t . . p. 183.
■^John M aurice C l a r k , The W age-P rlce Problem (New
York: American B ankers A s s o c i a t i o n , i 960) , pp. 3 3 -3 4 .
366
A more g e n e r a l i z e d a p p ro a c h . — S ince th e p r e c e d in g
c o n s i d e r a t i o n s have d e a l t p r i m a r i l y w ith w a g e -e a rn e rs and
p r o f i t - r e c e i v e r s , an a tte m p t m ust be made t o g e n e r a l i z e
them so as t o embrace a l l o t h e r t r a n s a c t o r s and t o make
more e x p l i c i t th e c o n n e c tio n s w ith governm ent econom ic
p o l i c y and t h e p o l i t i c a l e n v iro n m e n t.
As a p o i n t o f d e p a r t u r e i n th e f o r m u la ti o n of a
more g e n e r a l i z e d e x p l a n a t i o n o f i n f l a t i o n we may ta k e th e
e le m e n t of " p r i c e " i t s e l f : p r i c e i s n o t o n ly c e n t r a l to
th e i n f l a t i o n p r o c e s s b u t i s a l s o th e most p e r v a s iv e
phenomenon i n th e economy. I t i s p e r v a s i v e in th e se n se
t h a t a l l f a c t o r s o f p r o d u c tio n r e g a r d i t as Income r e c e i v e d
f o r t h e i r s e r v i c e s , and a l l p u r c h a s e r s r e g a r d I t as a c o s t
o f l i v i n g o r o p e r a t i n g .
T r a d i t i o n a l l y , r i s i n g p r i c e s and i n f l a t i o n have
been d i s c u s s e d m a in ly i n term s o f t h e i r Im p acts on th e
" r e a l " ( p h y s i c a l ) a s p e c t s o r v a lu e s o f incom e, e x p e n d i t u r e ,
and w e a lth . The r i s e i n p r i c e s i s presum ed to in v o lv e a
d e c l i n e In th e p u r c h a s in g power o f money, and c la im s to
f i x e d sums o f money become re d u c e d r e a l w e a lth . These
" r e a l " Im p a c ts i n t u r n a re presum ed t o e x e r t im p o rta n t
r e d i s t r i b u t i v e e f f e c t s , such as t h e e a s i n g o f th e d e b t o r 's
l o t a t th e e xpense o f c r e d i t o r s .
F o r o u r p u r p o s e s , t h e r e a re two main p o i n t s h e r e .
One i s t h a t s in c e r i s i n g p r i c e s c o n s t i t u t e an e r o s i o n of
367
m oney's p u r c h a s in g power th e y have th e e f f e c t of a " hid d en
t a x " on r e a l income and s p e n d in g . To th e e x t e n t t h a t such
a ta x i s a c c e p te d by t r a n s a c t o r s , who d e c id e sim p ly t o
re d u c e t h e i r sp e n d in g ( i . e . , th e " p a s s i v e " r e a c t i o n d i s
c u sse d a b o v e ) , th e p r i c e i n f l a t i o n can be a b o r t e d . But t o
th e e x t e n t t h a t i n i t i a l p r i c e r i s e s a r e n o t a c c e p te d and
a ro u s e t r a n s a c t o r s t o d e f e n s iv e r e a c t i o n s , th e n th e
te n d e n c y t o f u r t h e r " s e l f - f i n a n c i n g " and s p i r a l l i n g of
p r i c e s i s s t r e n g th e n e d .
The r e a s o n s , a s a lr e a d y n o t e d , a re b e c a u se such
d e f e n s i v e r e s p o n s e s ta k e th e form o f a tt e m p ts t o (a )
r e s t o r e r e a l sp e n d in g t o fo rm e r l e v e l s by r e s o r t i n g t o
c r e d i t - c r e a t i o n and re d u c e d s a v in g ( i . e . , i n c r e a s e d money
su p p ly a n d /o r v e l o c i t y o f c i r c u l a t i o n ) , and (b) r e s t o r e
r e a l income t o fo rm er l e v e l s by demands f o r h i g h e r s e l l i n g
p r i c e s o r money incom es.
The se co n d main p o i n t i s t h a t th e r e f u s a l t o a c c e p t
i n f l a t i o n ' s t a x on income and w e a lth can g e n e r a t e t h e
s p i r a l mechanism only by means of (1) i n c r e a s e d o r more
a c t i v e mour” su p p ly and (2) i n c r e a s e d in c o m e - c la im s , th e
l a t t e r c o m p risin g b o th a f a c e t o f " p r i c e s " a s w e ll a s a
weapon f o r c o m b a ttin g th e r i s e i n p r i c e s . In o t h e r w ords,
th e s e means o f d e fe n d in g a g a i n s t th e i n f l a t i o n a re p e r se
t h e means of f e e d i n g i t ; and t o t h e e x t e n t t h a t t r a n s a c t o r s
r e s o r t t o them , th e i n f l a t i o n p r o c e s s w i l l p r o c e e d .
368
I n t h i s c o n te x t we a re rem inded of t h e d e f e n s i v e -
p r o p a g a tiv e r o l e p lay e d by the t r a n s m i s s i o n mechanisms
( e . g . , c o s t - o f - l i v i n g a d ju s tm e n ts and e s c a l a t i o n , wage com
p a r i s o n s , markup p r i c i n g ) which can now a ls o be more
r e a d i l y a p p r e c i a te d as I n s t i t u t i o n a l d e v ic e s f o r th e m ain
te n a n c e o r r e d i s t r i b u t i o n of income s h a r e s .
The p re c e d in g h as d e a l t p r i m a r i l y w ith th e
d e f e n s iv e re s p o n s e s of t r a n s a c t o r s t o th e p r i c e r i s e . How
e v e r , t r a n s a c t o r s may a l s o r e s o r t t o "a g g r e s s i v e 1 1 a d j u s t
ments which seek t o r a i s e r e a l Incomes above th e custom ary
l e v e l . In th e s e c a se s t h e r e need be no p r e c e d in g p r i c e
r i s e t o provoke t h e a g g r e s s iv e In co m e-claim : f e e l i n g s of
g rie v a n c e about th e I n e q u i t y o r i n j u s t i c e of th e e x i s t i n g
Income d i s t r i b u t i o n may be p o w e rfu l enough t o im pel th e
wage o r p r i c e a g g r e s s io n . In any e v e n t , t h e main p o i n t
here i s n o t th e c l a s s i f i c a t o r y nuance but t h e f a c t t h a t
both o f th e s e r e s p o n s e s ( d e f e n s iv e and a g g r e s s iv e ) presume
th e e x i s t e n c e o f " b a r g a i n in g s t r e n g t h " or "m arket power"
more o r l e s s a d eq u a te t o o b t a i n th e d e s i r e d income a d j u s t
ment . 1
R evolt a g a i n s t th e m a rk e t. — In th e p r e s e n t c o n te x t
i t s h o u ld a ls o be n o te d t h a t t h i s r e f u s a l t o a c c e p t th e
m arket* s v e r d i c t o f r i s i n g p r i c e s (and d e c l i n i n g r e a l
^Machlup, "Statem ent," op. c i t . , p. 2826,
369
incom es) may be view ed as m e re ly a s p e c i a l case o f a
g e n e r a l te n d e n c y o f t r a n s a c t o r s t o r e j e c t th e i n s t a b i l i t y
and i m p e r s o n a l i t y o f m ark et v e r d i c t s on p r i c e s and incom es.
Thus th e e c o n o m ist K. E. B o u ld in g has r e f e r r e d t o
a " r e v o l t a g a i n s t th e m ark e t" and p r i c e c o m p e ti t io n which
he b e l i e v e s s e t i n more t h a n a c e n tu r y ago in o p p o s i t i o n t o
th e " s t r o n g p r e j u d i c e " o f e c o n o m is ts in f a v o r o f p r i c e
f l e x i b i l i t y . A cco rd in g t o B o u ld in g , th e b a s i c r e a s o n f o r
t h i s r e v o l t i s t h a t t r a n s a c t o r s d o n 't alw ays r e g a r d the
" g e n e r a l i n s t a b i l i t y " of th e m a r k e t 's p r i c e and income
a d ju s tm e n ts as " d e s i r a b l e ” ; h ence t h e i r r e v o l t may ta k e t h e
form o f n o n - p r i c e c o m p e titio n (by l a b o r and f i r m s ) , p r o t e c
t i o n i s m , governm ent l a b o r and farm l e g i s l a t i o n , c a r t e l s ,
and s o c i a l i s m . ^
I n t h i s c o n n e c ti o n , t h e r e a d e r may r e c a l l (from t h e
c h a p t e r on p r i c i n g ) th e d i s c u s s i o n of a s p e c i f i c ty p e of
d e p a r t u r e from " c l a s s i c a l " p r i c e c o m p e titio n (by th e firm )
in f a v o r o f n o n - p r i c e c o m p e t i t i o n . T h is developm ent was
i n t e r p r e t e d as r e f l e c t i n g t h e f a c t t h a t , i n r e a l l i f e ,
c o m p e titio n em braces o t h e r im p o r ta n t d im e n sio n s b e s i d e s
p r i c e s , e s p e c i a l l y (a) p ro d u c t d i f f e r e n t i a t i o n , (b ) t e c h
no lo g y , and econom ies o f l a r g e - s c a l e , i n n o v a t i o n , and i n t e r
d e p en d e n ce , ( c ) " u n c e r t a i n t y " an d t h e em p h asis on c o s t s and
K e n n e t h E. B o u ld in g , " D is c u s s io n o f K n i g h t 's
P a p e r ," i n David McCord W right ( e d . ) , The Im pact o f th e
Union (New York: K e lle y & M illm an , 1 9 5 6 ), pp. 114-17 .
370
th e lo n g r u n , (d) " s o c i a l p r e s s u r e s " and n o n - p r o f i t
m o ti v a t i o n s .
But w h ereas i n t h a t p a r t i c u l a r c o n te x t t h e means of
a d ju s tm e n t t o m arket p r i c e were n o t p e r se i n f l a t i o n a r y , i n
th e p r e s e n t c o n te x t we see t h a t th e y a r e i n f l a t i o n a r y . In
o t h e r w ords, n o t o n ly a r e t r a n s a c t o r s m o tiv a te d t o r e s i s t
th e p r i c e r i s e but t h e y u se r e s p o n s i v e weapons t h a t p ro p a
g a te t h e p r i c e r i s e .
R e d i s t r i b u t i o n and P o l i t i c s
These d e l i b e r a t i o n s b r i n g us t o th e p o i n t where we
must e x p l i c i t l y acknow ledge t h e p o l i t i c a l system a s an
e s s e n t i a l e n v ir o n m e n ta l d im en sio n w hich , i n th e lo n g r u n ,
can se rv e to s u p p o r t a n d /o r g e n e r a t e i n f l a t i o n a r y p r e s s u r e s
w ith t h e a i d o f m o n e t a r y - f i s c a l m e a s u re s , f o r u n iq u e ly
p o l i t i c a l m o tiv e s .
"L o g - r o l l i n g i n f l a t i o n . " — The p o l i t i c a l system
n e c e s s a r i l y en com passes a l l c i t i z e n g r o u p s , hence a l l ty p e s
o f t r a n s a c t o r s . W e have n o te d t h a t l a r g e segm ents of t h e
community may be d is e n c h a n te d w ith th e v e r d i c t s o f th e
m arket p la c e from t h e i r own p o i n t s of v iew , and t h e r e f o r e
may te n d t o se e k s p e c i a l p r o t e c t i o n a g a i n s t th e m ark et f o r
t h e i r income s h a r e s o r p u r c h a s i n g pow er.
