The Inflation Process: An Economic Analysis

PDF

Download

Open document

Flip pages

Download a page range

Download transcript

Copy asset link

Request this asset

Request accessible transcript

Transcript (if available)

Content 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
117
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 t a l l t h e n eed f o r more d r a s t i c
r e m e d ia l m e a su re s.
O th e r p r o c e d u r a l m e a s u r e s . — O th e r p r o p o s a l s c a l l
f o r more f a r - r e a c h i n g s t e p s a p p a r e n t l y b a s e d on th e assum p
t i o n t h a t more d r a s t i c m easu res would be r e q u i r e d t o (a)
In d u ce l a b o r and management t o e x e r c i s e th e n e c e s s a r y s e l f -
r e s t r a i n t i n wage- and p r i c e - s e t t i n g , and to (b) a s s e r t th e
" p u b l i c i n t e r e s t , " e s p e c i a l l y i n key c a se s where th e e f f e c t
of wage and p r i c e d e c i s i o n s would s i g n i f l e a n t l y a f f e c t i t ;
f o r exam ple, a s t e e l p r i c e r i s e t h a t m ight be re g a r d e d as
a d v e r s e t o th e b a la n c e o f paym en ts.
G e n e r a ll y , such p o l ic y p r o p o s a l s ran g e from mere
s u r v e i l l a n c e and p u b l i c i t y t o " p u b l i c d e t e r m i n a ti o n " f o r
one o r a few i n d u s t r i e s , show ing more o r l e s s t h e f o llo w in g
p r o g r e s s i o n o f s e v e r i t y :
410
1) N o tic e by th e l a r g e r firm s o f in te n d e d p r i c e
i n c r e a s e s , to be g iv en to some p u b lic a u t h o r i t y .
2) H e a r in g s , e i t h e r m andatory o r o p t i o n a l , i . e . ,
w ith in th e d i s c r e t i o n o f th e p u b lic a u t h o r i t y d e s ig n a te d t o
h o ld h e a r i n g s , o r th e p r e s i d e n t , or some o th e r a u t h o r i t y .
3) F a c t f i n d i n g i s p o s s i b l e w ith o r w ith o u t hearings^
and c o u ld be b a se d on a s p e c i a l s tu d y , h e a r i n g s , o r b o th .
4) P u b l i c a t i o n of f i n d i n g s , by c r e a t i n g a more
inform ed p u b l ic o p in io n and c o n s t i t u t i n g the m ild e s t form
o f s a n c t i o n , co uld be r e g a r d e d as an e s s e n t i a l f e a t u r e of
any form of p u b l ic p a r t i c i p a t i o n .
5) A dvisory o p in io n s o r recommended d e c i s i o n s co u ld
accompany th e p u b l i c a t i o n o f f i n d in g s a s a means of
e x te n d in g the d e g re e of p u b l i c p a r t i c i p a t i o n .
6) Delay o r s u s p e n s io n of wage and p r i c e i n c r e a s e s
might a l s o be r e q u i r e d f o r s p e c i f i e d p e r i o d s o f tim e .
7) P u b lic d e c i s i o n : as a l a s t r e s o r t , u t i l i t y - t y p e
c o n t r o l f o r key i n d u s t r i e s h a s been s u g g e s te d whereby p r o
posed p r i c e i n c r e a s e s would be v e to e d , o r p u b l ic d e c i s i o n s
would r e p l a c e c o l l e c t i v e b a r g a in in g i n w a g e -d e te rm in a tio n .
F o r exam ple, R. A. Musgrave h a s s u g g e s te d a wage-
p r i c e c o n t r o l by means of a p u b l ic f a c t f i n d i n g b o a rd w ith
lrThe above o u t l i n e i s based on R e d fo rd , op. c i t
pp. 9-10.
411
r e s p o n s i b i l i t y f o r h o l d i n g p u b l i c h e a r i n g s and making
recom m endations on b o t h wages and p r i c e s , and w ith power
to su b p en a and o b t a i n w h a tev e r f i n a n c i a l d a ta a re n eeded.
His. r e a s o n i s a p p a r e n t l y t h a t t h e consum er i s e n t i t l e d to
a p r i c e c u t w henever r e a s o n a b l e , and h i s hope i s t h a t th e
t h r e a t of h e a r in g s and th e s u rr o u n d in g p u b l i c i t y a b o u t
i n t e r n a l lab or-m an ag em en t a f f a i r s would s u f f i c e t o d e t e r
b o th p a r t i e s from i n f l a t i o n a r y s e t t l e m e n t s and th e r e b y
o b v i a t e th e need f o r h o l d in g h e a r i n g s i n th e f i r s t p l a c e . 1
Some tem po rary c o n c l u s i o n s . — I t would seem from
th e above t h a t f o r p o lic y - m a k in g p u rp o se s i t does n o t
r e a l l y m a t t e r how one view s t h e cause o f i n f l a t i o n , w h ether
as d e m a n d -p u ll or c o s t - p u s h ; i n e i t h e r c a se some form of
p u b l i c i n f l u e n c e or c o n t r o l o v e r wages and p r i c e s would
s e rv e as th e s t r a t e g i c t h i n g t o do i f i t s a c c e p t a b i l i t y o r
f e a s i b i l i t y co uld be a s s u r e d .
In t h e l i g h t o f some a d d i t i o n a l d im en sio n s t o be
c o n s id e r e d i n th e n e x t p a r t i t w i l l be p o s s i b l e t o
e v a l u a t e b e t t e r t h i s ap p ro a ch i n term s o f i t s f e a s i b i l i t y .
"^Richard A. M usgrave, " S t a te m e n t ," i n 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 Employment, Grow th, an d P r ic 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 , 1959)» PP» 2768- 6 9 .
412
P o lic y I m p l i c a t i o n s o f th e P r e s e n t Study
I n t h i s p a r t I t w i l l be n e c e s s a r y t o rev ie w some of
th e r e l e v a n t I d e a s o f p r e c e d in g c h a p t e r s , p a r t i c u l a r l y
C hapter v l , as a b a s i s f o r d raw ing th e p r o p e r 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 ic y . The s p e c i f i c p u rp o se s a r e two
f o l d : (1 ) to d e l i n e a t e th e p o s s i b l e u l t i m a t e s o u r c e s of
i n f l a t i o n a r y p r e s s u r e w orkin g th ro u g h demand, c o s t s , and
su p p ly , and (2) to I n d i c a t e how th e u n d e r l y i n g i n t e r r e l a
t i o n s o f th e m a jo r p o lic y a r e a s — o f p r i c e s t a b i l i t y ,
em ploym ent, g ro w th , and d i s t r i b u t i o n — a r e i n h e r e n t t o the
problem o f i n f l a t i o n and n o t m erely th e b y -p r o d u c t o f
academic d i s c u s s i o n s on t h e " r e c o n c i l i n g " o f m ajor
economic o b j e c t i v e s . Awareness of t h e s e complex i n t e r
r e l a t i o n s can h e l p the p o lic y - m a k e r d i s c e r n th e a l t e r n a
t i v e s open t o h im , and th e con seq u en ces he can e x p e c t ,
I n c lu d in g d is a p p o in tm e n ts o r u n e x p e c te d r e s u l t s .
F o llo w in g t h i s d i s c u s s i o n an a tte m p t w i l l be made
to (a) d i s c e r n t h e d i r e c t i o n s o f some e x i s t i n g p o l i c y
p r o p o s a ls and (b) d is c u s s t h e ty p e o f i n f o r m a tio n and v a lu e
prem ises r e l e v a n t f o r p o lic y -m a k in g .
Demand, Supply and I n f l a t i o n
I n the p r e c e d in g c h a p t e r I t was s t a t e d t h a t p r i c e
s t a b i l i t y depended b a s i c a l l y on th e r e l a t i o n betw een
a g g re g a te income c laim s and a v erag e p r o d u c t i v i t y , o r
413
betw een a g g re g a te demand and supp ly c o n d i t i o n s . T h is con
c e p t can be e x p r e s s e d sim p ly i n th e form of th e d e f i n i
t i o n a l e q u a t io n P = D/S i n w hich (1) P r e p r e s e n t s th e o v e r
a l l p r i c e l e v e l , (2) D r e p r e s e n t s a g g re g a te m onetary
demand, c o m p risin g e x p e n d i t u r e s , e f f e c t i v e demand, o r p u r
c h a s in g p o w er, b a se d on t h e s i z e and r e l a t i o n o f wage and
non-wage incomes as w e ll as t r a n s f e r p ay m en ts, and r e f l e c t
in g th e l e v e l of em ploym ent, and (3 ) S r e p r e s e n t s a g g r e g a te
p h y s i c a l s u p p ly o r o u tp u t a t c u r r e n t p r i c e s , a s d e te rm in e d
by c y c l i c a l and s e c u l a r l e v e l s of c o s t , o u tp u t and p r o d u c
t i v i t y g ro w th , and r e f l e c t e d in s h o r t - and lo n g - r u n s u p p ly
f u n c t i o n s and th e r a t e o f econom ic g ro w th .^ -
Same b a s i c e q u a t i o n . — The above e q u a t io n i s
a c t u a l l y a c u lm in a tin g g e n e r a l i z e d form of a s e r i e s t h a t
s t a r t e d w ith F i s h e r ' s t r a n s a c t i o n s m odel of t h e e q u a t i o n of
e x c h a n g e , P ® MV/T. T h is s tu d y has sought t o make e x p l i c i t
th e e v o l u t i o n o f t h i s e q u a t io n th ro u g h th e su b s e q u e n t
i n c o m e - v e lo c ity v e r s i o n Py = M Vy/T y , th e e f f i c i e n c y - w a g e s
v e r s i o n P = W/E, and W e in tr a u b 's markup v e r s i o n P = kw/A.
A lthough d i f f e r e n t i n form , th e s e e q u a t io n s n e v e r
t h e l e s s e x p r e s s a common i d e a : t h a t th e p r i c e l e v e l
depends on th e r e l a t i o n betw een some form of a g g r e g a te
1F o r a d i s c u s s i o n o f th e t h e s i s t h a t th e p r i c e
l e v e l depends on th e r a t i o o f money-income t o p h y s i c a l
o u t p u t , se e W. T. Newlyn, Theory o f Money (London: O xford
U n i v e r s i t y P r e s s , 1 9 6 2 ), pp"! U7-9^.
414
m onetary demand ( e . g . , MV, M Vy , kw, D) and a g g re g a te
p h y s i c a l su p p ly ( e . g . , T, Ty , p r o d u c t i v i t y , S ) . In d e e d ,
th e f i n a l v e r s i o n P * D/S may be r e g a r d e d as m ere ly a n o th e r
way o f e x p r e s s in g F i s h e r ' s o r i g i n a l e q u a t i o n . N e v e r th e le s s ,
t h e r e a r e a d v a n ta g e s i n s t a t i n g th e e q u a tio n i n th e form
P = D/S. In th e f i r s t p l a c e , i t e n a b le s us t o d i s c e r n in
t h e c o n te x t o f th e i n f l a t i o n p r o c e s s an u n d e r l y i n g l i n k t o
th e t r a d i t i o n a l law o f demand and su p p ly i n w hich th 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 ( i . e . , demand and
s u p p ly ) s e r v e as th e " c a t c h a l l " c a t e g o r i e s f o r t h e u l t i m a t e
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 .
In th e seco n d p l a c e , I t makes i t e a s i e r t o see t h a t
r e g a r d l e s s o f how I n f l a t i o n may o r i g i n a t e — w h e th e r as
d e m a n d -p u ll o r as c o s t - p u s h — th e m echanics o f th e I n f l a t i o n
p r o c e s s p e r s e , as a dynamic p r o c e s s in v o lv i n g th e i n t e r
a c t i o n of b o th demand and c o s t f a c t o r s , a r e e s s e n t i a l l y th e
same. In b o th e x c e s s demand and c o s t- p u s h c a s e s , com p eti
t i o n among g ro u p s f o r l a r g e r s h a r e s o f th e income a n d /o r
o u tp u t p ie can i n i t i a t e and p e r p e t u a t e th e same ty p e of
upward p r ic e - in c o m e s p i r a l r e s u l t i n g i n demand r i s i n g
f a s t e r th a n s u p p ly . To p u t i t a n o th e r way: i n te rm s o f
th e e q u a t i o n , a w a g e-p u sh , f o r exam ple, s i n c e I t r e p r e s e n t s
a f a s t e r r i s e i n f a c t o r Income th a n i n p r o d u c t i v i t y , can be
e x p r e s s e d by an i n c r e a s e i n demand r e l a t i v e t o su p p ly
(b e c a u se o f w a g e - p u l l ) , so t h a t w h ile th e r i s e In P may be
415
blamed on th e I n i t i a l c o s t - p u s h , th e p r o c e s s of demand
i n f l a t i o n rem ain s th e sam e.
I n t e r r e l a t e d o b j e c t i v e s . — Even more i m p o r t a n t ,
how ever, i s th e f o c u s in g on th e i n te r d e p e n d e n c e of p r i c e ,
demand and s u p p ly , which s e r v e s t o r e f l e c t 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 o f th e f o u r m ain a r e a s o f econom ic
p o lic y g o a ls : of p r i c e s t a b i l i t y , em ploym ent, econom ic
g ro w th , and income d i s t r i b u t i o n . 1 I t i s t h i s l a t t e r p o i n t
t h a t i s most s i g n i f i c a n t f o r the p r e s e n t c h a p t e r , as w i l l
be se e n from th e f o l lo w in g d i s c u s s i o n .
In th e f i r s t i n s t a n c e , th e c a t c h a l l c a te g o ry o f
demand, as i n d i c a t e d a b o v e , n o t o n ly subsumes th e im p a c ts
o f income s t r e a m s , p u r c h a s in g pow er, o r e x p e n d itu r e f o r c e s
( e . g . , o f co nsu m ers, b u s i n e s s , g o v e rn m e n t), but a ls o
r e f l e c t s th e l e v e l of employment and t r a n s f e r e x p e n d i tu r e s
by go vern m en t. Thus t h e l e v e l o f D r e f l e c t s not o n ly th e
c u r r e n t l e v e l o f p r o d u c t i v e a c t i v i t y (which i s a l s o
r e f l e c t e d i n t h e d e n o m in a to r S) b u t a l s o th e volume o f
w e lfa r e e x p e n d i tu r e s and f o r e i g n a i d . To th e e x t e n t ,
t h e r e f o r e , t h a t e x p a n sio n o f demand v i a w e l f a r e and a id
^The p o l i c y d im e n sio n o f Income r e d i s t r i b u t i o n i s
e x p l i c i t l y in c l u d e d b e c a u se o f i t s i n h e r e n t r e l a t i o n t o th e
I n f l a t i o n p r o c e s s . I n d e e d , K enneth E. B o u ld in g r e g a r d s
I n f l a t i o n and d e f l a t i o n as "by f a r " th e m ost im p o r ta n t
a g e n c ie s f o r a l t e r i n g t h e p a t t e r n o f income d i s t r i b u t i o n ,
e s p e c i a l l y s i n c e t h e 1920*s ; see h i s P r i n c i p l e s o f Economic
P o lic y (Englewood C l i f f s , N . J . : P r e n t i c e - H a l l , I n c . , 195S')'»
p . 12.
416
program s do n o t have a r e a l c o u n te r p a r t i n th e denom inator
S, p r i c e s w i l l tend t o r i s e , a t l e a s t i n the s h o r t ru n .
S i m i l a r l y , i t was noted t h a t th e c a t c h a l l c a te g o ry
sUPPly not o n ly b e a r s the im pact of c u r r e n t p h y s i c a l
o u t p u t , te c h n o lo g ic a l p r o g r e s s and p r o d u c t i v i t y , but a l s o
r e f l e c t s the m anner in which t h e gains o f p r o d u c t i v i t y a re
d i s t r i b u t e d . T hus, to t h e e x t e n t t h a t f a c t o r paym ents,
such a s wages o r p r o f i t s , are a b le to i n c r e a s e i n m onetary
term s w ithout c o rre s p o n d in g c o n t r i b u t i o n s t o p h y s i c a l
o u t p u t , the n u m e ra to r D i s allo w ed to i n c r e a s e f a s t e r th a n
the d en o m in ato r S, so t h a t P w i l l r i s e . (This assum es, of
c o u r s e , th ere a r e no 1 1 le a k a g e s ” i n t o s a v in g or h o a r d in g ,
t a x e s , or i m p o r t s .)
C o n v e rsely , to t h e e x t e n t th a t p r o d u c t i v i t y i s
a llo w e d to d e c l i n e w h ile f a c t o r s e r v i c e s c o n tin u e to
r e c e i v e the same rem u n e ratio n as b e f o r e , P w i l l r i s e as D
i n c r e a s e s r e l a t i v e to S . This l a t t e r a s p e c t has trem endous
im p lic a tio n s f o r p o lic y making: i f governm ent e v e r d e c id e s
to f r e e z e wages o r o t h e r incom es, in o r d e r to check th e
demand p r e s s u r e s on P, t h i s w i l l n o t n e c e s s a r i l y p re v e n t P
from r i s i n g a s a consequence, s a y , of a r e l a t i v e d e c lin e
in S a t t r i b u t a b l e to em p lo y ee s, i n r e t a l i a t i o n , , p ro d u c in g
le s s p e r m an-hour than b e fo r e .
F u rth e rm o re , t o th e e x t e n t t h a t th e d i s t r i b u t i o n o f
p r o d u c t i v it y g a i n s f a v o r s wage incom es, d evoted l a r g e l y t o
417
consum ption, a t th e expense o f e n t r e p r e n e u r i a l and o t h e r
incomes d e v o te d l a r g e l y to in v e s tm e n t, th e r a t e of economic
grow th (e x p r e s s e d th ro u g h th e s i z e of S) would te n d to la g
b eh ind th e r a t e of D, and P would te n d to r i s e as a r e s u l t
of demand p r e s s u r e s i n consumer goods.
Thus th e e q u a tio n P = D/S n o t only fo c u s e s on th e
t r a d i t i o n a l ap pro x im ate d e te rm in a n ts o f p r i c e b u t a ls o
r e f l e c t s th ro u g h D th e w orkings of the employment volume
and income d i s t r i b u t i o n , and th ro u g h S th e im p act o f t e c h
n o l o g i c a l p r o d u c t i v i t y on the d i s t r i b u t i o n of f a c t o r
incomes and th e r a t e of economic grow th.
P e r s p e c t i v e s on Economic Goals
The p r e c e d in g a n a l y s i s n o t only makes e x p l i c i t the
i n h e r e n t l y I n t e r r e l a t e d n a tu r e of th e m ajo r economic g o a l s ;
i t a ls o i n d i c a t e s t h a t governm ent can a f f e c t p r i c e s th ro u g h
i t s p o l i c i e s c o n c e rn in g employment, incom e, p r o d u c t i v i t y ,
and growth as w e ll as th ro u g h i t s s t a b i l i z a t i o n m ea su re s.
The fo llo w in g d i s c u s s i o n , b ased p a r t l y on m a t e r i a l in p r e
ced in g c h a p t e r s , w i l l b r in g t o g e t h e r some i n p l i c a t i o n s f o r
p r i c e s t a b i l i t y of governm ent p o l i c i e s i n the o t h e r
economic p o l i c y a r e a s .
^In t h i s c o n n e c tio n may be n o te d the F rench F inance
M i n i s t e r 's r e c e n t w arn ing t o F rench w a g e -e a rn e rs t h a t con
t in u e d wage I n c r e a s e s n o t only would redu ce th e n a t i o n ’ s
c a p a c ity to r e i n v e s t b u t would a ls o induce r i s i n g p r i c e s
which i n t u r n would a d v e r s e ly a f f e c t th e a b i l i t y to compete
418
I n t h i s c o n n e c tio n I t w i l l a l s o be u s e f u l t o ju d g e ,
from th e p o in t of view o f p r a c t i c a l p o l i c y , w h e th er t h e
c o n d it i o n s and b e h a v io r r e q u i r e d t o avoid i n f l a t i o n a r y
p r e s s u r e s a re l i k e l y to p a s s the t e s t of " p o l i t i c a l
f e a s i b i l i t y " o r " p o s s i b i l i t y . " T hat i s , would the m ain
te n a n c e o f p r i c e s t a b i l i t y r e q u i r e a t t i t u d e s and b e h a v io r
on th e p a r t o f th e m ajo r p a r t i c i p a n t s 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 i n g g o v ernm en t, c o n s i s t e n t w ith s e l f -
i n t e r e s t , " l o y a l t y " to t h e i r r e s p e c t i v e o r g a n i z a t i o n s , or
th e n a t i o n a l i n t e r e s t .