In a democracy th e a p p e a ls t o e x tr a - m a r k e t s o u rc e s
of p r o t e c t i o n fo c u s on th e p o l i t i c a l a d m i n i s t r a t i o n and
371
C o n g re ss. To th e e x t e n t t h a t p o l i t i c i a n s , i n t h e i r q u e s t
f o r v o t e s , c a t e r t o th e s p e c i a l i n t e r e s t s o f t r a n s a c t o r
g ro u p s o f w h a te v e r s o r t by e n a c t i n g l e g i s l a t i o n which adds
t o th e com m unity's a g g re g a te c o s ts more t h a n i t en h an c es
i t s p r o d u c t i v i t y ( a t l e a s t i n th e s h o r t r u n ) , th e n th e
p o l i t i c a l system becomes an in d e p e n d e n t s o u rc e o f i n f l a
t i o n a r y p r e s s u r e .
The e co n o m ist A. G. H a rt h as term ed t h i s phenomenon
" l o g - r o l l i n g i n f l a t i o n . " He v i s u a l i z e s governm ent econom ic
p o l i c y as b e in g s u b j e c t t o p r e s s u r e s from t h r e e im p o r ta n t
g ro u p s — f a r m e r s , l a b o r u n i o n s , and b u s i n e s s f i r m s — whose
in c o m e -c la im s a re " f a r from c o n s i s t e n t " w ith th o s e of l e s s -
o r g a n iz e d g ro u p s s e e k in g c o n t i n u i t y o f p r o d u c t i o n a t
" r e a s o n a b l e " p r i c e s . Under th e s e c o n d i t i o n s t h e " n a t u r a l
im p u lse " of th e p o l i t i c i a n i s t o y i e l d somewhat t o e a c h
o rg a n iz e d group by r a i s i n g t h e i r r e s p e c t i v e s e l l i n g p r i c e s
— th e fa rm e r r e c e i v i n g h i s h i g h e r - t h a n - m a r k e t p r i c e s , l a b o r
i t s h ig h e r w ages, and firm s t h e i r d e s i r e d m arkups— i n a
c o n tin u o u s m e rry -g o -ro u n d o f r e n e g o t i a t e d in c o m e -c la im s and
" r e t r e a t s t o a h i g h e r p r i c e l i n e . " ^
l A l b e r t G a i lo r d H a rt and P e t e r B. K enen, Money,
D e b t, and Economic A c t i v i t y (3d e d . ; Englewood C l i f f s , N . J . :
P r e n t i c e - H a l l , I n c . , 1 9 6 1 ), p p . 3 9 0 -9 1 . A s i m i l a r view i s
h e ld by M a rtin B r o n f e n b r e n n e r , "Some N e g le c te d I m p l i c a t i o n s
o f S e c u l a r I n f l a t i o n , " i n K enneth K. K u r ih a r a ( e d . ) , P o s t -
K ey n esian Economics (New B ru n sw ick , N . J . : R u tg e rs U n i v e r s i t y
P r e s s , 195*0! pp. 3 1 -5 8 , who r e g a r d s i n f l a t i o n as a " s o c i a l
l u b r i c a n t " c a p a b le of " m o l l i f y i n g c l a s s c o n f l i c t " betw een
w o rk ers and fa rm e rs and b u s i n e s s .
372
S t a b i l i z a t i o n v e r s u s r e d i s t r i b u t i o n . — In t h i s con
n e c t io n we have a lr e a d y n o te d th e p r o - i n f l a t i o n p o s s i b i l
i t i e s o f p e rm is s iv e m o n e t a r y - f i s c a l p o l ic y which may
" r a t i f y " e x i s t i n g excess-dem and and c o s t- p u s h p r e s s u r e s
r a t h e r th a n r e s t r a i n them a t th e c o s t of i n c r e a s e d unemploy
m ent. That i s , our r e f e r e n c e s t o th e m o n e t a r y - f i s c a l
a u t h o r i t i e s were e s s e n t i a l l y in th e c o n te x t o f s t a b i l i z a
t i o n p o l i c y , and m ainly in c o n n e c tio n w ith th e dilemma of
" i n f l a t i o n o r unem ploym ent." Now we must a l s o n o te t h a t
th e m o n e t a r y - f i s c a l a u t h o r i t i e s , th a n k s t o th e w orkings of
th e p o l i t i c a l sy ste m , a re a l s o in v o lv e d i n th e im plem enta
t i o n o f r e d i s t r i b u t i o n p o l ic y which— com p risin g such
e n d ea v o rs as th e c r e a t i o n of " f l o o r s " u n d e r incomes and
p r i c e s , th e r e a d ju s tm e n t o f r e l a t i v e s h a re s o f income
g ro u p s , th e e x te n s io n of a id and r e l i e f , and th e e x p an sio n
o f th e " p u b l ic s e c t o r " — may a ls o c r e a t e a d d i t i o n a l so u rc e s
o f i n f l a t i o n a r y p r e s s u r e .
T h is i s n o t t o imply t h a t s t a b i l i z a t i o n p o l i c i e s
do n o t have r e d i s t r i b u t i v e im p a c ts , n o r t h a t r e d i s t r i b u t i v e
p o l ic y cannot e x e r t s t a b i l i z i n g i n f l u e n c e s on th e economy.
R a th e r , in th e c o n te x t of th e i n f l a t i o n p r o c e s s , t h i s
p a r t i a l l y a r b i t r a r y d i s t i n c t i o n (betw een s t a b i l i z a t i o n and
r e d i s t r i b u t i o n ) has a n o th e r re a so n f o r e x i s t e n c e : i n th e
f i e l d of s t a b i l i z a t i o n th e c h i e f problem would seem t o be
th e dilemma of i n f l a t i o n v e r s u s unemployment ( o r how
373
p e r m i s s iv e sh o u ld t h e m o n e t a r y - f i s c a l a u t h o r i t i e s b e ) ,
w hereas in th e f i e l d of r e d i s t r i b u t i o n t h e c h ie f problem
a p p e a r s to be t h e te n d e n c y f o r su c h p o l i c i e s t o in d u c e th e
v a r i o u s p r e s s u r e g ro u p s o r i n t e r e s t s to demand b e n e f i t s and '
p r o t e c t i o n . To t h e d e g re e t h a t su c h w e lf a r e m ea su re s add
t o t h e com m unity's c o s t s more th a n th ey add to i t s p ro d u c
t i v i t y , and t o t h e e x t e n t t h a t t h e m o n e t a r y - f i s c a l system
i s u se d t o im plem ent such p r o t e c t i o n , r e d i s t r i b u t i o n p o l ic y
becomes an a d d i t i o n a l " e n g i n e ” o f i n f l a t i o n .
Viewed from a n o th e r f a m i l i a r a n g l e , t o t h e e x te n t
t h a t w e l f a r e m e a su re s e s t a b l i s h " f l o o r s " below w hich
incom es and p u r c h a s in g power a re n o t p e r m i t t e d to f a l l ,
th e y com p rise th e b a s i s f o r lo n g - r u n " r a t c h e t " i n f l a t i o n ,
b u t on a more g e n e r a l i z e d s c a l e .
A p o l i t i c a l - s o c i a l phenomenon. — I t i s n o t s u r p r i s
i n g t h e r e f o r e t h a t some e c o n o m is ts and s t u d e n t s o f th e
i n f l a t i o n p r o c e s s have c o n s id e r e d i t as much a p o l i t i c a l -
s o c i a l phenomenon— e m b racin g th e r e d i s t r i b u t i o n o f Income
and w e a l t h — as an econom ic one, i f n o t more so. The
f o l lo w in g p a r a g r a p h s d i s c u s s m ain ly two o f th e s e i n t e r p r e
t a t i o n s .
F o r e x am p le , th e te n d e n c y f o r p r e s s u r e g ro u p s to
demand governm ent m ea su re s f o r t h e r e d i s t r i b u t i o n o f income
and w e a lth can be t r a c e d b a ck to v e ry e a r l y s ta g e s o f our
econom ic h i s t o r y , a c c o r d in g t o th e e c o n o m ists H. P a r k e r
374
W i l l i s and John M. Chapman, i n t h e i r 1935 s tu d y of i n f l a
t i o n i n t h e U n ited S t a t e s . T h e ir t h e s i s i s t h a t i n f l a t i o n
r e f l e c t s a c o n tin u in g s o c i a l - p o l i t i c a l " d e b a te " a b o u t th e
r e d i s t r i b u t i o n of income and w e a l t h .^
W i l l i s and Chapman t r a c e t h i s " d e b a te " back t o th e
d i s c u s s i o n s on th e F i r s t and Second Banks o f th e U n ite d
S t a t e s and th e i n t e r l u d e s o f s t a t e b a n k in g t h a t had p r e
ceded th e s e two i n s t i t u t i o n s . They b e li e v e t h i s d e b a te was
co n cern ed p r i m a r i l y w ith demands f o r changes i n d e b t o r -
c r e d i t o r r e l a t i o n s by means o f changes in t h e money and
b a n k in g sy ste m .
A f t e r th e C i v i l War, f o r i n s t a n c e , many fa rm e rs
were h i t by d e c l i n e s i n la n d and fa r m -p r o d u c t p r i c e s and
so u g h t r e l i e f from m ortgage debt a f t e r 1880 i n a d e v a lu a
t i o n o f th e c u rre n c y ( v i a th e f r e e coin ag e o f s i l v e r ) ,
g e n e r a t i n g p r e s s u r e s f o r an I n f l a t i o n movement d u r in g th e
n e x t t h i r t y y e a r s . By 1908, how ever, th e i n f l a t i o n d i s
c u s s io n became much b r o a d e r i n c o n c e p t th a n a mere s i l v e r
movement: i t began t o im ply t h a t i t was th e duty o f the
s t a t e to " r e c t i f y " th e i n c id e n c e o f i n d i v i d u a l "econom ic
b lu n d e r s " and th e " u n d e r l y i n g econom ic i n j u s t i c e " i n
w e a lth d i s t r i b u t i o n . The r e c t i f i c a t i o n so u g h t was an
P a r k e r W i l l i s and John M. Chapman, The Economics
o f I n f l a t i o n (New York: Columbia U n i v e r s i t y P r e s s , 1 93 5 ),
p . 1 6. The f o llo w in g d i s c u s s i o n i s based m a in ly on
pp. 3- 2 1 7 , p a s s im .
375
a l t e r a t i o n of p r i c e s and v a l u e s , p a r t i c u l a r l y i n th e c i r
c u l a t i n g medium, so a s t o redu ce o r evade th e b u rd en of
l o s s e s i n c u r r e d .
The f i r s t World War b ro u g h t in i t s wake a d d i t i o n a l
p r e s s u r e s to r e v i v e th e i n f l a t i o n p sy c h o lo g y — r e f l e c t i n g
th e i n t e n s i f i e d burden o f p r i v a t e d e b t r e s u l t i n g from
d e c l i n e s i n commodity p r i c e s — and i n c r e a s e d demands f o r
T re a s u ry f i n a n c i a l a s s i s t a n c e t o u n s u c c e s s f u l and d i s
t r e s s e d e n t e r p r i s e s a f t e r 1929 ( e . g . , P r e s i d e n t H o o v er’ s
R e c o n s tr u c tio n F in a n c e C o r p o r a t i o n ) .
H e ra ld o f t h in g s t o come. — F or W i l l i s and Chapman
th e R. F. C. and r e l a t e d m easures p r e s a g e d th e r a p i d
developm ent a f t e r 1933 o f program s co m m itting th e g o v e rn
ment to s u b s i d i z e th e incom es o f e c o n o m ic a lly d i s t r e s s e d
g r o u p s , w h e th e r th e y be f a r m e r s , b u sin e ssm e n , o r o t h e r s ,
by s h i f t i n g th e b u rd e n o f t h e i r l o s s e s o n to th e s h o u ld e r s
of th e community a s a w h ole.
I n c o n c l u s i o n , W i l l i s and Chapman s t a t e t h a t i n f l a
t i o n i s a p r o c e s s by w hich th e d i s t r i b u t i o n of th e
com m unity's p u r c h a s in g pow er i s " a r t i f i c i a l l y " a l t e r e d to
f a v o r d i f f e r e n t g ro u p s by r a i s i n g t h e i r incom es beyond t h a t
which I n d i v i d u a l b u y e rs can pay. The p e rs o n s who f a r e
w o rst i n t h i s p r o c e s s a r e th o s e w ith " l i m i t e d c o m p e titiv e
a b i l i t y " o r l e a s t a b i l i t y o r i n c l i n a t i o n t o a d j u s t them
s e l v e s and t h e i r in c o m e -p ro d u c in g power t o econom ic change—
376
by engaging i n a " c o n s t a n t p r o c e s s o f b a r g a in in g and r e v a l
u a t i o n " — su c h as p e rs o n s t y p i c a l l y foun d among f i x e d -
income g ro u p s.
Baches " p r e s s u r e group" i n f l a t i o n . —The contempo
r a r y r e le v a n c e of th e W illis-C hapm an t h e s i s I s echoed i n
th e re c e n t (1958) s tu d y on i n f l a t i o n by econom ist G. L.
B ach, which i n o u t l i n e seems t o have b e en i n s p i r e d by th e
e a r l i e r s t u d y . ^ F o r Bach, t o o , I n f l a t i o n i s as much a
p o l i t i c a l - s o c i a l phenomenon as an economic and f i n a n c i a l
o n e , and i s e x p re s s e d th ro u g h th e r u U s t r i b u t i o n of incom e,
a s s e t s , and d e b t o r - c r e d i t o r r e l a t i o n s . In d e e d , f o r Bach
( a s f o r W i l l i s and Chapman) m onetary changes a r e more a
m a n i f e s t a t i o n th an a cause of th e u n d e rly in g p e r s i s t e n t
s o c i o - p o l i t i c a l s t r u g g l e f o r l a r g e r income s h a r e s among
m a jo r economic g ro u p s. I n f l a t i o n a r y p r i c e r i s e s become
I n e v i t a b l e as the r i s i n g in co m e-claim s o f m ajor p r e s s u r e
g ro u p s exceed the t o t a l n a t i o n a l o u tp u t a v a i l a b l e a t
c u r r e n t p r i c e s .
For Bach, how ever, i t would seem t h a t th e main new
im p a ct of r e c e n t i n f l a t i o n ( i . e . , betw een 1932 and 1953)
was n ot so much the r e d i s t r i b u t i o n among d i f f e r e n t groups
and c la s s e s b u t the l a r g e t r a n s f e r o f w e a lth from "house
h o ld s " to g o v ern m en t, v i a governm ent d e b t . However, th e
-^George L eland Bach, I n f l a t i o n (P ro v id e n c e ; Brown
U n iv e rs ity P r e s s , 1 9 5 8 ), p a s s im .
377
b e n e f i t s o f t h i s i n c r e a s e d governm ent d e b t and i n f l a t i o n
a p p e a r t o have gone more t o (a) th e b u y in g p u b l i c i n
g e n e r a l and t o w a g e -e a rn e rs and o t h e r "m ajo r" econom ic
g ro u p s in p a r t i c u l a r , r a t h e r th a n t o (b) t h e s a v e r s of th e
community ( e . g . , h o l d e r s o f governm ent bonds and money) and
o t h e r " p a s s i v e " g ro u p s such as th e a g e d , th e r e t i r e d ,
u n i n c o r p o r a t e d b u s i n e s s e s , and em ployees o f governm ent and
c h a r i t a b l e i n s t i t u t i o n s .
A m ajo r s o c i a l phenomenon. — As f o r t h e f u t u r e , Bach
s e e s i n f l a t i o n as a c o n tin u in g "m ajo r s o c i a l phenomenon"
f o r a t l e a s t th e n e x t h a l f c e n t u r y , f o r w hich an e f f e c t i v e
means of p r e v e n t i o n w i l l be l a c k i n g , d e s p i t e g r e a t s t r i d e s
i n p r o d u c t i v i t y . H is r e a s o n s f a l l i n t o t h r e e main g ro u p s .
The f i r s t re a s o n c o n c e rn s th e enhanced r o l e o f
g o v e rn m e n t, e x p re s s e d p a r t i c u l a r l y in (a ) t h e f u l l -
employment commitment and th e b e l i e f t h a t s u f f i c i e n t
governm ent sp e n d in g w i l l r e a l i z e t h i s g o a l , and (b) th e
i n c r e a s i n g a ssu m p tio n by governm ent of r e s p o n s i b i l i t y , f o r
t h e w e lf a r e of th e p u b l i c , so t h a t no a d m i n i s t r a t i o n w i l l
h e e d l e s s l y sto p o r c u r t a i l th e s e a c t i v i t i e s .
R e la te d to th e s e expanded r e s p o n s i b i l i t i e s i s th e
t e r m i n a t i o n of th e g o ld s t a n d a r d w hich— i n t h e ab sen c e o f
a s u b s t i t u t e c o n t r o l mechanism— s i g n i f i e s th e grow ing
b e l i e f t h a t governm ent e x p e n d i t u r e s beyond i t s re v e n u e s
s h o u ld n o t be r e s t r a i n e d by a m onetary s t a n d a r d t h a t
378
s e r v e s t o check th e q u a n t i t y of money and i n f l u e n c e s th e
flo w s o f g o ld a t home and a b ro a d .
The seco nd r e a s o n c o n c e rn s i n s t i t u t i o n a l and
s t r u c t u r a l c h a n g e s, p a r t i c u l a r l y th e i n c r e a s e d p o l i t i c a l
and econom ic s t r e n g t h of m a jo r s o c io -e c o n o m ic groups (such
as th e l a b o r u n i o n s ) and th e i n c r e a s i n g l y a d m i n i s t e r e d
s t r u c t u r e o f p r i c e s . These chang es a re r e f l e c t e d i n
g r e a t e r p r e s s u r e on C ongress from f a r m e rs , w o rk e rs , and
b u s i n e s s f i r m s to p r o t e c t them from th e m ark e t p la c e .
F i n a l l y , Bach p o i n t s t o i n f l a t i o n a r y p r e s s u r e s due
t o th e b u rd en s im posed by th e e x ig e n c ie s of w a r, h o t and
c o ld .
Bach does n o t b e l i e v e th e g u a ra n te e o f f u l l employ
ment i s p o s s i b l e w ith o u t i n f l a t i o n : under t h i s commitment
th e p r i c e l e v e l becomes d om in ated by a k in d o f " t r i l a t e r a l
b a r g a in in g " among w a g e - s e t t e r s , p r l c e - s e t t e r s , and g o v e rn
m ent t o advance t h e i r r e s p e c t i v e money-income claim s a t th e
ex p en se of t h e " n o n - a c t iv e " fix e d -in c o m e g r o u p s , b u t w ith
o u t e x p o sin g t o th e p u b l i c a t l a r g e t h e i r u n d e r l y i n g b i a s
f o r i n f l a t i o n .
Thus t h e unemployment and red u ced s a l e s t h a t m ight
be cau sed by c o s t - p u s h (o f wages and p r i c e s ) can be
e x p e c te d to in d u c e more governm ent sp en din g (even when
r e s t r i c t i v e m onetary c o n t r o l s may a ls o be i n u s e ) , and
t h i s w i l l o n ly s e rv e t o in d u c e s t i l l f u r t h e r e x c e s s i v e
379
in c o m e -c la im s . In t h i s e x p a n s io n a r y e n v iro n m e n t, l a r g e
firm s s e e k in g a d d i t i o n a l fund s f o r e x p a n sio n from i n c r e a s e d
r e t a i n e d e a r n in g s r a t h e r th a n from th e c a p i t a l m a rk e ts w i l l
i n t e n s i f y th e p r e s s u r e t o i n c r e a s e t h e i r p r i c e s and
p r o f i t s . Even s m a ll p r o d u c e rs w i l l be l e s s h e s i t a n t to
push p r i c e s up s in c e th ey a t l e a s t escap e th e p u b l ic lim e
l i g h t beamed upon th e l a r g e r f i r m s .
I n c r e a s i n g demands f o r w e lf a r e t o " t a k e c a r e " of
th e w eaker c o m p e tito r s w i l l in v o lv e a f u r t h e r t r a n s f e r of
i n c o m e - d i s t r i b u t i o n p r o c e s s e s from th e m ark et p la c e t o
combined m ark e t-a n d -g o v ern m en t b a r g a i n in g p r o c e s s e s .
The o u t l o o k , h ow ever, i s n o t a l t o g e t h e r h o p e le s s .
As c o u n te r p o is e s and o f f s e t s to t h e s e demand and c o s t
p r e s s u r e s f o r i n f l a t i o n Bach h o ld s out th e f o l lo w in g :
(a) th e s t i l l " p e r v a s i v e " f o r c e s o f c o m p e titio n — from
c o m p e tito r s and s u b s t i t u t e s — which can r e s t r a i n th e
im p u lse s t o r a i s e p r i c e s ; (b) th e " p r o d ig io u s " American
p r o d u c t i v i t y ; (c ) th e p e r s i s t e n c e o f s t r o n g sta b le -m o n e y
b e l i e f s and m o res; and f i n a l l y (d) th e e x i s t e n c e o f la r g e
numbers o f p e o p le who, m ain ly out o f ig n o ra n c e (w hich may
n o t l a s t f o r e v e r ! ) , have n o t y e t le a r n e d how t o g e t i n t o
the a c t , so t o s p e a k , of demanding a " c o n t i n u a l l y r i s i n g
income s h a r e . "
Some c o n c u r r e n t v i e w s . — In c o n c l u s i o n , some
q u o t a t i o n s of s i m i l a r view s on th e n a tu r e o f i n f l a t i o n may
380
be subm itted. Thus the economists of the re c e n t study fo r
the O rganization f o r European Economic C o-operation
emphasize th e " s h e lte rin g " of p ric e s as the reason f o r
t h e i r re c e n t upward movements:
W e are convinced th a t th e most d i f f i c u l t
problems involved in securing g r e a te r s t a b i l i t y
of p ric e s are fundam entally p o l i t i c a l — in the
broad meaning of th a t word. . . .
. . . S t a b i l i t y of p r ic e s r e s u l t s from an
averaging pro cess in which the tendency of some
p r ic e s to r i s e i s o f f s e t by the tendency of o ther
p ric e s to f a l l . I f la rg e groups of p r ic e s are
co n tin u a lly s h e lte re d by one means or a n o th e r from
the fo rc e s t h a t would produce p r ic e d e c lin e s , the
averaging process must y ie ld a b iased r e s u l t in the
upward d ir e c tio n . . . . P o l i t i c a l d e c isio n s p re
v en tin g longer-run p r ic e f l e x i b i l i t y , whatever the
techniques u se d , are p r e j u d i c i a l to th e aim of
g e n e ra l p ric e s t a b i l i t y . !
Even more f o rc e f u l i s the assessm ent o f economist
P. J. S tra y e r :
. . . The is s u e s th a t are most troublesome are
now those of p re ssu re groups and power blocs th a t
have learned to use t h e i r s tr e n g th to g ain a tempo
rary advantage from government. . . .
. . . The danger of the p o l i t i c a l i z a t i o n of
the economy a t the co st of p ro d u c tiv ity remains one
of th e most s e rio u s t h r e a t s . . . .
. . . The problem uppermost i s t h a t of the
lim ite d cap acity of government to be able to s a t i s f y
a l l o f the people a l l of the tim e. . . .
!W illia m F e l l n e r and O th e r s , The Problem o f R i s i n g
P r ic e s ( P a r i s : O r g a n iz a tio n f o r E uropean Economic Co-
o p e r a t i o n , 19 6 1) , p . 12.