Employment v e rs u s p r i c e s . — P ro b a b ly th e most
e x p lo r e d r e l a t i o n s h i p i s th e one betw een th e employment and
p r i c e o b j e c t i v e s , th e g e n e r a l c o n sen su s b e in g t h a t , w ith a
g iv e n p r o d u c tiv e c a p a c i t y , l e v e l s of o u tp u t and employment
a t o r n e a r f u l l employment would in d u c e r i s i n g p r i c e s
m ainly b e c a u se o f b o t t l e n e c k s , s h o r t a g e s , d im i n i s h i n g
r e t u r n s , and th e s t r o n g e r b a r g a i n in g p o s i t i o n o f l a b o r . 1
On th e o t h e r h a n d , th e f u l l employment commitment
and r e l a t e d p u r c h a s in g power m aintenan ce program s (s u c h as
i n e x p o rt m ark ets (" F re n c h See P e r i l In A f f l u e n t E r a , " in
The New York Times [W estern E d i t i o n ] , J a n u a ry 18, 1963>
_ _ T _
^ o r Musgrave th e "most s e r i o u s " p o t e n t i a l con
f l i c t a r i s e s when the b a s i c i n f l a t i o n a r y f o r c e stem s from
e x c e s s iv e wage demands w h ic h , in t u r n , may be a f u n c t i o n
o f a g u a ra n te e d p o l ic y o f h ig h employm ent; o p . c i t . ,
p . 2758.
419
unemployment i n s u r a n c e , s o c i a l s e c u r i t y , e t c . ) — t h a t come
i n t o p la y to f o r e s t a l l o r m inim ize r e c e s s i o n s i n employment
and income— have i n tr o d u c e d a s e c u l a r b i a s tow ard h ig h e r
p r i c e s to th e e x t e n t t h a t t h e p r i c e r i s e s a t t e n d i n g
c y c l i c a l p r o s p e r i t y p h a ses a re n o t o f f s e t by p r i c e d e c l i n e s
in r e c e s s i o n b e c a u se of th e " f l o o r ” p la c e d u n d e r demand,
c r e a t i n g th e " r a t c h e t " e f f e c t i n p r i c e movements o v e r th e
long r u n . 1 T his g o v e rn m e n t-s p o n so re d f l o o r u n d e r demand,
in r e c e s s i o n s , not o n ly su p p lem en ts th e p r i v a t e c u sh io n s
f o r s a g s in demand— i n th e form of d iv id e n d s and sa v in g s-—
b u t , as n o te d by H ansen, a l s o s e r v e s t o r e i n f o r c e th e down
ward " r i g i d i t y " of a d m i n i s t e r e d wages and p r i c e s .
Even more i m p o r t a n t , a c c o rd in g to G. L. B ach, a
com plete f u l l employment g u a ra n ty p r o v id e s th e s t r a t e g i c
env iro nm ent f o r an " e x c e s s income c la im s" ty p e o f i n f l a
t i o n : in h i s m odel th e m a jo r economic gro u p s i n l a b o r ,
b u s i n e s s , and a g r i c u l t u r e a re encou raged t o i n c r e a s e t h e i r
r e s p e c t i v e demands f o r e v e r l a r g e r income s h a r e s — even
■ ’ ’ T he f u l l employment o b j e c t i v e i s r e g a r d e d by
Dennis H. R o b e rtso n as th e m ost im p o r ta n t f a c t o r l i k e l y t o
make f o r s e c u l a r p r i c e r i s e s i n th e modern economy; see h i s
a r t i c l e " C ree p in g I n f l a t i o n , " r e p r i n t e d i n h i s Economic
Commentaries (London: S t a p l e s P r e s s L im ite d , 1 9 ^ 6 ), pT 118.
The Commission on Money and C r e d it a ls o b e l i e v e s t h a t th e
n a t i o n a l commitment t o h i g h - l e v e l o u tp u t and employment
p r e s e n t s a d i f f i c u l t y f o r m a i n t a i n in g p r i c e s t a b i l i t y f o r
the re a s o n g iv e n ab o v e; see I t s r e p o r t Money and C re d it
(Englewood C l i f f s , N, J . : P re n tic e -H a ll" J I n c . , 1961), p. 22.
420
though th e y exceed th e t o t a l Income p ie and fo rc e p r i c e s
up— s in c e th e f u l l employment commitment removes th e f e a r
of unemployment and l o s t s a l e s which a r e th e norm al conse
quences o f p r i c i n g o n e s e l f out of th e m a rk e t. Thus Bach
se e s two key i n g r e d i e n t s added to p e ac etim e i n f l a t i o n : th e
p u b l i c 's a n t i c i p a t i o n of governm ent s u p p o r t f o r e x c e s s iv e
c la im s , and r e l a t e d e x p e c ta ti o n s of r i s i n g p r i c e l e v e l s . 1
Employment and p u r c h a s in g pow er. — In t h i s connec
t i o n i t may be n o te d t h a t the employment o b j e c ti v e proves
t o be e s s e n t i a l l y a p u rc h a s in g power g o a l , f u l f i l l e d
p a r t l y by in v e s tm e n t- ty p e e x p e n d itu r e s ( p r i v a t e and govern
m en tal) s e r v i n g t o induce h i g h e r l e v e l s o f employment, and
p a r t l y by e x p e n d itu r e s of th e " t r a n s f e r " type d e sig n e d
p r i m a r il y t o b o l s t e r consum ption.
I t i s a ls o im p o rta n t to n o te t h a t the lo n g -ru n
upward b i a s in p r i c e s im p la n te d by g o v e rn m e n t-sp o n so red
f l o o r s to demand may a ls o e x e r t o p p o s ite e f f e c t s i n th e
s h o r t run t h a t s e rv e to m oderate t h i s b i a s . The re a so n
l i e s in th e p o s t- w a r t r e n d in o v erhead c o s t s (see C hapter
v i ) a c c o rd in g to which u n i t c o s t s , over c e r t a i n ra n g e s o f
o u t p u t, have te n d e d to r i s e as o u tp u t l e v e l s d e c lin e d ( f o r
-^-George L elan d B ach, "How Im p o rta n t Is P r ic e
S t a b i l i t y In S t a b le Economic Growth?" i n U .S ., C on gress,
J o i n t Economic Com m ittee, Compendium, The R e la ti o n s h ip of
P r ic e s to 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 ) » PP» 43-46.
421
e x am p le , In r e c e s s i o n ) and f a l l as o u tp u t expanded (as In
r e c o v e r y p h a s e s ) . I n t h i s c o n t e x t , t h e r e f o r e , i t i s con-
1
c e i v a b l e t h a t e x p a n s io n a ry governm ent p o l i c i e s may n o t only
in d u c e an e x p a n s io n o f o u tp u t b u t , o v e r c e r t a i n ra n g e s o f
p r o d u c tiv e c a p a c i t y , a r e d u c t i o n in u n i t c o s ts as w e l l.
T h u s, a l e s s th a n f u l l - b l o w n c y c l i c a l upsw ing m ig h t w itn e s s
r i s i n g o u tp u t l e v e l s w ith o u t i n f l a t i o n a r y p r e s s u r e s .
F i n a l l y , e co n o m ist P. W iles s u g g e s t s t h a t i n a
w o rld com m itted to h ig h employment th e t r a d e u n io n as p r e s
e n t l y c o n s t i t u t e d may be o b s o l e t e , a t l e a s t f o r p u rp o s e s o f
jo b and incom e m a in te n a n c e . He re a s o n s t h a t w h ile s o c i a l
j u s t i c e i m p l i e s income be d i s t r i b u t e d a c c o r d in g to "need,*1
and economic e f f i c i e n c y c a l l s f o r d i s t r i b u t i o n a c c o rd in g to
f a c t o r p r o d u c t i v i t y , he se e s no com parable P r i n c i p l e o f
d i s t r i b u t i o n p r o v id e d by th e d i f f e r e n t i a t e d b a r g a i n in g
powers of u n i o n s . He s p e c u l a t e s t h a t th e d i f f e r e n t i a l c o l
l e c t i v e b a r g a i n i n g s t r e n g t h among u n io n s , b ased on d i f f e r
e n t i a l r a t e s o f p r o d u c t i v i t y among f irm s and i n d u s t r i e s ,
m e re ly in d u c e s " l a r g e perm anent d i f f e r e n t i a l s " betw een
wages of s i m i l a r g rad e j o b s . 1
W iles a ls o r a i s e s a r e l a t e d q u e s t i o n : i f p r o f i t s
are d e riv e d fro m an im provem ent in t e c h n i q u e , r a t h e r th a n
from l a b o r 's w orking h a r d e r o r b e t t e r , does l a b o r in th e
1P e t e r W ile s , "Are T rade Unions N e c e ss a ry ? "
E n c o u n te r , V I I (S e p tem b er, 1 9 5 6 ), pp. 5 - H «
H22
g iv e n i n s t a n c e have any p r i o r r i g h t t o them a t a l l ? For
p u rp o se s o f th e p r e s e n t d i s c u s s i o n th e most r e l e v a n t
i m p l i c a t i o n o f W ile s ' p r o v o c a tiv e p r o p o s a l i s t h a t th e
e l i m i n a t i o n o f th e need f o r wage a g g r e s s io n by t r a d e u n io n s
in a w orld o f h ig h employment would remove a m ajor c o s t -
push f a c t o r , and le a v e d e m a n d -p u ll as th e m a jo r I r r i t a n t to
p r i c e s t a b i l i t y .
R i g i d i t i e s and p r i c e s . — The p o l ic y a t t i t u d e of
e c o n o m ists to w ard such p u r c h a s in g power f l o o r s and r i g i d
i t i e s i s m ixed. W ith r e s p e c t to governm ent-s p o n s o re d
r i g i d i t i e s , a t t i t u d e s seem to g e n e r a l l y depend on th e
w r i t e r ' s own p r e f e r e n c e f o r governm ent r a t h e r th a n m ark e t
d e te r m i n a ti o n o f c o s t s , p r i c e s , and incom es. With r e s p e c t
to p r i v a t e l y sp o n so re d r i g i d i t i e s , some se ek a d im in u tio n
o r e l i m i n a t i o n of "m arket power" o v e r wage- and p r i c e -
s e t t i n g as a means o f r e s t o r i n g f l e x i b i l i t y in c o s ts and
, 1
p r i c e s .
On th e o p p o s ite s i d e , how ever, a re men l i k e Musgrave
who b e l i e v e r i g i d i t i e s a re a f a c t of l i f e and h e re t o s t a y .