381
. . . A ll of us want the f re e se rv ic e s pro
vided by government--few of us lik e to pay the p ric e
re q u ire d . . . . One s o lu tio n is to follow th e path
of i n f l a t i o n . This would r e f l e c t a degree of
p o l i t i c a l i r r e s p o n s i b i l i t y . . . a breakdown in
capacity to govern and a f a i l u r e to reso lv e through
any orderly procedure the b a s ic problem of the d i s
t r i b u t i o n of the t o t a l product of the e c o n o m y . !
Summary and Conclusions
This ch ap ter of a n a ly tic sy n th e s is and development
has i t s e l f c o n s titu te d something of a sum m ary-analysis— a
ra th e r long one, to be su re — so t h a t , ap art from a b i t of
necessary r e p e t i t i o n , i t now remains to note mainly some
om issions.
Very b r i e f l y , th is chapter has attem pted to
accomplish mainly two th in g s : (1) to dem onstrate how i t is
p o ssib le to d e p ic t a g e n e ra liz e d , in te g ra te d i n f l a t i o n
process th a t follow s n e c e s s a rily ( i . e . , i s deducible or
in f e r a b le ) from the a n a ly s is of th e preceding c h a p te rs; (2)
to ex p lain why the i n f l a t i o n process unfolds in the fash io n
describ ed .
In the l a t t e r connection, i t i s now p o ssib le to
s ta te th e follow ing culm inating h y p o th e s is : The peace-tim e
i n f l a t i o n process r e f l e c t s , f o r the most p a r t , 2 the
^ a u l J. S tra y e r , F is c a l Policy and P o l i t i c s (New
York: Harper & B ro th e rs , 1958)* PP. 280 -9 5.
2The ch ief exceptions are (a) th e cases of excess
demand generated by en larg ed government expenditures f o r
r .
382
g e n e r a t i o n of e x c e s s iv e inco m e-claim s and p u rc h a sin g power
( i . e . , e x c e s s iv e in r e l a t i o n t o e x i s t i n g supply c o n d it i o n s )
t o f a v o r th e s e v e r a l t r a n s a c t o r groups in s o c ie ty ( i n c l u d
in g th e w eakest in economic power) and c o n s t i t u t i n g a
m onetary demand t h a t , o v e r th e long r u n , i s ind u ced a n d /o r
s u p p o rte d by th e p o l i t i c a l system (w ith th e a id of monetary-
f i s c a l p o l ic y ) as a means of r e d i s t r i b u t i n g th e n a t i o n a l
income and w e a lth .
In t h i s l i g h t , r i s i n g p r i c e s and i n f l a t i o n a re no
lo n g e r m erely a cause o f th e r e d i s t r i b u t i o n o f income and
w e a lth — as i n th e t r a d i t i o n a l view — b u t may a l s o be
r e g a r d e d as th e outcome of u n d e rly in g p o l i t i c a l - s o c i a l
e f f o r t s a t r e d i s t r i b u t i o n .
As a c o r o l l a r y , th e "hid den" t a x on income and
w e a lth imposed by i n f l a t i o n may be view ed as th e same ty p e
of so u rc e of s o c i o - p o l i t i c a l f r i c t i o n s in th e community as
a re t h e "open" ta x e s ( i . e . , d i r e c t and i n d i r e c t t a x e s ) f o r
ta x p a y in g g ro ups in p a r t i c u l a r . ^ -
d e fe n s e , and (b) s h o r t - r u n r i s e s in p r i c e s due t o p u re ly
c y c l i c a l e v e n t s , such as c a p i ta l - g o o d s booms. A lso
e x c e p te d , o b v io u s ly , i s th e c ase o f w ar-tim e e x c e s s demand
g e n e r a te d by governm ent e x p e n d itu re s f o r war p u rp o s e s .
"^In t h i s c o n n e c tio n see Randolph E. P a u l, T a x a tio n
in th e U nited S t a t e s (B oston: L i t t l e , Brown & C o ., i9 5 * 0»
pp. 7 3 1 - 5 ^ » a n d R o y B lough, The F e d e r a l Taxing P ro c e s s
(New York: P r e n t i c e - H a l l , I n c . , 195 2), pp. 3 -58 .
CHAPTER VII
IMPLICATIONS FOR ANTI-INFLATION POLICY
The p r e s e n t c h a p t e r d i s c u s s e s t h e i m p l i c a t i o n s o f
th e p re c e d in g a n a l y s i s o f th e i n f l a t i o n p ro c e s s f o r
econom ic p o l i c y . One may a g re e w ith J . M. C lark t h a t any
u s e f u l d i s c u s s i o n of a n t i - i n f l a t i o n re m e d ie s or p o l i c i e s
s h o u ld f i r s t of a l l acknow ledge th e n eed t o s u i t th e
p o l i c i e s to th e "k in d and d e g re e of i n f l a t i o n " u n d e r con
s i d e r a t i o n . 1
ft
Thus one o f th e t a s k s o f t h i s c h a p t e r i s a r e
e x a m in a tio n o f th e i n f l a t i o n p r o c e s s d i s c u s s e d above in
term s of th e ty p e s o f econom ic m e a su re s— m o n e ta r y , f i s c a l ,
and o th e r w is e — l o g i c a l l y c a l l e d f o r in th e r e a l i z a t i o n o f
p r i c e s t a b i l i t y . However, as C la rk p o i n t s o u t, f o r m a tio n
o f a n t i - i n ' • i t i o n p o l i c y i n v o lv e s c o n s i d e r a t i o n o f a l l t h e
k in d s of e f f e c t s ( d i r e c t and i n d i r e c t ) t h a t i t may cause o r
in d u c e In a g iv e n type of i n f l a t i o n , i n c l u d i n g any p o s s i b l e
" u n d e s ir e d b y - p r o d u c t s ."
T h is b r in g s up a n o th e r m a t t e r o f co ncern t o t h i s
c h a p t e r : th e r e l a t i v e p r i o r i t i e s of p r i c e s t a b i l i t y and
^"John M aurice C la r k , The W age-P rice Problem (New
York: American B ankers A s s o c i a t i o n , I 9 6 0 ) , p. 4'7.
383
the o th er major economic g o a ls. I t has become commonplace
fo r w rite rs on a n t i - i n f l a t i o n p o lic y to r e f e r to c o n f lic ts
among the th re e major g o a ls -- o f employment, growth, and
p ric e s t a b i l i t y — when any one of them is pursued ex c lu
s iv e ly or at the expense of the o th e rs . A p e r tin e n t
example is the unemployment th a t may r e s u l t from a p u rs u it
of p ric e s t a b i l i t y " a t any cost" in the case of a cost-push
i n f l a t i o n . A d e c isio n concerning the degree of compromise
in the p ric e o b je c tiv e re q u ire d to c a te r to the employment
o b je ctiv e impinges upon the co n s id e ra tio n of value judg
ments im plied by the re s p e c tiv e o b je c tiv e s , a m a tte r
beyond the scope of the p rese n t study.
The d isc u ssio n of p o licy im p lic a tio n s w ill gener
a l ly proceed on two le v e ls . One in v o lv es th e im p lic a tio n s
f o r p o lic ie s seeking to a f f e c t th e causes or s tim u li of
i n f l a t i o n , p a r t i c u l a r l y dem and-pull and cost-push im pulses.
The second group of im p lic a tio n s concerns the response and
environm sntal mechanisms th a t a ls o c o n trib u te s u b s t a n t i a l l y
to the i n f l a t i o n p ro c e ss, p a r t i c u l a r l y when government is
under p ressu re to m aintain employment and demand. A
thorough d isc u ssio n of both la y e rs of im p lic a tio n s would
carry th is study f a r beyond i t s in ten d ed scope, sin c e i t
has sought p rim a rily to in d ic a te th e m u lti- f a c e te d , i n t e r
dependent n a tu re of in f la tio n a r y p re ssu re s and mechanisms,
and se co n d arily to draw und erly in g im p lic a tio n s f o r eco
nomic p o lic y .
385
Problems of I n te r p r e ta t io n and Policy Proposal
This p a r t o f the chapter deals with the rele v an t
problem of the an a ly sis and in te r p r e t a ti o n of the i n f l a t i o n
p ro c e ss, p rep arato ry to a deeper co n sid eratio n of a n t i
i n f l a t i o n p o lic y . I t In d ic a te s some of the main reasons
fo r the lack of agreement among economists on (1) the
causes of s p e c if ic i n f l a t i o n episodes and (2) the types of
a n t i - i n f l a t i o n medicine th a t may be adm inistered, as a
consequence of which th ere has developed what th is study
c a l l s a " s t r a te g ic " approach to the countering of in fla tio n .
The l a t t e r approach is based not only on the a n a ly tic a l
understanding of the mechanics of the i n f l a t i o n process but
on a tendency to invoke the " n a tio n a l i n t e r e s t " as i t s
m otivation. A d isc u ssio n of* the im p licatio n s of th is
approach f o r policy making, however, must await the second
p a r t of t h i s c h a p te r, which centers around the p o lic y
im p lic a tio n s to be drawn from th is study.
Leading Policy Approaches
As an in tro d u c tio n to the follow ing d isc u ssio n , i t
is u se fu l to in d ic a te b r i e f l y the main lin e s of approach
th a t have been suggested f o r p u b lic policy on the p r ic e -
r a is i n g powers of the market economy.^
^The follow ing review is based on Emmette S.
Redford, P o te n ti a l P ublic P o lic ie s To Deal With I n f la tio n
Caused By Market Power, U .S ., Congress, Jo in t Economic
386
M o n e ta ry -fisc a l approach. — Probably most f a m ilia r
i s the g en e ra l c o n tro l or in flu e n c e over aggregate demand
ex e rc ise d ch ie fly through monetary and f i s c a l measures.
The main appeal of t h i s approach i s i t s app aren tly non-
d isc rim in a to ry e f f e c tiv e n e s s .
A second popular lin e of approach, of which th ere
are th re e v a r i a n t s , i s th at th e market economy should be
l e f t to i t s own s e l f - c o r r e c t i v e devices as a means of r e
s tr a i n in g p ric e in c re a s e s . One v a ria n t holds th a t p r ic e -
and w ag e -se ttin g be l e f t to th e conscience and r e s t r a i n t
of labor and management, not. by a retu rn to l a i s s e r - f a i r e
but by re fe re n ce to le g a l stan d ard s of " tr u s te e s h ip " or
r e s p o n s i b ilit y f o r the "public i n t e r e s t " as w ell as to
p riv a te o rg a n iz a tio n a l sta n d a rd s. Another v a ria n t i s the
" c o u n te rv a ilin g power" school of thought which reg ard s the
r i s e of opposing power groups as serving lik e a check and
balance system. The t h ir d v a r i a n t would re ly e x c lu siv e ly
on the "freedom of e n t e r p r is e ," since the l a t t e r would
prevent the prevalence of e f f e c t i v e market power over the
long run.
Reduced p u b lic su p p o rt. — A th ir d approach would go
one ste p f u r th e r and c a l l fo r a s i g n i f i c a n t r e t r e a t from
governmental measures th a t serv e to b o l s t e r or p r o te c t
Com m ittee, Study P a p e r No. 10 (W ashington: U.S. Government
P r i n t i n g O f f i c e , 1959)* PP» **-9.