I n d e e d , Musgrave a s s e r t s t h a t r i g i d i t i e s were s i g n i f i c a n t l y
r e s p o n s i b l e f o r th e " r e l a t i v e m ild n e s s " o f p o s t-w a r
r e c e s s i o n s , by p r e v e n t in g t h e u n le a s h in g o f downward
s p i r a l s b a se d on a n t i c i p a t i o n s of f a l l i n g p r i c e s and
^For exam ples of such p r o p o s a l s , s e e R e d fo rd ,
o p . c i t . , pp . 3- 29 .
423
d e c l i n i n g p u r c h a s in g p o w e r.1 S i m i l a r l y , a good word has
a l s o been s a i d f o r " m o n o p o lis tic " p r i c i n g in p e r i o d s of
p r o s p e r i t y , when p r i c e - s e t t e r s may te n d out o f " s h e e r
i n e r t i a " t o hold th e l i n e a g a i n s t i n f l a t i o n a r y im pulses
r a t h e r th a n behave as an " e x p l o i t a t i v e " f o r c e . ^
A c o n d i t i o n a l g u a r a n t e e ?— To round o u t t h i s d i s
c u s s io n , i t i s im p o rta n t to n o te t h a t w h ile some eco n o m ists
te n d to a t t a c h a number-one p r i o r i t y to th e employment
o b j e c t i v e , as a m a t t e r of " s o c i a l v a l u e ," o t h e r s have
e n te r e d r e s e r v a t i o n s , b e l i e v i n g t h i s p r i o r i t y need not be
u n c o n d i t i o n a l l y im plem ented. Econom ist M. B r o n f e n b r e n n e r ,
f o r exam ple, has even s u g g e s te d t h a t th e u n c o n d it i o n a l
g u a ra n ty o f f u l l employment sh o u ld be abandoned. However,
he would n o t want such a s t e p c o n s tru e d as an abandonment
o f the employment g o a l p e r s e , b u t r a t h e r as an a l t e r n a t i v e
means of a t t a i n i n g i t : by im p ly in g th e t h r e a t o f unemploy
ment as a "means o f economic d i s c i p l i n e . " He i s a lso q u ic k
to add t h a t t h i s s t r i c t l y economic p r e s c r i p t i o n would
h a rd ly be openly embraced by th e " p r a c t i c a l p o l i t i c i a n " and
t h a t i t m ig h t take a very lo h g time b e fo re th e c lim a te o f
M u s g r a v e , op. c i t . , p. 2760. See a l s o John P.
L ew is, " P r i c i n g f o r S t a b i l i t y and G row th," i n U . S . , Congress
J o i n t Economic Com mittee, Compendium, The R e la ti o n s h ip o f
P r i c e s to 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 , 1958)', pp. 389-90.
p
Boulding, op. c i t ., p. 289.
42 4
o p in io n changed s u f f i c i e n t l y to make i t s enactm ent
p o s s i b l e .
I t may be t h a t B r o n fe n b re n n e r1s p r e s c r i p t i o n has
a c t u a l l y been p r a c t i c e d more th a n he s u s p e c t s . As W . G.
Bowen has s t a t e d , th e g o v e rn m e n t’s w i l li n g n e s s t o c o u n te r
a c t unemployment in th e p o s t- w a r p e r i o d by means of d i s
c r e t i o n a r y f i s c a l p o l ic y may a c t u a l l y have been tem pered by
a c lim a te o f o p in io n c h a r a c t e r i z e d by f e a r of I n f l a t i o n and
a n ti p a t h y tow ards a r i s i n g n a t i o n a l d e b t , both a s s i d u o u s l y
c u l t i v a t e d by a d m i n i s t r a t i o n o f f i c i a l s and spokesmen. As
a conseq u en ce, Bowen s a y s , th e p o s t-w a r re c o rd o f f i s c a l
p o lic y may be re a d as showing r a t h e r c a u tio u s r e a c t i o n s by
government to m oderate downturns in b u s in e s s a c t i v i t y ,
e v id e n ce d p a r t i c u l a r l y by C o n g re s s io n a l r e l u c t a n c e to e n a c t
O
ta x c u ts e x c e p t as a l a s t r e s o r t to meet a d i r e emergency.
M a rtin B ro n fe n b re n n e r, " S e c u la r I n f l a t i o n and
S h i b b o l e t h s ," C h a lle n g e , VI (December, 1957)> P» 21. F o r
a s i m i l a r v iew , see B ach, op. c i t . , p. 45.
p
W illia m G. Bowen, The W age-Price I s s u e ( P r i n c e to n :
P r in c e to n U n i v e r s i ty P r e s s , 1960)7 PP» 375-7^. F o r a
s i m i l a r view see S c h l e s i n g e r , o p . c i t . . p. 26. A p p a re n tly ,
how ever, th e p o s t- w a r f i s c a l p o lic y r e c o r d canno t be r e a d
unam biguously. For exam ple, A lb e r t G a ilo rd H a r t b e l i e v e s
t h a t p o s t- w a r f i s c a l p o lic y made a " g r e a t " c o n t r i b u t i o n t o
s t a b i l i z a t i o n of th e economy by a d h e rin g to th e "new
f a n g le d " s t a b i l i z a t i o n " r e c i p e s " r a t h e r th a n t o th e " o ld -
f a s h io n e d o r th o d o x y ." See h i s " S ta te m e n t," In U .S .,
C on g ress, J o i n t Economic Com mittee, H e a rin g s , Pa **t 9A,
Study of Employment, Growth, and P r ic e L evels (W a sh in g to n :
U.S. Government P r i n t i n g O f f i c e , 1959), p. 2666.
425
In apparent support of th is p o s itio n i s the recen t
Brookings I n s t i t u t i o n study of post-w ar a n ti-r e c e s s io n
f i s c a l p o lic y by W ilfred Lewis J r . , which a s s e r ts th a t the
autom atic s t a b i l i z e r s were more e f f e c tiv e in countering
rec e ssio n s than was d is c r e tio n a r y p o lic y . The l a t t e r , i t
sa y s, was g en e ra lly c o n s tra in e d by economic and p o l i t i c a l
f a c t o r s , such as u n c e rta in ty about whether the economy was
in re c e ssio n or not and the tendency to delay a c tio n u n t i l
re c e ssio n was c le a rly under way, out of f e a r of undermining
p u b lic "confidence," In a d d itio n , f e a r of i n f l a t i o n and
concern over balanced budgets also served as a c tiv e
c o n s tra in ts in each re c e s s io n . The study a lso p o in ts to
d i f f i c u l t i e s in the speeding up of expenditures outside the
defense budget (except p o ssib ly f o r highway c o n s tru c tio n ) ,
and to o b sta c le s to quick tax cuts caused by the " p o l i t i c a l
s e n s i t i v i t y " of eq u ity aspects and the absence of "advance
p o l i t i c a l consensus" on which types of tax cuts would be
most d e s ir a b le .
Growth versus p r i c e s . — What about the r e la tio n s h i p
between economic growth o b je c tiv e s — of expanded productive
c a p a c ity , e f f i c i e n c y , and te c h n o lo g ic a l p ro g re ss— and p ric e
"^See Brookings I n s t i t u t i o n , E ffe c ts of F is c a l Pol
icy in the Postwar R e c e ssio n s, Brookings Research Report
No. 7 (Washington, D.C.: Brookings I n s t i t u t i o n , 1962),
pp. 1-8; see a lso the newspaper re p o rt of th i s stu d y , The
New York Times [Western E d itio n ] , December 31» 1962, p. 13.
426
s ta b ili ty ? I f we look f i r s t at the expenditure sid e— at
the investm ents comprising the growth process— the e f f e c ts
of increased investm ent expenditures on the p r ic e le v e l may
be regarded i n the same l ig h t as in creased consumption
ex p en d itu res, th at i s , as depending on t h e i r s i z e , ty p e ,
tim ing, and degree of excess capacity.
So lo n g as th e investment expenditures come in
p erio d s of l e s s than f u l l employment and are th e re fo re not
excessive—n e i t h e r in th e aggregate sense nor in the p ar
t i a l or s e c to r a l sense— then the upward pressu re on p ric e s
w ill tend to be sm aller than i f they had created excessive
monetary demand (in th e aggregate or s e c to r a lly ) and
associated b o ttle n e c k s in periods approximating f u l l employ
ment. In S. S l i c h t e r ’ s view, f o r in s ta n c e , we have not yet
le a r n t to av o id at l e a s t small in c re a se s in p r ic e s during
c y c lic a l p e rio d s of e x p a n sio n .- * -
In t h i s context may also be mentioned S l i c h t e r 's
emphasis on o u r "dynamic economy" and i t s g reat ra te of
te c h n o lo g ica l progress as c o n s titu tin g a s ig n if ic a n t cause
of creeping i n f l a t i o n . In h is view i t Is the "voracious"
demand for c a p i t a l goods— re s u ltin g from the ra p id growth
of productive capacity and te c h n o lo g ic a l discovery, and the
^On t h i s and th e follow ing p o in ts see Sumner H.
S lic h te r , "On the Side of I n f la tio n ," Harvard Business
Review, X X X V (Septem ber-October, 1957), pp. 30-32.
427
r e la te d demands fo r s h i f t s of re so u rc e s, including r is in g
wages— and the slowness of wages to decline in co n tra ctin g
i n d u s t r i e s , th a t have made fo r stro n g in f la tio n a r y te n
dencies .
The p ro d u c tiv ity s i d e . —I f , on the other hand, we
look only a t the co st-red u cin g or p ro d u c tiv ity side of the
investment p ro c e ss, the e f f e c t of increased investment on
the p rice le v e l would depend on which of the various
p o ssib le outcomes discussed by F. Machlup (and described
in Chapter v i) is a c tu a lly experienced. On the assumption
th a t in d iv id u a l p ric e s could be reduced in the wake of
reductions in u n it costs (enabled by the gains in produc
t i v i t y enjoyed by the te ch n o lo g ic a lly progressive secto rs
of the economy), the a c tu a l ex ten t of such p rice reductions
—and t h e i r impact on the o v e r - a ll price le v e l—would
depend s u b s ta n tia lly on how much of the p ro d u c tiv ity gains
were passed along to consumers (in the form of lower
p ric e s ) r a th e r than to labor and/or e n te r p r is e r s (in the
form of hig h er incomes).
I t was noted in Chapter v i th a t in the case of
te c h n o lo g ic al advances involving a n e t displacem ent of
labor in a community committed to m aintaining employment
and demand, p ro d u c tiv ity -in d u c e d p ric e reductions would be
req u ire d not only (a) to perm it reab so rp tio n of the d is
placed workers but also (b) to m aintain o v e r - a ll s t a b i l i t y
428
of th e p r i c e l e v e l . O therw ise t e c h n o l o g i c a l p ro g r e s s
would i r o n i c a l l y in d u ce a s e c u l a r r i s e in t h e p r i c e l e v e l .
P r o d u c t i v i t y and p r i c e s . — The r e a s o n given by
Machlup f o r t h i s r e s u l t can be r e c a l l e d b r i e f l y as f o l lo w s :
even i f em ployers in t h e t e c h n o l o g i c a l l y p r o g r e s s i v e
i n d u s t r i e s l i m i t e d t h e i r wage i n c r e a s e s to th e p r o d u c t i v i t y
g a in s e n jo y e d by th e r e s p e c t i v e i n d u s t r i e s , th e mechanism
of i m i t a t i v e wage i n c r e a s e s by th e l e s s p ro d u c tiv e
i n d u s t r i e s would sim ply le a d to o v e r - a l l e x c e s s iv e w a g es,
r i s i n g c o s t s , and i n f l a t i o n .
Even in the a b sen c e o f such i m i t a t i v e or s p i l l - o v e r
w a g e - i n c r e a s e s , i n f l a t i o n of consumer p r i c e s would e n su e
owing t o th e f u l l employment commitment and th e r e m e d ia l
e x p a n sio n of demand r e q u i r e d to re-em ploy th o se d i s p l a c e d
by t e c h n o l o g i c a l p r o g r e s s . Only i f consum ers were f a v o r e d
by p r i c e r e d u c t io n s i n t h e more p r o d u c tiv e s e c t o r s , and
e n a b le d th e re b y to i n c r e a s e t h e i r q u a n t i t i e s demanded out
of a g iv e n money incom e, could th e d i s p l a c e d w orkers have
a chance to be re-e m p lo y e d w ith o u t in d u c in g i n f l a t i o n . By
■'■This model o f i n f l a t i o n has been c l a s s i f i e d as a
t h i r d ty p e — a lo n g s id e d e m a n d -p u ll and c o s t - p u s h — as
" p r o d u c t i v i t y i n f l a t i o n , " a lth o u g h i t e s s e n t i a l l y r e q u i r e s
o p e r a t io n o f t h e t r a n s m i s s i o n mechanism o f " i m i t a t i o n "
( d e s c r i b e d i n C hapter v) to g iv e i t e f f e c t ; see P a u l
S t r e e t e n , "W ages, P r i c e s and P r o d u c t i v i t y , " K yklos, XV
(November, 1962), a b s t r a c t e d i n The J o u r n a l of Economic
A b s t r a c t s , I ( J a n u a r y , 1963), ppT 56-67.
H29
th e same to k e n , t o th e e x t e n t t h a t t o t a l demand was n o t
expanded s u f f i c i e n t l y t o r e a b s o r b th e d i s p l a c e d w o r k e r s ,
the p r e s s u r e f o r i n f l a t i o n would be r e d u c e d . I t may be
n o t e d , i n p a s s i n g , t h a t th e r e l a t i v e l y m o d era te c re e p of
p r i c e s i n r e c e n t y e a r s may r e f l e c t p r e c i s e l y such m o d e ra te
n e ss of anti-u n em p lo y m en t p o l i c y and th e absen ce of e x c e s s
demand.
I t sh o u ld be added t h a t th e g a in s of p r o d u c t i v i t y
may be f i l t e r e d n o t only t o l a b o r , b u s i n e s s , and ho use
h o ld s b u t a ls o t o governm ent v i a th e c h a n n e l of ta x e s on
th e i n c r e a s e d r e a l income a c c r u i n g t o th e community from
p r o d u c t i v i t y g a in s i n th e f i r s t instance."*' In t h i s con
t e x t , governm ent t a x a t i o n and t r a n s f e r paym ents can be
view ed p a r t l y as a means of r e d i s t r i b u t i n g th e p r o d u c t i v i t y
g a in s of 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 or non
p r o d u c t i v e s e c t o r s .
I n any e v e n t , i t i s a p p a r e n t t h a t th e e f f e c t of
econom ic grow th— of expanded c a p a c i ty and r i s i n g p ro d u c
t i v i t y — on th e o v e r - a l l p r i c e l e v e l depends m ain ly on th e
r e s p e c t i v e p r e s s u r e s e x e r t e d by (a) in v e s tm e n t e x p e n d i t u r e s
and th e demand f o r c a p i t a l - c r e a t i n g r e s o u r c e s , and (b) th e
com peting income c la im s made upon th e g a in s o f p r o d u c t i v i t y .
In e f f e c t , t h e r e f o r e , th e a n a l y s i s o f th e p r i c e e f f e c t s o f
^ •O n th is point see also W iles, op. c i t . , p. 8.
430
grow th a l s o e n t a i l s an u n d e r s ta n d in g of th e manner i n
which the g a in s from p r o d u c t i v i t y — in th e form of lower
u n i t c o s ts o r h i g h e r r e a l incom es— a re d i s t r i b u t e d among
th e p ro d u cin g and n o n -p ro d u c in g segm ents o f the community.
P r o d u c t i v i t y and d i s t r i b u t i o n . — T h e, t r a d i t i o n a l o r
" o ld - f a s h i o n e d " view of d i s t r i b u t i o n , J . M. C lark rem inds
u s , i s t h a t th e g a in s in r e a l income r e s u l t i n g from
i n c r e a s e s i n p r o d u c t i v i t y sh o u ld be d i f f u s e d among con
sumers v i a a g e n e r a l r e d u c t io n in p r i c e l e v e l . In term s of
e q u i t y , th e r e s u l t i n g s e c u l a r d e c l in e in p r i c e s would
s p e c i a l l y b e n e f i t p e rs o n s dependen t on f i x e d money incom es.
This a s p e c t , how ever, a p p e a rs to be c o u n te rb a la n c e d by th e
p ra g m a tic o b j e c t i o n s of th o s e who b e li e v e (a) t h a t th e g o a l
o f p ro g re s s and o u tp u t e x p a n sio n i s b e s t s t i m u l a t e d by
a l l o c a t i n g th e p r o d u c t i v i t y g a in s to th e groups d i r e c t l y
engaged in p r o d u c t i o n , or (b) t h a t p r i c e d e c l i n e s would be
s p e c i a l l y burdensome f o r d e b t o r s , in c l u d i n g governm ent.
A nother r e a l i s t i c o b j e c t i o n i s t h a t a l i t e r a l a p p l i c a t i o n
of th e p r i c e - r e d u c t i o n i d e a l in v o lv e s c o n s ta n t money
incomes o r f a c t o r p r i c e s , which means t h a t la b o r u n io n s
would lo se t h e i r "most co n sp icu o u s and t a n g i b l e economic
f u n c t i o n , " t h a t of r a i s i n g th e g e n e r a l l e v e l of w a g e s .1
■^Clark, op. c i t . , pp. 19-22, and Boulding, op. c i t .,
pp. 57-61.
431
A p ersu asiv e argument Is a lso o ffe re d fo r the id e a l
of a sta b le p r ic e l e v e l , with money incomes allowed to ris e
only in step w ith p r o d u c tiv ity . The main case for t h i s
i d e a l is t h a t , by a s su rin g a co n stan t purchasing power for
money, i t would minimize in te rf e r e n c e s with long-term
c o n tra c ts and enable th e use of accounting systems w ithout
d i s t o r t i o n of in fo rm a tio n .1
However, im plem entation of t h i s id e a l would req u ire
e i t h e r (a) th e a l lo c a tio n of p r o d u c tiv ity gains to con
sumers in the form of lower p r i c e s , as in d ic a te d by Machlup,
(b) th e lim ita tio n of in d iv id u a l wage in c re a s e s to produc
t i v i t y increm ents in th e given firm or in d u s tr y , or (c) the
lim ita tio n of the average r a te of wage in c re a se to the
average rate o f p ro d u c tiv ity growth in the economy as a
wh o l e .
To each of th e s e procedures th e re i s lik e ly to be
s tro n g o p p o sitio n by th e trad e unions. In the f i r s t case
they may seek t o stake a p r io r claim to these gains in the
name of t h e i r m e m b e r s .^ in the second case th e "g ro ssly
Unless otherw ise s p e c if ie d , th is d isc u ssio n on
s ta b le p rice s i s based mainly on Boulding, op . c i t . , p. 58;
C lark , op. c i t . , pp. 37-40, 45-46; and Machlup, op. c i t . ,
PP. 134-35.
2In th e view o f Sumner H. S l i c h t e r , a major function
of th e "powerful" tra d e unions Is to assure t h a t the gains
of te c h n o lo g ic a l progress are "broadly d is t r ib u t e d " ; see
his Economic Growth in the United S ta te s (ed. John T.
Dunlop. B altim ore: L ouisiana S ta te U n iv ersity P re s s ,'
1 9 6 1) , p. 1 9 1 .
432
i n e q u i t a b l e " wage d i f f e r e n t i a l s im p lie d i n i n d u s t r y - b y -
in d u s t r y wage a d ju s tm e n ts — owing to the 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 in d i f f e r e n t i n d u s t r i e s — would n o t be
" t o l e r a t e d " by w orkers in the l e s s t e c h n i c a l l y p r o g r e s s i v e
i n d u s t r i e s . In th e t h i r d c a s e , as noted i n C h ap ter i v ,
un ions can be e x p e c te d t o a s s e r t t h e i r t r a d i t i o n a l r e l u c
ta n c e to a cc ep t th e r a t e of p r o d u c t i v i t y grow th as a b in d
in g g u id e to wage a d ju s tm e n ts because i t im p lie s 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 — among w a g e -e a rn e rs as
w e ll as 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 — as
r e p r e s e n t i n g e q u ity e q u il i b r i u m and t h e r e f o r e beyond a l t e r
a t i o n .
F u rth e rm o re , th ey may argue a g a in s t th e f e a s i b i l i t y
of e x p e c tin g w orkers i n i n d u s t r i e s w ith a b o v e -a v e ra g e
p r o d u c t i v i t y to a c c e p t l e s s th a n the r a t e o f p r o d u c t i v i t y
growth e n jo y e d by t h e i r p a r t i c u l a r f ir m s , as would be r e
q u ir e d by th e p r o d u c t i v i t y fo rm u la . On th e o th e r hand,
firm s in th e b e lo w -a v era g e p r o d u c t i v i t y c l a s s may o b j e c t t o
the n e c e s s i t y of r a i s i n g t h e i r p r i c e s in o r d e r t o be a b le
to r a i s e wages in l in e w ith a v erag e p r o d u c t i v i t y .