387
p riv a te market power by means of government p ric e -s u p p o rt
or p r ic e - p r o te c tiv e measures. P o ssib le exceptions include
the minimum wage or farm p ric e supports which, w hile they
may e x e rt in f la t io n a r y e f f e c t s , are not normally regarded
as supports of market power. However, safeguards fo r
u n io n iz a tio n and c o lle c tiv e b arg ain in g r i g h t s , p r o te c tio n s
ag a in st com petition and r a t e re d u c tio n s in re g u la te d
i n d u s t r i e s , p ro te c tiv e t a r i f f s and q u o ta s, r e s a le p ric e
maintenance laws, pro d u ctio n co n tro ls f o r o i l , and govern
ment purchasing and d is p o s a l p o lic ie s ( e s p e c ia lly defense)
are regarded as tending to p r o te c t market power, so th a t
t h e i r removal f o r th is reason might be considered as per se
a n t i - i n f l a t i o n a r y .
A fo u rth approach involves maintenance or r e s t o r a
tio n of com petitive market s tr u c t u r e s through th e a l t e r n a
tiv e avenue of a n t i t r u s t l e g i s l a t i o n , by more a l e r t
d e te c tio n and vigorous enforcem ent, and even in c lu d in g a
r e s tr u c t u r in g of hig h ly co n cen trated and interdependent
i n d u s t r i e s , w ith p o s s ib le a p p lic a tio n s t o labor unions.
A l a s t r e s o r t . —F i n a l l y , to the ex ten t t h a t the
above approaches prove inadequate or unprom ising, th e re is
a tendency to c a l l f o r some type of p u b lic c o n s id e ra tio n —
e i t h e r ex e cu tiv e o r a d m in is tra tiv e — of s p e c if ic wage and/or
p ric e in c r e a s e s , such as proposed by th e O'Mahoney an<
Reuss-Clark b i l l s .
388
Before proceeding, i t may be noted th a t the mere
l i s t i n g of these measures serves to r e f l e c t b asic economic
and p o l i t i c a l r e a l i t i e s a f fe c tin g the form ulation and
implementation of a n t i - i n f l a t i o n p o lic y . Thus, they
r e f l e c t the f a c t th a t some of th e o b je ctiv es encompassed by
p u b lic p o lic y — such as employment, growth, income d i s t r i b u
t i o n , defense and conservation--may not harmonize with the
p r i c e - s t a b i l i t y o b je c tiv e . For public o f f i c i a l s t h i s
c re a te s the problem of (a) determ ining r e la tiv e p r i o r i t i e s
among c o n f lic tin g o b je c tiv e s and thereupon (b) achieving a
f e a s ib le balance of means used to r e a l iz e a given o b je ctiv e
such as s ta b le p r ic e s . U ltim ate ly , however, the p o l i t i c a l
r e a l i t i e s and powers of s p e c ia l i n t e r e s t groups demanding
supports or p ro te c tio n may be g reat enough to prevent
government from doing anything more than paying lip serv ice
to the p ric e o b je c tiv e .
Problems of Data I n te r p r e ta t io n
As in d ic a te d above, the most obvious approach to
the task of p re s c rib in g a n t i - i n f l a t i o n policy involves
f i r s t a determ ination of the nature ( i . e . , causes) and
mechanics of the i n f l a t i o n p ro cess, on the b a s is of which
a policy can be proposed. W riters on in f la t io n tend to
proceed in t h i s fash io n . The problems th a t a r is e are
th e re fo re not so much of a procedural nature but r e l a t e to
the disagreem ents among economists as to (a) the a n a ly sis
389
and in te r p r e t a ti o n of s p e c if ic i n f l a t i o n episodes and (b)
th e prem ises, value judgm ents, and s o c ia l p r i o r i t i e s under
ly in g the p o lic ie s proposed.
Some b asic im p lic a tio n s .--W ith re s p e c t to the f i r s t
v a r ie ty of problems— a n a ly s is and i n t e r p r e t a t i o n — the
p re se n t study has served to illu m in a te why i t is p o ssib le
f o r economists to d isag ree on the i n t e r p r e t a t i o n of a
p a r t i c u l a r e p iso d e, although they may a l l possess roughly
eq u a l access to the same re le v a n t in fo rm atio n . Two of th e
b a s ic a lly im portant conclusions of t h i s study re le v a n t to
t h i s point have been (1) the underlying interdependence and
i n t e r r e l a t i o n s h i p of the key i n f l a t i o n v a ria b le s of money,
demand, and c o sts (wages and p r i c e s ) , and (2) the conse
quent need to broaden the concept of the "cause" of i n f l a
t i o n to embrace tran sm issio n and enabling or supportive
f a c to r s as w e ll as " i n i t i a l " s tim u li.
For example, an understanding of th e underlying
interdependence of i n f l a t i o n ’ s v a ria b le s h elp s us see th a t
th e two dominant th e o rie s o f i n f l a t i o n , demand-pull and
co st-p u sh , bo th seem to Involve the same m echanical process
by means of which the i n i t i a l stim ulus can u ltim a te ly lead
to a ris e in p r ic e s . Thus i t was shown t h a t excessive
demand of whatever o rig in depends no le s s than excessive
wages or p r o f i t s on the co st and p ric in g mechanisms of the
economy in o rd e r to e f f e c t a p rice r i s e . That i s , in the
390
r e a l world, excess demand does not a u to m a tic a lly e x e rt
p r i c e - r a i s i n g e f f e c t s but must w ait f o r price-m akers or
a d m in is tra to rs (of lab o r unions as w ell as business firm s)
to acknowledge i t in the form of c o s t- r a i s in g responses
such as c o s t - o f - l i v i n g e s c a la tio n and markup maintenance.
I t i s no coincidence t h a t excess demand models
n e c e s s a r ily assume co n d itio n s of f u l l employment as the
environment making p ric e r i s e s in e v ita b le : when the
economy f u l l y employs i t s la b o r and equipment, an in c re a se
in demand i s t h e o r e t i c a l l y expected to induce only a
response in p r ic e s , because of the c e ilin g s on output and
employment. But t h i s assumes firm s w ill au to m a tic a lly and
immediately acknowledge and respond to the excess demand by
r a i s i n g t h e i r p r i c e s , thereby " r a ti f y in g " t h i s in f l a t i o n a r y
p re s s u re . That i s , since in the r e a l world I t is the
p r ic in g mechanism of firm s t h a t gives e f f e c t to ex cess-
demand im pulses, p ric e makers are expected to a u to m a tica lly
recognize and pass along the I n f la tio n a r y p re ssu re of
excess demand In the form of a p ric e In c re a s e .
Furtherm ore, even in the case of l e s s - t h a n - f u l l
employment, where th e expected t h e o r e t i c a l response to
excess demand i s an in c re a se In output and employment
r a t h e r than r i s i n g p r i c e s , the r e a l world may disappoint
such e x p e c ta tio n s by inducing in c re ase d wages and p ric e s
( i . e . , a cost-push) r a t h e r than or in a d d itio n to an
391
expansion of o u tp u t, as exem plified by the c y c lic a l boom of
1 9 5 5 -1 9 5 7 .1
The concept of cause. — With r e s p e c t to the need fo r
a broader concept of "cause," i t was seen th a t in ad d itio n
to th e usual c a te g o rie s of (a) excess-demand i n f l a t i o n — in
which consumers and government on the one hand seek to
in c re a se t h e i r aggregate re a l expenditures fo r products and
se rv ic e s at a f a s t e r r a t e than r e a l output (a t constant
p r i c e s ) , or producers on the o th e r hand seek to increase
output a t a f a s t e r r a te than th e current supply of resources
and s t a t e of technology perm it— and (b) cost-push or
"incom e-share" i n f l a t i o n —a r i s i n g out of the s o c ia l
jockeying of la b o r and other groups to m aintain t h e i r r e a l
incomes at a h ig h e r le v e l than the r e a l output of so ciety
can support— th e re were also im portant co n trib u tin g
f a c to r s such as response mechanisms and environmental
i n s t i t u t i o n s which also served to d e te r or augment the
impact of o r ig in a l stim u li and th e re fo re also c o n s titu te d
s ig n ific a n t determ inants of th e u ltim ate p rice rises*
As a consequence of th e se two broad co n sid eratio n s
i t was necessary to view the i n f l a t i o n process as a
^Economist James R. S ch le sin g er b e lie v e s cases of
Keynesian " s e m i-in fla tio n " (discussed in Chapter i i i ) are
very lik e ly to occur long b e fo re f u ll employment has been
reached; see h is "The Role of th e Monetary Environment in
C o s t-I n f la tio n ," The Southern Economic J o u r n a l, XXIV
(J u ly , 1957), P. 25.
392
lo n g - r u n e v e n t , sp a n n in g a tim e p e r i o d s u f f i c i e n t l y lo ng t o
encompass th e c o n t r i b u t i o n s made to th e u l t i m a t e p r i c e r i s e
by a l l r e l e v a n t p a r t i c i p a t i n g f a c t o r s .
D i f f e r e n c e s i n i n t e r p r e t a t i o n . — Thus i t i s n o t s u r
p r i s i n g to f i n d t h a t d i f f e r e n c e s i n th e i n t e r p r e t a t i o n o f
s p e c i f i c i n f l a t i o n e p is o d e s may be a t t r i b u t e d t o one or
more o f th e f o llo w in g r e a s o n s : th e y may be due t o in a d e
q u a te a n a l y s i s ( i . e . , a f a i l u r e t o f u l l y r e a l i z e th e i n t e r
d e p en d e n t n a tu r e of th e i n f l a t i o n p r o c e s s ) , which i n t u r n
c r e a t e s two ty p e s o f d i f f i c u l t i e s : (a ) on th e one h a n d , i t
makes i t very d i f f i c u l t to draw c o n c lu s io n s from p u r e ly
a g g r e g a t i v e s t a t i s t i c a l d a ta , and (b) on th e o t h e r h a n d , i t
l e a d s t o c o n c lu s io n s b ased on in a d e q u a te o r in c o m p le te
i n f o r m a ti o n as r e f l e c t e d , f o r exam ple, i n th e d i f f e r e n c e s
i n t i m e - p e r i o d s j, o r d a t i n g s u s e d . With r e s p e c t t o p o l i c y
p r o p o s a l s , e c o n o m is ts may a l s o d i f f e r i n t h e i r h y p o th e s e s
c o n c e rn in g th e s e n s i t i v i t y o f p r i c e s and wages t o changes
i n demand.
Ex p o s t a g g r e g a t e s . — F o r exam ple, ex p o s t s t a t i s t i
c a l d a t a on a g g re g a te wages and p r o d u c t i v i t y ( e . g . , o u tp u t
p e r m an-hour) r e v e a l t h a t d u r in g th e 1 9 5 0 *s th e fo rm e r had
i n c r e a s e d f a s t e r th a n th e l a t t e r ; from t h i s com parison t h e
c o n c lu s io n i s o f t e n drawn t h i s i s e v id e n c e t h a t c o s t - p u s h
was th e p red o m in an t cause of i n f l a t i o n . A c t u a l l y , t h i s
r e l a t i o n s h i p betw een wages and p r o d u c t i v i t y does n o t p e r se
393
r e v e a l th e t r u e u n d e r ly in g n a tu r e o r cause of t h e I n f l a t i o n .
Any s u s t a i n e d r i s e I n p r i c e l e v e l , r e g a r d l e s s o f i t s u n d e r
l y in g c a u s e s , would y i e l d s t a t i s t i c s showing wage r a t e s
r i s i n g f a s t e r th a n p r o d u c t i v i t y . Any p ro lo n g e d r i s e i n
wages above two o r t h r e e p e r c en t a y e a r — I n r e a l i t y i t may
be much g r e a t e r — would be In e x c e s s o f th e h i s t o r i c a l r a t e
o f p r o d u c t i v i t y g r o w t h .1
Even i n th e case of pure d em a n d -p u ll i n f l a t i o n ( i n
a w o rld o f p e r f e c t l y c o m p e titiv e m ark e ts and no l a b o r
u n i o n s ) , th e demand f o r f a c t o r s would become e x c e s s i v e and
wages would e v e n t u a l l y r i s e f a s t e r th a n p r o d u c t i v i t y ;
in d e e d , t h i s phenomenon i s th e e s s e n t i a l mechanism by which
an I n i t i a l " i n f l a t i o n a r y gap" i s p e r p e t u a t e d .