C o n d itio n s f o r s t a b i l i t y . — G e n e ra lly th e s t a b l e
p r i c e outcome r e q u i r e s n o t only (a) v o lu n ta r y r e s t r a i n t in
o rg a n iz e d l a b o r 's use of m arket power or s t i f f em ployer
r e s i s t a n c e t h e r e t o , b u t a ls o (b) downward f l e x i b i l i t y of
p r i c e s where c o s ts and p r o f i t s p e rm it. O therw ise any
433
p r o f i t s "above a c o m p e titiv e minimum" th a t a r e not con
v e r t e d i n t o lo w er p r i c e s w i l l i n v i t e a d d i t i o n a l wage
demands.
In C l a r k ’ s o p in io n th e c o n d itio n s e s s e n t i a l t o th e
r e a l i z a t i o n of s t a b l e p r i c e s do n o t e x i s t so lo n g as t h e
" b a la n c e o f b a r g a i n in g power" l i e s i n the i n f l a t i o n a r y
d i r e c t i o n . T hat i s , so lo n g as th e r e a l w ages of p a r t i c u
l a r u n io n s o r th e r e a l p r o f i t s of p a r t i c u l a r f ir m s o r
i n d u s t r i e s can be i n c r e a s e d a t th e expense o f o t h e r s , s e l f -
r e s t r a i n t by th e l a t t e r may e i t h e r be u n l i k e l y or
i n s u f f i c i e n t to m oderate t h e i n f l a t i o n p r e s s u r e s .
On th e b u s i n e s s s i d e , C lark a d d s, f i r m s do n o t ten d
t o red u c e p r i c e s u n t i l c o m p e titiv e p r e s s u r e s im p el them to
do so ; and any p r o f i t s a c c r u i n g from s lu g g is h c o m p e titio n
o r from i n n o v a t i o n a re r e g a r d e d by them as t h e w h e re w ith a l
w ith which to m eet i n e v i t a b l e wage demands.
A r e l a t e d view i s h e l d by t h e Commission on Money
and C r e d it which p o i n ts t o a te n d e n c y of p r o d u c t i v i t y
i n c r e a s e s to be s h a r e d among em ployees and em ploy ers
(th ro u g h h ig h e r money incom es) r a t h e r than w i t h the c o n
sumer th ro u g h lo w er p r i c e s as a d e t e r r e n t to p r i c e s t a b i l
i t y . S i m i l a r l y do th ey r e g a r d th e ten dency o f w a g e -r a te
i n c r e a s e s i n th e l e s s p r o d u c t i v e i n d u s t r i e s t o r i s e i n l i n e
w ith th e n a t i o n a l averag e as c o n t r i b u t i n g to a r i s i n g p r i c e
l e v e l . - 1 -
^-Commission on Money and C redit, op. c i t ., p. 22.
434
Case fo r r i s i n g p r i c e s . —F in a ll y , th e re is the case
fo r accepting moderately r is in g or creeping i n f l a t i o n over
the long run. A v a r ie ty of j u s t i f i c a t i o n s have been
o ffe re d , but only a few need be p resen ted h e re .^ F i r s t ,
there is the gen eral argument th a t moderate i n f l a t i o n
stim u la tes c u rre n t r e a l output and economic growth, and
should be accepted fo r any b e n e fits the l a t t e r bring.
However, the a v a ila b le evidence in support of th is th e s is
In d ic a te s th a t the b e n e f ic ia l e f f e c ts are only s lig h t in
most in s ta n c e s , and a p r i o r i u n p re d ic ta b le , a t le a s t in the
context of th e American economy.
Second, th ere is the argument t h a t labor-management
r e la tio n s are more apt to be p eacefu l under a slowly r i s i n g
p rice le v e l than under a s ta tio n a ry one. Under s ta tio n a ry
p r ic e s , fo r example, management is viewed as being more
r e s i s t a n t to wage in c re a s e s — the very increm ents which
unions fe e l they must "gain"— while f o r workers the gearin g
of wages to p ro d u c tiv ity in o rd er to assure p r ic e s t a b i l i t y
may not be an acceptable formula.
^On t h i s p o in t see George Leland Bach, I n f la tio n
(Providence: Brown U niversity P ress, 1958), pp. 14-22;
Boulding, op. c i t . , pp. 59-60; John P. Lewis, Price and
Wage P o l i c i e s , A Report to the White House Conference on
N ational Economic I s s u e s , Washington, D.C., May 21, 1962,
p. 3 (Mimeographed.); S l i c h t e r , "On the Side of I n f l a t i o n ,"
op. c i t . , and Economic Growth . . . , op. c i t . , pp. 186-87.
435
F or S l i c h t e r , h ow ever, c r e e p in g i n f l a t i o n i s th e
n e c e s s a r y c o s t o f a s s u r i n g th e b e n e f i t s n o t only o f a
"dynam ic" economy of grow th and r a p i d t e c h n o l o g i c a l
p r o g r e s s but a l s o of a " v ig o r o u s " t r a d e u n io n movement.
What a b o u t th e g e n e r a l o b j e c t i o n t o c r e e p in g
i n f l a t i o n : t h a t once m ild i n f l a t i o n becomes th e " e x p e c te d "
or n orm al co u rse o f e v e n t s , th e a n t i c i p a t e d p r i c e r i s e s
would in d u ce more w id e s p re a d p r o t e c t i o n v i a " p u r c h a s in g
power" o r " e s c a l a t o r " c la u s e s and a p r e f e r e n c e f o r s p e c u l a
t i v e r a t h e r th a n p r o d u c t i v e a c t i v i t i e s . For S l i c h t e r ,
a p p a r e n t l y , t h e s e d a n g ers co u ld be h o p e f u l l y a v o id e d e i t h e r
b e ca u se (a) i n f l a t i o n c o u ld be k e p t t o a c re e p i n d e f i n i t e l y
and need n o t sp e e d up as p e o p le grew accustom ed t o i t , o r
(b) t h e problem o f c re e p in g I n f l a t i o n co u ld e v e n t u a l l y
d i s a p p e a r a l t o g e t h e r as th e " e x c e s s iv e s t r e n g t h " of th e
t r a d i t i o n a l u n io n s o f m anual w o rk e rs— which S l i c h t e r
r e g a rd e d as th e b a s i s o f th e i n f l a t i o n p roblem — d im in is h e d
r e l a t i v e to th e grow ing numbers of w h i t e - c o l l a r , t e c h n i c a l ,
and p r o f e s s i o n a l w o rk ers who would be w eakly o r g a n iz e d a t
b e s t .
In a d d i t i o n to th e above l i n e s of j u s t i f i c a t i o n ,
which g e n e r a l l y te n d to em phasize th e b e n e f i c i a l e f f e c t s
of i n f l a t i o n upon g ro w th , employment and i n d u s t r i a l
r e l a t i o n s , t h e r e a re s e v e r a l o t h e r s w hich m e r i t a t l e a s t
b r i e f m ention b e c a u se of t h e i r e x p l i c i t o r i m p l i c i t a p p e a l
43 6
t o l a r g e r c o n s i d e r a t i o n s , su c h as th e n a t i o n a l i n t e r e s t o r
s o c i a l - p o l i t i c a l s t a b i l i t y .
Thus i n f l a t i o n has a l t e r n a t i v e l y been re g a rd e d as
(a ) the p r i c e th e n a t i o n must pay to meet the e x ig e n c ie s
o f the C old War, n a t i o n a l d e fe n s e and f o r e i g n a i d , (b)
e n a b lin g th e g ra d u a l l i g h t e n i n g of th e r e a l b u rd en o f th e
p u b lic d e b t , and ( c ) p r o v id in g a " s o c i a l l o g r o l l i n g
p ro c e ss " o r "escape v alve" f o r the e x c e s s income claim s o f
com peting groups whose in c o m p a tib le demands ( i n r e l a t i o n to
t o t a l s u p p ly ) m ight o th e rw is e d i r e c t l y d e s tr o y th e
c a p i t a l i s t i c system.-*-
The Role o f Government in I n f l a t i o n
One im p o rta n t and f a i r l y obv io u s c o n c lu s io n t h a t
fo llo w s from the above d is c u s s i o n i s t h a t w ith r e s p e c t t o
th e im p le m e n ta tio n o f the p r i c e - s t a b i l i t y g o a l— which may
decide a g iv e n a d m i n i s t r a t i o n 's p o l i t i c a l f o r t u n e s — g o v e rn
ment i s n o t c o n fr o n te d w ith a sim ple ch o ice betw een p r i c e
s t a b i l i t y and i n f l a t i o n but r a t h e r betw een p r i c e s t a b i l i t y
and n o n - r e a l i z a t i o n of o t h e r m ajor g o a l s . I t was seen how
a number o f f a c t o r s — such as th e i n f l a t i o n a r y b i a s o f t h e
employment g oal and p a r t l y t h e growth g o a l, th e a g g re s s iv e
te n d e n c ie s of t r a d e u n io n s , th e d e t e r r e n t s to p r i c e
^On th e s e p o i n t s se e Bach, I n f l a t i o n , op. c i t . ,
p p . 64-65; H a rt, op. c i t . , p . 2864; and R o b e rts o n , op. c i t . ,
p . 121.
43 7
r e d u c tio n s by f i r m s , th e com peting income claim s of m ajor
economic and p o l i t i c a l b lo c s and i n t e r e s t s , and th e demands
of f o r e i g n p o l i c y — a l l c o n s p ire to make i t p o l i t i c a l l y
d i f f i c u l t f o r governm ent p o l ic y a t home and ab ro ad to
assume a c o n s i s t e n t a n t i - i n f l a t i o n program .
As a b y - p r o d u c t , p r o - i n f l a t i o n f o r c e s have impeded
a w ider d i s t r i b u t i o n o f th e g a in s of p r o d u c t i v i t y i n the
form of lower p r i c e s t o the consum er: i t seems as though
the g a in s in r e a l income a c h ie v e d by p r o d u c t i v i t y , and
going t o th e more fa v o ra b ly s i t u a t e d w a g e -e a rn e rs and firm s
in th e f i r s t i n s t a n c e , may have induced government to
i n c r e a s e i t s t r a n s f e r b e n e f i t s to the l e s s f a v o r a b ly s i t u
a te d groups of th e community.