A s i m i l a r ty p e of r e a s o n i n g c o u ld , w ith e q u a l
i n v a l i d i t y , c i t e a s " p ro o f" o f d e m an d -p u ll i n f l a t i o n th e
f a c t t h a t m onetary e x p e n d i tu r e s r o s e f a s t e r th a n a g g r e g a te
o u t p u t , o r t h a t money su p p ly o r i t s v e l o c i t y had i n c r e a s e d .
Wages v e rs u s p r o f i t s . --N o r a re ex p o st d a ta on th e
w a g e s - v e r s u s - p r o f i t s sh a re of o u tp u t a c o n c lu s iv e I n d i c a t o r
o f th e cause o f i n f l a t i o n . F o r exam p le, i n th e c ase o f an
I n f l a t i o n i n i t i a t e d by l a b o r 's a tte m p t to r a i s e r e a l wages
•^On t h i s p o in t se e C h a rle s L. S c h u l t z e , R ecent
I n f l a t i o n In th e U n ite d S t a t e s , U .S ., C o n g re ss, J o i n t
Economic C om m ittee, Study P a p e r No. 1 (W ashington: U.S.
Government P r i n t i n g O f f i c e , 1 9 5 9 ), PP« 7, 1 8 -1 9 , 2 6 -2 7 , 3 1 ,
and F r i t z M achlup, "A n o th er View of C o st-P u sh and Demand-
P u l l I n f l a t i o n , " The Review of Economics and S t a t i s t i c s ,
XLII (May, I 9 6 0 ) , pp. 126-29.
394
f a s t e r than p ro d u c tiv ity : I f ex an te markups remain
unchanged, and raw m a te ria l p rice s follow o th e r prices
upward, then lab o r would f a i l to achieve i t s o b je c tiv e
(except to the e x te n t th a t a lag may cause some r e d is t r ib u
tio n to labor) but the ex post data would not r e f l e c t i t s
role as a stim ulus.
Sometimes the comparative r a t e s or sh a re s of wages
and p r o f i t s are used as a b a sis fo r determ ining whether
demand-pull has been the most a c tiv e force. The reasoning
i s as follow s: since an expansion o f demand (without a
wage-push) would p u ll up product p r ic e s and in c re a se
p r o fits (and p r o f i t r a te s ) u n t i l wage rates were also
pulled up by the derived demand fo r labor, th e apparent
ris e In consumer p ric e s and p r o f i t s and lagging wage r a t e s
would In d ic a te th e ex isten ce of demand-pull I n f l a t i o n .
This th e o ry , however, ap p lie s only to an economy
in which most p r ic e s are determined by autonomous market
forces and not to an economy o f m ostly adm inistered p r ic e s :
in the l a t t e r ca se , the s t a t i s t i c a l In d ic a to rs could show
the same r e s u lts as above but would be based on a t o t a l l y
d if f e r e n t "cause"— an enlargement of p ro fit margins by
price a d m in istra to rs r a th e r than an autonomous demand
expansion. Hence a lead by p r o f i t r a t e s would per se n o t
be an adequate I n d ic a to r of dem and-pull, since i t might
also s ig n ify a cost-push by p ric e makers.
395
Some o th e r symptoms. — Some w rite r s reg ard as a
r e l i a b l e symptom of demand-pull I n f l a t i o n th e e x iste n c e of
"over-employment" and overtime payments. The over
employment symptom would be measured by the excess of job
vacancies over job a p p l ic a tio n s , and overtim e pay by a
comparison of average hourly earn in g s with wage r a te s .
This approach, however, does not r u le out the p o s s i b i l i t y
th a t cost-push may a ls o have c o n trib u te d to the p rice r i s e .
I t i s even p o ssib le th a t a cost-push a c tu a lly i n i t i a t e d the
process and th a t compensatory monetary and f i s c a l programs—
by expanding demand in o rd e r to prevent the th rea ten e d
unemployment—may have overcompensated, proving la rg e r than
was r e a l l y n e c e ssary . Thus, while the s t a t i s t i c a l d a ta
could v e r if y the expansion of demand, they cannot prove
th a t excess demand p r e c i p i t a t e d the i n f l a t i o n of consumer
p r i c e s .
Nor can the mere tim ing or sequence of wage and
p ric e in c re a se s serve by them selves as evidence of th e
cause of th e i n f l a t i o n ep iso d e. For example, Chapter v i
r a is e d the g e n e ra l qu estio n of how I s i t p o ssib le to d e t e r
mine whether p ric e s o r wages had in c re a se d " f i r s t . ”
" F i r s t " since which date? I f p ric e s and wages had been
r i s i n g In a leap fro g g in g p a t t e r n , th e choice of a base or
re fe re n c e date would be e s s e n t i a l l y a r b i t r a r y and so would
be the blame assig n ed to the " i n i t i a t o r , " whether i t be
p r ic e s or wages.
396
S im ila rly , to i n f e r th a t demand-pull or wage-push
had i n i t i a t e d the r i s e in p r ic e s from a comparison of the
in c re a se in money-wage ra te s w ith consumer p r ic e s also
involves an a r b i t r a r y choice of base d a te s . Even more
Im portant: since annual increm ents in p r o d u c tiv ity
norm ally enable in c re a s e s in r e a l wages over the long ru n ,
i t is reasonable to expect th a t wage r a t e s would r is e
f a s t e r than consumer p r ic e s , re g a rd le s s of whether p ric e s
had in c re ase d due to dem and-pull or wage-push.
Another example: in case firms had marked up
p ric e s mainly in response to r i s i n g wages, at a time when
an excess demand had f i r s t induced the r i s e in wage r a te s
through i t s impact on th e lab o r m arket, the s t a t i s t i c a l
s e rie s would show an in c re a se in wages preceding the r i s e
in p r ic e s ; y e t i t is known th a t the i n f l a t i o n was a c tu a lly
" i n i t i a t e d " by the excess demand. Indeed, an excess-demand
i n f l a t i o n can and o ften does o p era te by causing the p ric e s
of f a c t o r s of p ro d u ctio n to be b id up, w ith commodity
p ric e s being marked up in response th e re to .
S im ila rly , a w age-price s p i r a l t h a t occurs at a
time when excess demand seems no longer o p e ra tiv e , and i s
th e re fo r e a t t r i b u t e d to wage r a t e s r i s i n g f a s t e r than
p r o d u c tiv ity , may a c tu a lly have o r ig in a te d also In p r ic e -
in c re a s e s th a t had been " in h e rite d " from the preceding
p erio d of excess demand. Although the e a r l i e r excess
397
demand has vanished, the downward i n s e n s i t i v i t y of p r ic e s
and wages to the sag in demand has r e s u lte d in a continua-
t i o n of th e s p ir a l even a f t e r the i n i t i a l i n f l a t i o n
p re ssu re has gone. Such a com bination of c o n d itio n s may
have c o n trib u te d to the 1955-1957 i n f l a t i o n .
In the same v e in , a c o s t-p r ic e s p i r a l i s not proof
p e r se o f a cost-push i n f l a t i o n . A p u rely excess-demand
i n f l a t i o n , to o , could induce a continuing c o s t-p r ic e r i s e
i f , once the i n i t i a l excess demand had been i n j e c t e d , r e a l
demands were somehow subsequently m aintained by induced
in c re a s e s in wages ( i . e . , c o s t - o f - l i v i n g e s c a la tio n ) and
p r i c e s .
The S e n s it iv ity of P rices and Wages
Even i f economists could agree upon the "cause" of
the I n f l a t i o n process as much as they did on th e mechanics
of i t s o p e ra tio n — t h a t i s , t h a t p ric e r is e s occur v ia a
c o st and markup mechanism ( in which p ric e s and wages are
both se t w ith re fere n c e to c o s t s ) — they would n o t
n e c e s s a r ily agree upon the s e n s i t i v i t y or resp o n siv en ess of
p r ic e s and wages ( i . e . , c o s ts ) to changes in demand.
Skepticism about t h i s degree of s e n s i t i v i t y Im plies a
doubt about the s u i t a b i l i t y of using dem and-depressing
t
monetary and f i s c a l to o ls as a means of c o n tro llin g p n
and wage movements.
398
R elevance f o r m o n e t a r y - f i s c a l p o l i c y . — F o r In s ta n c e ,
i t i s argued by C. L. S c h u ltz e t h a t i f p r i c e s and wages a re
g e n e r a l l y b e li e v e d t o behave v e ry s e n s i t i v e l y , th e n
eco n o m ists co uld a g ree t h a t m onetary and f i s c a l p o l i c y can
be d e sig n e d t o a c h ie v e p r i c e s t a b i l i t y by sim ply a f f e c t i n g
a g g re g a te demand (and o u tp u t) in th e d e s i r e d d i r e c t i o n ,
w ith o u t n e c e s s a r i l y i n v o lv in g s u b s t a n t i a l unemployment.
That i s , i n f l a t i o n could n o t c o n tin u e b e ca u se th e e x cess
c a p a c ity and unemployment in d u ced by th e p r e v e n t io n of
excess demand would s e rv e t o h a l t any r i s e i n p r i c e s ,
u n le s s th e e x c e ss demand were somehow c o n s t a n t l y renew ed.
The e x t e n t of ren ew al o f th e e x c e s s demand i n th e fa c e of
r i s i n g p r i c e s would depend p a r t i c u l a r l y on such i n d i r e c t
f a c t o r s as th e d eg ree o f ta x p r o g r e s s i o n and th e t i g h t n e s s
of money s u p p l y . 3-
On the o t h e r h a n d , i f p r i c e s and wages a r e re g a rd e d
as r e l a t i v e l y i n s e n s i t i v e t o m oderate changes in demand
( i . e . , were " in d e p e n d e n tly " or "au to nom o usly" d e te r m in e d ) ,
th e co nverse would h old t r u e . In t h i s c a s e , how ever, th e
r e s t r i c t i v e m onetary and f i s c a l p o l ic y and th e i n d i r e c t
i n f l u e n c e s of t a x p r o g r e s s i v e n e s s and t i g h t e r money would
d e term in e n o t how la r g e th e p r i c e r i s e would be b u t how
much e x c e s s c a p a c i ty and unemployment th e y would g e n e r a t e .
■ ^O n t h i s d i s c u s s i o n see S c h u l t z e , op. c i t . ,
pp. 1 - 7 , 1 8 -2 0 , 30, 39, 40-42.
399
In o t h e r w o rd s , sa y s S c h u l t z e , th e more s e n s i t i v e
o r r e s p o n s iv e p r i c e s and wages a re t o changes i n demand,
th e more c a p a b le i s m o n e t a r y - f i s c a l p o l i c y o f p r e v e n t i n g
p r i c e r i s e s r a t h e r t h a n in d u c in g d e c l i n e s of o u tp u t and
employment. C o n v e rs e ly , th e g r e a t e r t h e i n s e n s i t i v i t y o f
p r i c e and wage m arkups t o e x c e s s c a p a c i t y and unemploym ent,
th e g r e a t e r th e i n f l a t i o n a r y p o t e n t i a l . F u rth e rm o re , t o
th e e x te n t t h a t p r i c e s and wages are more f l e x i b l e upward
in re s p o n s e t o i n c r e a s e s i n demand t h a n they a r e in t h e
downward d i r e c t i o n i n re s p o n se t o d e c r e a s e s i n demand,
t h e r e a r i s e s o v e r th e long ru n an "asym m etry" i n b e h a v io r
t h a t may e x p l a i n th e s e c u l a r upward b i a s o r " c r e e p " o f
p r i c e s .