Two a s p e c ts o f p o l i c y . — Two m ajor a s p e c t s o f a n t i
i n f l a t i o n p o lic y are h i g h l i g h t e d in t h i s c o n te x t. One
in v o lv e s an u n d e r s ta n d in g of th e t h e o r e t i c a l u n d e rp in n in g s
c o n ce rn in g th e r e l a t i o n s betw een income d i s t r i b u t i o n ,
m a rg in a l c o n t r i b u t i o n s t o p r o d u c t i v i t y , and p r i c e s , in th e
c o n te x t of dynamic economic grow th b ased on t e c h n o l o g i c a l
advances in th e use o f la b o r and c a p i t a l equipm ent.
C l e a r l y , h e re i s an a r e a c a l l i n g f o r f u r t h e r e x p l o r a t i o n :
how can th e g a in s in p r o d u c t i v i t y in s p e c i f i c case s be
d i s t r i b u t e d among th e income s h a r e s in a manner c o n s i s t e n t
w ith o v e r - a l l p r i c e s t a b i l i t y ? That i s , what c r i t e r i a a re
r e q u i r e d f o r d e te rm in in g w h eth er a p a r t i c u l a r w a g e -p ric e
43 8
d e c is io n i s c o n s i s t e n t w ith s t a b i l i t y of th e p r i c e l e v e l ?
R e la te d to t h i s q u e s tio n i s an o th er im p o rta n t t a s k :
th e s p e l l i n g out of th e c r i t e r i a f o r d e te rm in in g why
s t a b i l i t y o f the p r i c e l e v e l , w hile not an e n d in i t s e l f ,
i s n e v e r t h e l e s s a s u p e r i o r o b j e c t i v e to e i t h e r a d e c l i n i n g
or r i s i n g p r i c e l e v e l , i n c lu d in g f o r example th e b e n e f i c i a l
e f f e c t s of s t a b l e p r i c e s f o r making economic c a l c u l a t i o n s
in term s of money.
The second p o lic y a s p e c t concerns t h e d e te r m in a tio n
of p r a c t i c a l m achinery to im plem ent the p o l i c y im p l i c a ti o n s
of th e o ry f o r wage and p r i c e b e h a v io r : what p o l i c i e s w i l l
be both- a c c e p ta b le to a l l p a r t i e s concerned a n d cap a b le of
a s s u r i n g o v e r - a l l p r i c e s t a b i l i t y ? That i s , could a
g e n e r a l p o l ic y be a d ap ted t o i n d i v i d u a l c irc u m s ta n c e s
w ith o u t i n v i t i n g m o d if i c a t io n s f o r " e x c e p tio n s " and s p e c i a l
c a se s t h a t would p r e v e n t s t a b i l i z a t i o n of p r i c e s ?
A lthough th e s e two m a tte r s a re beyond the scope of
t h i s s tu d y , i t i s p r o p e r t o n o te some of th e d i r e c t i o n s of
work a lr e a d y done ( e s p e c i a l l y i n th e l a t t e r a r e a ) w hich may
be a h a r b i n g e r of a fu n d am en tal change in government
a t t i t u d e to i n f l a t i o n .
^■For a u se fu l in tro d u c tio n to such sp e c u la tio n s see
Bach, I n f l a t i o n , op. c i t . , pp. 54-66.
439
The payments d e f i c i t . — A s p e c i a l i n c e n t i v e to th e
r e - a s s e r t i o n of p r i c e s t a b i l i t y as a n a t i o n a l o b j e c t i v e has
been th e p e r s i s t e n t d e f i c i t i n th e n a t i o n 's b a la n c e o f pay
m ents. P r e s id e n t Kennedy i n 1962 invok ed t h i s d e f i c i t in
th e n a t i o n a l i n t e r e s t d u rin g the p u b lic d e b ate over s t e e l
p r i c e s . The d e f i c i t has become im p o rta n t enough to command
s i g n i f i c a n t m e l i o r a t i v e s t e p s a t home and abx’o a d , in
c o o p e ra tio n w ith a l l i e s i n W estern E urope.
While th e problem of the payments d e f i c i t may n o t
be g e n e r a l l y r e g a r d e d as a s u f f i c i e n t re a so n f o r e n f o r c in g
p r i c e s t a b i l i t y upon th e economy, i t has a t l e a s t been
o f f i c i a l l y acknowledged by th e p r e s i d e n t 's e co n o m ists as a
"co m p e llin g " o n e .^ T his i s b ecau se th e payments d e f i c i t ,
among o th e r t h i n g s , r e f l e c t s a lo n g -ru n problem as w e ll as
a s h o r t - r u n one: th e d eg ree of c o m p e titiv e n e s s of th e
American economy i n dom estic and world m a r k e ts ; and, as th e
p r e s i d e n t 's economic a d v i s e r s rem ind u s , a t th e " h e a r t of
the m a tte r " of c o m p e titiv e n e s s l i e p r i c e s .
I t i s p o s s i b l e to s p e c u l a te t h a t w h ile ,o n th e one
hand, th e payments d e f i c i t c o n s t i t u t e s an emergency o r
t r a n s i t o r y c o n d itio n w h ich, a t l e a s t a t th e s t a r t , has
ind uced r e l a t i v e l y e x p e d ie n t a t t a c k s on th e p roblem of
■^This d i s c u s s i o n on g u i d e l i n e s i s b a se d on U .S .,
P r e s i d e n t (K ennedy), Economic R eport of 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 , 196 2 ),
pp. 167, 174, 185-90.
HliO
r i s i n g d o m estic p r i c e s , i t may y e t se rv e t o s t i m u l a t e
development of a fu n d a m e n ta l approach to th e achievem ent of
p r i c e s t a b i l i t y .
The p r e s i d e n t s " g u i d e p o s t s . " — One f o r e r u n n e r of
such an approach i s the P r e s i d e n t 's C o u n c il of Economic
A d v is e rs ' a n a l y s i s of p r i c e b e h a v io r and i n f l a t i o n . In th e
f i r s t p l a c e , t h e i r a n a l y s i s fo c u s e s on wages and s a l a r i e s
as c o n s t i t u t i n g b o th th e p r i n c i p a l c o s ts of th e n a t i o n 's
em ployers and th e m ajo r so u rc e o f Income and demand. T hus,
so long a s r i s i n g money wage r a t e s do n o t exceed i n c r e a s e s
in o u tp u t p e r m an-hour, u n i t la b o r c o s ts and p r i c e s can
rem ain re a s o n a b ly s t a b l e . However, i f th e p r i c e l e v e l
manages t o r i s e — w h e th er caused by dem and -pull or c o s t- p u s h
— i t w i l l be c h a r a c t e r i s t i c a l l y accom panied by wage
I n c r e a s e s in e x c e s s of th e p r o d u c t i v i t y r a t e . S in c e th e
r e s u l t i n g r i s e in p r i c e s may a t tim e s be re g a rd e d as
c o n tra ry t o the n a t i o n a l i n t e r e s t — f o r exam ple, th e p r e s i
dent f e l t so in th e s t e e l p r i c e d i s p u t e — th e p r e s i d e n t 's
a d v is e r s c a l l f o r c r e a t i o n of an inform ed p u b lic and "an
a tm o sp h e re ” i n which l a b o r and management a re In duced to
a c t " r e s p o n s i b l y ."
The i m p l i c a t i o n s of t h i s r e a s o n i n g , which rem ind us
of W e in tra u b 's s t r a t e g i c a p p ro a c h , a re c l e a r enough,
a lth o u g h th e p r e s i d e n t 's a d v is e r s do n o t e x p l i c i t l y s t a t e
them: I f a t th e h e a r t of c o m p e titiv e n e s s l i e p r i c e s , th e n
441
a t th e h e a r t of p r i c e s l i e s th e pro b lem of d i s t r i b u t i n g the
g a i n s of p r o d u c t i v i t y ; and s i n c e e x c e s s i v e wage i n c r e a s e s
a r e th e c h a r a c t e r i s t i c accompanim ent o f r i s i n g p r i c e
l e v e l s , n a t i o n a l p o l i c y sh o u ld seek t o harm onize " im p o r t
a n t " p r i v a t e l y - e s t a b l i s h e d wages and p r i c e s w ith th e
n a t i o n a l i n t e r e s t r a t h e r th a n s e a r c h f o r e l u s i v e s p e c i f i c
c a u s e s or s c a p e g o a t s . Toward t h i s end th e a d v i s e r s o f f e r
a " g u id e p o s t" or s t a n d a r d 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 b a se d on th e fu n d a m e n ta l f a c t t h a t th e
a v e ra g e r a t e of p r o d u c t i v i t y grow th i s th e " c e n t r a l g u id e -
p o s t " or "benchm ark" ( r a t h e r th a n a " r u l e " ) f o r a p p r a i s i n g
s u c h b e h a v io r .
Im p lem en tin g th e g u i d e l i n e s . — The " g e n e r a l g u id e "
f o r n o n - i n f l a t i o n a r y wage b e h a v io r i s th e same as t h e one
made f a m i l i a r by Machlup and W ein tra u b : i n each i n d u s t r y
t h e r a t e o f i n c r e a s e in wage r a t e s ( i n c l u d i n g f r i n g e
b e n e f i t s ) s h o u ld a d h e re to th e t r e n d r a t e o f th e 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 i n c r e a s e .
Im p le m e n ta tio n of t h i s g e n e r a l w a g e -p ric e g u i d e
l i n e t h e o r e t i c a l l y c a l l s f o r (a) p r i c e r e d u c t io n s In
i n d u s t r i e s e n jo y in g a b o v e -a v e ra g e r a t e s of p r o d u c t i v i t y
g r o w th , (b) p r i c e i n c r e a s e s i n c a s e s of b e lo w -a v e ra g e
p r o d u c t i v i t y I n c r e m e n ts , and (c) s t a b l e p r i c e s in c a s e s of
f i r m s e n jo y in g a v e r a g e r a t e s o f p r o d u c t i v i t y . The
p r e s i d e n t ’ s a d v i s e r s acknow ledge t h a t i n p r a c t i c e " s p e c i f i c
442
m o d ific a tio n s '* would have to be made to a d a p t th e b ro ad
g u i d e l i n e to p a r t i c u l a r c ir c u m s ta n c e s , f o r re a so n s o f
e q u ity and e f f i c i e n c y , b u t they b e li e v e such m o d if i c a t io n s
can be f o r m u la te d so as to be c o n s i s t e n t w ith o v e r - a l l
p r i c e s t a b i l i t y .