H ypotheses a b o u t s e n s i t i v i t y . — A ccording to
S c h u l tz e , th e c l a s s i f i c a t i o n o f d em a n d -p u ll and c o s t- p u s h
t h e o r i e s o f th e i n f l a t i o n p r o c e s s may be a t t r i b u t e d t o
d i f f e r e n c e s i n t h e i r p o s t u l a t e s about th e s e n s i t i v i t y o r
r e s p o n s i v e n e s s o f p r i c e s and wages t o changes i n demand.
He r e g a r d s i n f l a t i o n t h e o r i e s as c o m p risin g a "sp e c tru m " on
w hich th e p o s i t i o n of any p a r t i c u l a r th e o r y i s d e te rm in e d
by th e d e g re e o f s e n s i t i v i t y i t p o s t u l a t e s c o n c e rn in g th e
b e h a v io r o f p r i c e s and wages. The g r e a t e r th e d e g re e o f
" in d e p e n d e n c e " a s s i g n e d to d e c i s i o n s o v e r p r i c e s and wages
from th e i n f l u e n c e o f demand, th e c l o s e r th e t h e o r y comes
t o th e c o s t- p u s h end o f th e sp e c tru m ; and v ic e v e r s a ,
400
o f c o u rs e , In th e case o f d e m a n d -p u ll t h e o r i e s .
Toward th e s e n s i t i v e extrem e o f th e sp e c tru m , where
p r i c e s and wages a r e c h a r a c t e r i z e d c h i e f l y by r e s p o n s i v e
n e s s to demand, s t a n d such t h e o r i e s as F rie d m a n 's which do
n o t r e g a r d th e c o s t- p u s h power of o r g a n iz e d g r o u p s , i n th e
absen ce o f ex a n te e x c e ss demand, as e m p i r i c a l l y s i g n i f i
c a n t . Only when demands i n th e a g g r e g a te a re e x c e s s iv e can
t h e g e n e r a l l e v e l o f p r i c e s be e x p e c te d to r i s e , and any
i n c r e a s e i n c o s t s — t o which wages and p r i c e s a r e a l s o
r e s p o n s i v e — would d e r i v e fu n d a m e n ta lly from th o s e e x c e s s iv e
dem ands.
? Toward th e o t h e r end o f th e sp ectru m a re t h e o r i e s
l i k e S l i c h t e r ' s w hich c la im t h a t p r i c e d e t e r m i n a t i o n ,
p a r t i c u l a r l y of w ag es, i s w i t h in a s u b s t a n t i a l ran g e i n s e n
s i t i v e t o t h e s t a t e o f a g g r e g a te demand, so t h a t i t would
t a k e a l a r g e d e g re e o f e x c e s s c a p a c i ty and unemployment to
r e s t r a i n t h e p r i c e c re e p . The i m p l i c a t i o n i s t h a t u n d er
c o n d it i o n s of r e l a t i v e l y f u l l em ploym ent, even w ith o u t
e x c e s s demand, a s e c u l a r r i s e in p r i c e l e v e l i s i n e v i t a b l e .
F i n a l l y , somewhere i n th e m id d le ran g e of th e
sp e c tru m S c h u l tz e p l a c e s t h e o r i e s l i k e B a c h 's i n which (a)
w h ile i t i s n o t r e a l i s t i c t o e x p e c t a s u s t a i n e d r i s e in
wages in t h e f a c e o f l i m i t e d demand e x p a n s io n , (b) th e
d e g re e o f demand r e s t r i c t i o n r e q u i r e d t o weaken th e c o s t -
o r i e n t e d n a t u r e of p r i c e s (g iv e n th e c u r r e n t m ark et
M01
s t r u c t u r e ) i s p ro b a b ly to o l a r g e t o be c o m p a tib le w ith a
p o l i c y o f c o n tin u o u s f u l l employment and econom ic gro w th.
U n t i l f a i r l y r e c e n t l y , S c h u ltz e c o n c lu d e s , most
t h e o r i e s o f i n f l a t i o n were o f the d em a n d -p u ll t y p e ,
e m p h a siz in g t h e r o l e o f e x c e s s i v e m onetary demand and t h e
s e n s i t i v i t y o f p r i c e s and wages to changes in demand. The
"new i n f l a t i o n " s c h o o l o f c o s t - p u s h t h e o r i e s , on th e o t h e r
h a n d , i s o f more r e c e n t v i n t a g e , a t t r i b u t i n g p r i c e in c re a se s
t o autonomous upward movements in a d m i n i s t e r e d wages and
p r i c e s , movements t h a t w ould p e r s i s t even i n t h e fa c e o f
s l a c k demand, as i n r e c e n t r e c e s s i o n s .
In summary, S c h u ltz e s t a t e s t h a t s in c e (a ) th e
e s s e n t i a l d i f f e r e n c e betw een d e m a n d -p u ll and c o s t- p u s h
e x p l a n a t i o n s o f i n f l a t i o n t u r n s out to be a d i s p u t e o v e r
t h e d egree o f e x c e s s c a p a c i t y and unemployment c o n s id e r e d
n e c e s s a r y t o weaken th e c o s t - o r i e n t e d n a tu r e o f p r i c e and
wage d e c i s i o n s , (b) t h i s d i s p u t e i n t u r n may be viewed as
a d e b a te o v e r th e c o m p a t i b i l i t y of f u l l employment and
p r i c e s t a b i l i t y o b j e c t i v e s .
P o lic y i m p l i c a t i o n s . — What a r e th e i m p l i c a t i o n s o f
t h i s sp e c tru m f o r p o l ic y m aking? In t h i s c o n n e c tio n
S c h u ltz e a s s e r t s t h a t th e a n t i - i n f l a t i o n p o l i c i e s p ro p o se d
by e c o n o m is ts fo llo w more o r l e s s d i r e c t l y from t h e i r
t h e o r e t i c a l p o s t u l a t e s a b o u t th e s e n s i t i v i t y o f p r i c e s and
wages to demand c o n d i t i o n s .
k02
The p o l i c i e s p ro p o se d by th o s e who a n a ly z e modern
i n f l a t i o n p r o c e s s e s i n term s o f d e m a n d -p u ll g e n e r a l l y f a l l
i n t o two g ro u p s . In one g ro u p , c o s t - d e t e r m i n e d wages and
p r i c e s a r e n o t r e g a r d e d as s i g n i f i c a n t a n d , t h e r e f o r e ,
e x c e s s a g g r e g a te demand can be a t t r i b u t e d m a in ly to
e x c e s s i v e l y e x p a n siv e m o n e t a r y - f i s c a l p o l i c y . C o n tr o l o f
th e l a t t e r would a s s u r e c o n t r o l o f th e i n f l a t i o n p r o c e s s
w ith o u t d e t r a c t i n g from f u l l employment.
The o t h e r g ro u p , how ever, b e l i e v e s t h a t c o s t -
d e te rm in e d wages and p r i c e s have been " a p p ro x im a te ly "
r e s p o n s i b l e f o r r e c e n t i n f l a t i o n i n th e U n ite d S t a t e s .
They r e a s o n t h a t g o v e rn m e n t's r e a d i n e s s to a s s u r e f u l l
employment i s r e s p o n s i b l e f o r th e i n s e n s i t i v i t y o f b u s i n e s s
f irm s and l a b o r u n io n s t o demand c o n d i t i o n s ; t h a t i f
governm ent would t h r e a t e n to c o n t r o l a g g r e g a te demand a t a
l e v e l s u f f i c i e n t t o m a in ta in fu11-em ploym ent o u tp u t o nly a t
s t a b l e p r i c e s , th e n b u sin essm en and u n io n l e a d e r s would
r e a l i z e t h a t any c o s t - p u s h e f f o r t s on t h e i r p a r t w i l l
m ere ly r e s u l t i n im m ediate e x c e ss c a p a c i ty and unemployment.
I n o t h e r w o rd s, a few s h a rp to k e n r e c e s s i o n s in d u c e d by
governm ent would presum ably t e a c h b u s i n e s s and l a b o r th e
a p p r o p r i a t e l e s s o n .
C o st-p u sh i m p l i c a t i o n s . — I n c o n t r a s t t o th e demand-
p u l l I m p l i c a t i o n s f o r p o l i c y , th o s e who a n a ly z e r e c e n t
i n f l a t i o n i n term s o f c o s t- p u s h f o r c e s a re m o tiv a te d by th e
403
d e s i r e t o av oid o r p r e v e n t th e "dilem m a" o f unemployment o r
I n f l a t i o n . G e n e ra lly th e y b e l i e v e t h a t t o make c o s t -
o r i e n t e d wages and p r i c e s s u f f i c i e n t l y f l e x i b l e i n th e
downward d i r e c t i o n would r e q u i r e a s u b s t a n t i a l d e g re e of
e x ce ss c a p a c ity and unemployment. To th e e x t e n t t h a t i t
would be c o n s id e r e d u n d e s i r a b l e p u b l i c p o l ic y t o a p p ly
m o n e t a r y - f i s c a l t o o l s on a s c a l e s u f f i c i e n t t o r e s t r a i n
p r i c e i n c r e a s e s by means o f a s i g n i f i c a n t volume of
unemployment— e s p e c i a l l y when t h e r e a lr e a d y e x i s t e d a
g e n e r a l s l a c k in demand, e x c e ss c a p a c i t y , and unem ploym ent—
e c o n o m is ts te n d t o p ro p o se a l t e r n a t i v e o r su p p le m e n ta ry
s o l u t i o n s , two v a r i a n t s o f which a re o u t l i n e d by S c h u l t z e .
To one v a r i a n t S c h u ltz e a s s i g n s w r i t e r s l i k e
S l i c h t e r who, b e cau se o f th e presum ed econom ic and p o l i t i
c a l " f a c t s of l i f e , " b e l i e v e th e s o c i a l c o s t o f a c h ie v in g
p r i c e s t a b i l i t y i s to o g r e a t . They t h e r e f o r e p ro p o se
a c q u ie s c e n c e to a " c r e e p in g " r a t e of i n f l a t i o n , n o t m erely
as th e l e s s e r of two e v i l s but as th e p r i c e t o be p a id f o r
s e c u r i n g f u l l employment and t e c h n o l o g i c a l p r o g r e s s .
To th e o t h e r v a r i a n t b e lo n g th o s e whom S c h u ltz e
c a l l s th e " p u l v e r i z e r s , " who d e s i r e t o r e s o l v e t h e dilemma
o f unemployment o r i n f l a t i o n by s t r e n g t h e n i n g th e a n t i t r u s t
laws and a p p ly in g them more v i g o r o u s l y , i n c l u d i n g l a b o r
where f e a s i b l e . F or t h e s e e c o n o m is ts th e e n fo rc em e n t of
a n t i t r u s t l e g i s l a t i o n would become p r i m a r i l y th e means of
40 4
r e s h a p in g th e b a s i s o f m ark et s t r u c t u r e and power of
i n d u s t r y so as t o make wages and p r i c e s s u f f i c i e n t l y
f l e x i b l e .
I t i s im p o rta n t t o em phasize th e p o i n t S c h u ltz e and
th e o t h e r members of t h e c o s t- p u s h s c h o o l a r e r e a l l y
m aking: t h e i r r e l u c t a n c e to r e l y upon g e n e r a l m onetary and
f i s c a l m easu res as p r i c e - r e s t r a i n i n g d e v ic e s does n o t stem
p r i m a r i l y from d o u b ts a b o u t t h e i r u l t i m a t e e f f e c t i v e n e s s ;
r a t h e r th e y a re n o t w i l l i n g to pay th e s o c i a l c o s t s of
d e p re s s e d o u tp u t and employment t h a t a r e e x p e c te d t o
accompany such m easures i f wage- and p r i c e - s e t t e r s s t u b
b o r n ly c o n tin u e to e x e r t c o s t- p u s h p r e s s u r e s i n t h e fa c e of
d e f l a t i o n a r y f o r c e s . In o t h e r w ords, t h e s e e c o n o m is ts a re
n o t s a y in g t h a t m o n e t a r y - f i s c a l t o o l s a re n o t c a p a b le of
a f f e c t i n g th e mechanism of i n f l a t i o n ( o f e x p a n s io n a ry
demand, w h e th e r caused by d em a n d -p u ll o r c o s t - p u s h ) ; r a t h e r
th e y are s a y in g t h a t i n t h e c o n te x t o f p e r s i s t e n t wage and
p r i c e a g g r e s s io n t h e s e t o o l s can n o t d e t e r th e im p u lse s
to w ard i n f l a t i o n .
The “ S t r a t e g i c " Approach
To th e above two grou ps o f a n t i - c o s t - p u s h p o lic y
a p p ro a ch e s may be added a t h i r d one, which w i l l be r e f e r r e d
to as th e " s t r a t e g i c " a p p ro a c h . I t s m ain p o i n t o f
d e p a r tu r e seems t o be th e a ssu m p tio n s— e x p l i c i t o r I m p l i c i t
— t h a t from th e p o in t o f view o f " s o c i a l c o n t r o l " (a) I t i s
405
n o t e s s e n t i a l t o know p r e c i s e l y what caused o r i n i t i a t e d a
p a r t i c u l a r i n f l a t i o n e p is o d e b ecau se (b ) c o n t r o l of wages
a n d /o r p r i c e s p e r s e ,b y some g o v e rn m e n t-sp o n so red d e v ic e or
ag en c y , may be a p r e f e r a b l e o r su p plem entary means of
a c h ie v in g r e a s o n a b le p r i c e s t a b i l i t y , compared w ith (c) th e
use o f g e n e r a l demand-r e s t r i c t i v e m o n e t a r y - f i s c a l to o ls
t h a t would o n ly compound the problem s a t hand: w ith c o s t -
push fo rc e s p e r s i s t i n g in the f a c e o f s la c k demand, e x c e ss
c a p a c i t y , and unemployment, a f u r t h e r r e d u c tio n of demand
and output w ould more l i k e l y r a i s e u n i t c o s t s — by re d u c in g
p r o d u c t i v i t y — r a t h e r t h a n reduce them by re d u c in g wages and
p r o f i t m a r g i n s .1
W eintraub and w ages. — An o u ts ta n d in g example of
t h i s s t r a t e g i c p o lic y approach i s t h a t o f econom ist S.
W ein trau b , whose r e a s o n in g ru n s as f o l lo w s .^ S in c e i t i s
h a rd t o d e te rm in e from s t a t i s t i c a l a g g re g a te s a lo n e w h eth er
l a b o r or b u s i n e s s is t h e cause of i n f l a t i o n (w hich stu dy he
compares to t h e p r o v e r b i a l d e b a te about the " c h ic k en o r th e
e g g " ) , a s u i t a b l e a l t e r n a t i v e i s the a p p l i c a t i o n of
" c o n j e c t u r a l th in k in g " about th e n a tu r e and s t r e n g t h o f th e
1I b i d . , p. 133.
2Por t h e f o llo w in g d i s c u s s i o n see Sidney W ein trau b ,
A G e n e ra l T heory of t h e P ric e L e v e l. O u tp u t. Income D i s t r i
b u tio n ,. and Economic Growth ( P h i l a d e l p h i a : C h ilto n ' Company,
1959)7 PP. 69-9^« C l a s s i c a l K e y n e sia n ism , M onetary Theory
and th e P r ic e L evel ( P h i l a d e l p h i a : C h ilto n Company, 1 9 6 1 ),
pp. 43-63, 1 4 5 -5 9 , 3 1 1( 1 "Anatomy of th e New I n f l a t i o n , "
C h a lle n g e . X ( J a n u a r y , 1962), pp. 3 9 -4 1 .
406
c h i e f f o r c e s a t work and about th e "symptoms" o f i n f l a t i o n ,
on t h e b a s i s o f which p o l ic y can be d ed uced . Thus
W e in tra u b ’s forem ost p r o p o s i t i o n i s t h a t no s i g n i f i c a n t
r i s e in p r i c e s can o c c u r o r p e r s i s t w ith o u t a s i m i l a r
a s s o c i a t e d re s p o n s e on th e p a r t of w ages. I f wages c o u ld
o n ly be p r e v e n te d from re s p o n d in g s i g n i f i c a n t l y o r even
s l i g h t l y t o a p r i c e r i s e , th e n l a r g e i n f l a t i o n would be
i m p o s s i b l e .
F or exam ple, W ein trau b r e g a r d s th e grow th of t h e
money su p p ly d u rin g t h e 1950’ s as m o d erate compared w ith
t h a t o f th e 1 9 4 0 's , i n s p i t e o f h i g h e r l e v e l s o f o u tp u t and
g ro w in g p o p u l a t i o n . I n c o n t r a s t to th e " f a i r l y I n c o n s p i c
uous r o l e " o f money, W ein trau b n o te s th e c o n tin u in g r i s e of
w a g es, and t h e n r e a s o n s : i f t h e r a t e o f wage i n c r e a s e s
c o u ld be l i m i t e d on t h e a v erag e to n o n - i n f l a t l o n a r y p r o
p o r t i o n s — s a y , to th e same r a t e as a v e ra g e p r o d u c t i v i t y
g a i n s — p r i c e s could re m a in s t a b l e . Even i f , f o r any
r e a s o n , p r i c e s were r i s i n g , any r e s p o n s iv e wage i n c r e a s e s
( e . g . , v i a e s c a l a t i o n ) would m e re ly s e r v e l i k e a "tw o -ed g ed
sw ord" f a n n in g i n f l a t i o n a r y f la m e s — g e n e r a t i n g a w a g e -p u ll
as w e l l as c a u s in g u n i t c o s ts t o r i s e .
C oncludes W e in tra u b : I n th e absen ce o f a re s p o n
s i v e r i s e i n money w a g e s, th e g e n e r a l p r i c e r i s e would be
more l i m i t e d o r te m p o ra ry ; s i n c e r i s i n g money wages a re
a p p a r e n t l y t h e " c e n t r a l f e a t u r e " or "symptom" o f th e
407
i n f l a t i o n , th e y c o n s t i t u t e th e " d e c i s i v e " or " c r u c i a l "
c o n t r o l v a r i a b l e , and wages p o l i c y s h o u ld t h e r e f o r e be
employed as a r e - in f o r c e r a e n t f o r m o n e t a r y - f i s c a l p o l i c y .
I n d e e d , f o r W eintraub t h e r e i s an e s s e n t i a l "o n e n e ss" of
m o n etary p o l i c y and wages p o l i c y : when th e m onetary
a u t h o r i t i e s hav e a wages p o lic y as a " h an d m a id e n ," th ey
w i l l have l e s s f e a r o f , and g r e a t e r freedom f o r , in d u c in g
an e x p a n s io n o f demand and employment w ith o u t i n f l a t i o n .
Why wages a r e c e n t r a l . — Of s p e c i a l n o te a re th e
t h r e e re a s o n s given by W eintraub f o r h i s focus on th e need
to c o n t r o l t h e wage v a r i a b l e . F o r one t h i n g , wages a r e to
be c o n t r o l l e d n o t b e c a u s e th ey a re th e only p ro v en c u l p r i t
in t h e m elodram a, b u t sim ply b e c a u s e , compared t o th e o t h e r
e le m e n ts of t h e i n f l a t i o n p r o c e s s , th e y a re th e " d e c i s i v e
p r i c e l e v e l v a r i a b l e . . . from th e s t a n d p o in t o f s o c i a l
c o n t r o l . S i n c e p ric e - m a k in g d e c i s i o n s r e f l e c t money
c o s t s , i n c l u d i n g w a g e s, and money wages c o n s t i t u t e income
( i . e . , w a g e - p u l l ) , i t i s c l e a r t h a t money wages a re th e
"p rim e mover" f o r th e " b i g jo b s of s h i f t i n g th e p r i c e
l e v e l , and n o t th e o t h e r way a ro u n d . . . . The p r i c e l e v e l
•^Weintraub i s n o t a lo n e on t h i s p o i n t . Says A lv in
H. H ansen: "One can s a y t h a t th e wage l e v e l . . . i s th e
backbone of t h e p r i c e l e v e l . . . . No s o c i e t y can f o r lo n g
E x p e rie n c e i n f l a t i o n i f i t f i r m l y h o ld s th e wage l i n e " ;
see h i s Economic I s s u e s of t h e 1960s (New York: McGraw-Hill
Book Company, I9 6 0 ), p . 9 ~ ,
408
. . . cann ot e x e c u te any l e a p s t o sp eak o f , u n l e s s th e
money wage c a l l s th e t u n e ."
S eco n d , a c c o rd in g t o W eintraub money wages a re n o t
o nly a s t r a t e g i c v a r i a b l e b u t th e y a re th e o n ly f r e e l y
" f l o a t i n g " o r autonomous v a r i a b l e i n th e p r i c e l e v e l e q u a
t i o n kw/A. S ince he presum es th e p r o d u c t i v i t y f a c t o r "A"
and t h e markup f a c t o r "k" a r e c o n s t a n t — b e in g l a r g e l y
"ex ogen ous" and n o t d e te rm in e d by p u r e l y econom ic f o r c e s
su ch as p r i c e s , Incom e, o u t p u t , and employment and t h e r e
f o r e not p r e d i c t a b l e by t h e i n s i g h t s of economic t h e o r y — he
l a t c h e s o n to wages as th e v a r i a b l e t h a t can be h e l d
" c u l p a b le " f o r I n f l a t i o n a r y d e v elo p m e n ts.
F i n a l l y , as a m a t t e r o f p r a c t i c a l p o l i c y , p e r se
c o n t r o l o f t h e money su p p ly would o n ly l e a d t o u n d e s i r a b l e
r e s u l t s , w h ile v e l o c i t y of money i s a p p a r e n t l y beyond
p u b l i c c o n t r o l , and th e same goes f o r th e p r o d u c t i v i t y and
markup f a c t o r s .
To im plem ent a wage p o l i c y , W eintraub a d v o c a te s
f o r m a tio n o f a p u r e ly f a c t f i n d i n g o r " w a tc h -to w e r" ty p e o f
p u b l i c agency t h a t would (a) m o n ito r th e wage agreem ent's
i n v o lv i n g t h e l a r g e r u n io n s , (b) make e s t i m a t e s o f th e
p ro b a b le p r i c e - l e v e l e f f e c t s of n e g o t i a t e d wage b a r g a i n s ,
and (c ) p u b l i s h i t s f i n d i n g s p e r i o d i c a l l y i n o r d e r t o f i l l
c u r r e n t l y e x i s t i n g in f o r m a ti o n gaps and la g s and p r o v id e a
more in fo rm e d p u b l i c o p in io n and gov ernm ent. No o t h e r
409
powers or r e s p o n s i b i l i t i e s th a n r e s e a r c h would be c a l l e d
f o r .
W e in tr a u b 's f a c t f i n d i n g p r o p o s a l i s l e s s f a r -
r e a c h i n g th a n some o t h e r s t h a t a l s o seek to i n f l u e n c e o r
c o n t r o l th e c o s t- p u s h f a c t o r s In p r ic e - m a k in g . He c o n fin e s
h i s p r o p o s a l t o a f a c t f i n d i n g agency In t h e hope t h a t a
more in fo rm e d p u b l i c o p in io n and p u b l i c i t y would s u f f i c e t o
co n v in c e l a b o r l e a d e r s t h a t , I n t h e i r own s e l f - i n t e r e s t ,
th e y sh o u ld e x e r c i s e s e l f - r e s t r a i n t and m o d e ra tio n i n wage
demands and t h e r e b y f o r e s