Leading exam ples of c a s e s r e q u i r i n g s p e c i a l modi
f i c a t i o n s would in c lu d e wage r a t e s e x c e p ti o n a l l y below o r
above p r e v a i l i n g r a t e s f o r th e same g ra d e s of l a b o r , p r o f i t
l e v e l s t h a t a re e i t h e r " i n s u f f i c i e n t " o r above n o rm a l,
i n d u s t r i e s w ith e x c e ss c a p a c i t y , and p r o d u c t i v i t y i n c r e
ments a t t r i b u t a b l e more to im proved l a b o r q u a l i t y th a n t o
c a p i t a l goods.
D e sp ite t h i s a p p a re n t c o n fid e n c e t h a t s p e c i a l modi
f i c a t i o n s of t h e g e n e r a l g u i d e l i n e w i l l p ro v e c o n s i s t e n t
w ith s t a b l e p r i c e l e v e l s , some r e a s o n s f o r doubt have
a lr e a d y been im p lie d a b o v e , in th e d i s c u s s i o n s on th e
d i s t r i b u t i o n o f p r o d u c t i v i t y g a in s and th e c o n d itio n s f o r
p r i c e s t a b i l i t y . At t h i s p o in t some a d d i t i o n a l p o i n t s may
be n o te d .
For ex am ple, t h e r e i s th e fu n d am e n ta l problem
r a i s e d by C. L. S c h u l t z e , of how b u s in e s s and l a b o r
l e a d e r s i n the f i r s t i n s t a n c e a re to d i s t i n g u i s h betw een
p r i c e and wage i n c r e a s e s t h a t c o u ld be r e g a r d e d as
" d e s i r a b l e " and hence r e w a r d a b le , f o r r e a s o n s of e f f i c i e n t
r e s o u r c e a l l o c a t i o n , and th o se t h a t would be deemed
44 3
" a n t i s o c i a l " and t h e r e f o r e p u n i s h a b l e . 1 By what c r i t e r i a ,
one may add, w i l l government m o n ito rs them selv es be guided?
Then th e re i s th e e x p e rie n c e o f Western and
S c a n d in a v ia n Europe w ith "wage d r i f t ," where t h e a c tu a l
growth of money wages te n d s t o become l a r g e r t h a n the
n e g o t i a t e d i n c r e a s e s in wage r a t e s , because of p ie c e r a t e s
and payment a c c o rd in g t o r e s u l t s , r i s i n g l e v e ls o f over
tim e , and o t h e r s o u r c e s , in c l u d i n g s e c t o r a l e x c e s s dem and.2
A dm ittedly t h i s i s a t e c h n i c a l and complex s u b j e c t , beyond
th e scope of t h i s s t u d y , and i t i s by no means c l e a r t h a t
E u ro p e ’ s e x p e rie n c e w i l l be e n t i r e l y r e le v a n t t o the
American economy; n e v e r t h e l e s s i t i s n e c e s s a ry t o be aware
o f th e p o s s i b l e e f f e c t s of wage d r i f t on the p r i c e l e v e l .
Some p r o s p e c t i v e d e v e lo p m e n ts. - - A d d i t i o n a l stra w s
in th e wind of an u n f o ld in g n a t i o n a l w a g e -p ric e p o lic y may
be th e r e c e n t app o in tm en ts t o th e C ou ncil of Economic
A d visers of John P. Lewis and G ardner Ackley as r e p l a c e
ments f o r Kermit Gordon and James T o b in , r e s p e c t i v e l y .
Both Lewis and Ackley h a v e , i n the p a s t , p ro p o se d s te p s f o r
^ c h u l t z e , op. c i t . , p. 42. F o r a d e t a i l e d c r i t i
cism of th e " g u i d e l i n e s " approach see J u le s Backman,
" P r o d u c t i v i t y — No G uid epost f o r Wage S e t t l e m e n t s ,"
C h a lle n g e . X (Ju n e , 1 9 6 2 ), pp. 24-27.
2H. A. C legg, "A P o lic y f o r Incomes?" Lloyds Bank
Review, New S e r ie s No. 64 ( A p r i l , 19 6 2 ), p. 12; W illiam
F e l l n e r and O th e rs , The Problem of R is in g P r ic e s ( P a r i s :
O rg a n iz a tio n f o r European Economic C o -o p e ra tio n , 1961),
pp. 67-68.
c o u n te r in g c r e e p in g i n f l a t i o n t h a t may y e t f i n d t h e i r way
i n t o n a t i o n a l p o l i c y and are t h e r e f o r e w o rth n o t i n g a t t h i s
p o i n t .
P r i o r t o h i s s t a te m e n t o f May 1962, John P. Lewis
had s t a t e d h is view s b e f o r e th e J o i n t Economic Committee o f
■Congress in l a t e 1958 and e ls e w h e r e .^ W hile he avowedly
s t i l l s u b s c r i b e s to a l l o f h is e a r l i e r v ie w s — t h a t th e
i n h e r e n t i n f l a t i o n a r y b ia s- of p r i v a t e w age- and p r i c e -
s e t t i n g was r e a l but n o rm a lly n o t very s e r i o u s , and needed
no u r g e n t th e r a p y — two s u b s e q u e n t developm ents have f o r c e d
him to a d i f f e r e n t c o n c lu s io n : (a) the " c h r o n ic s la c k " of
th e economy a t t r i b u t a b l e t o th e p u b l i c ' s f e a r of th e
i n f l a t i o n a r y e f f e c t s of an ti-u n em p lo y m e n t m e a s u re s , and
(b) th e b a la n c e o f paym ents d e f i c i t and th e c o n seq u e n t need
t o prom ote e x p o r t s .
F o r Lewis th e s o l u t i o n now l i e s m ain ly i n th e
hands o f governm ent which w i l l have to shape new p o l i c i e s
t o "m odify" th e b e h a v io r of our p r i c i n g sy ste m ; he does n o t
e x p e c t t h a t l a b o r and b u s i n e s s w i l l v o l u n t a r i l y d i s p l a y
"more r e f i n e d s e n s e s of s o c i a l r e s p o n s i b i l i t y " th a n
h i t h e r t o . Above a l l , he s a y s , i s needed some " s y s t e m a t i c
^For t h e views o f John P. Lewis se e h i s " P r i c i n g
f o r S t a b i l i t y and G row th," op. c i t . , " P r i c e and Wage
P o l i c i e s , " op. c i t . , and "The Problem o f P r ic 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 Review,
XLIX (May, 1 9 5 9 ), PP. 3 0 9 -2 1 .
445
and e f f e c t i v e , y e t n o n a u t h o r i t a t i v e " way of i n f l u e n c i n g
" k e y ” p r i v a t e p r i c e and wage d e c i s i o n s so t h a t th ey do n ot
"m arkedly d iv e r g e " from th e n a t i o n a l i n t e r e s t .
In t h i s c o n n e c tio n Lewis se e s a need f o r more th an
" g e n e r a l i z e d n a t i o n a l g u i d e l i n e s , " s in c e he b e l i e v e s
g o v e rn m e n t's a d v ic e must be much more " p a r t i c u l a r i z e d ,
p o i n t e d , and t i m e l y ," and y e t i t s d e l i v e r y must be much
more " r o u t i n i z e d " th a n i t was i n th e s t e e l c a s e .
L ew is' p r o p o s a l s . — Toward t h i s end Lewis s u g g e s ts
two " g ro u n d w o rk -la y in g s t e p s " t h a t would h e lp p r e p a r e th e
way f o r a lm o st any new p r i c e and wage p o lic y t h a t g o v e rn
ment m ight r e a s o n a b ly u n d e r t a k e . One i s a f e d e r a l i n c o r
p o r a t i o n s t a t u t e which makes p ro cu re m en t of a f e d e r a l
c h a r t e r m andatory f o r c o r p o r a t i o n s l a r g e r th a n a s p e c i f i e d
s i z e , and which may ask a p p ly in g c o r p o r a t io n s t o subm it t o
new s ta n d a r d s o f " p u b l ic a c c o u n t a b i l i t y " i n c l u d i n g , a t
g o v e rn m e n t's o p t i o n , c o n s u l t a t i o n on m a jo r wage and p r i c e
d e c i s i o n s . S i m i l a r r e q u ir e m e n ts would be a sk ed of l a b o r
u n io n s d e s i r i n g a c c e s s t o b e n e f i t s o f f e d e r a l l a b o r
l e g i s l a t i o n .
L ew is' second s u g g e s t i o n i s e s t a b l i s h m e n t of an
O f f ic e of I n d u s t r y Economics in th e E x e c u tiv e b ra n c h . This
u n i t would have th e u n iq u e r e s p o n s i b i l i t y o f m a in t a i n in g
a " c o n tin u in g a u t h o r i t a t i v e f a c t u a l " a n a l y s i s o f p a r t i c u l a r
i n d u s t r y c ir c u m s ta n c e s , and would become a c c e p te d as an
HH6
" i n d is p e n s a b l e " c o n s u l t a n t and an " a u t h o r i t a t i v e a r b i t e r "
of d i s p u t e s o v e r f a c t s , e s p e c i a l l y ov er p r o d u c t i v i t y
c h a n g e s .
A c k le y 's p r o p o s a l . — A ckley, t o o , had s u g g e s te d to
the J o i n t Economic Committee i n 1958 t h a t th e p r i c e creep
a t t r i b u t a b l e to wage and p r i c e "markup" i n f l a t i o n r e q u i r e d
some ty p e of p u b l i c a c t io n i n view o f th e p u b l i c 's " s ta k e "
in i n f l a t i o n a r y wage and p r i c e d e c i s i o n s . He a s s e r t e d t h a t
the p u b l i c s ta k e needed some m achin ery which would " s h a r p ly
d e f i n e " i t and b r i n g i t t o b e a r i n s p e c i f i c term s upon th e
c o n c r e te i s s u e s t h a t a r i s e .
Toward t h i s end Ackley p ro p o se d t h a t Congress
e s t a b l i s h a perm anent Wage and P r i c e Commission charged
w ith th e r e s p o n s i b i l i t y of (a) f o r m u la ti n g g e n e r a l s t a n
dard s 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 d e c i s i o n s , (b)
c o l l e c t i n g th e n e c e s s a r y i n f o r m a t i o n , and (c) making p u b l i c
i t s f i n d i n g s and judgm ent as to how th e g e n e r a l o b j e c t i v e
of p r i c e s t a b i l i t y m ight be im plem ented i n s p e c i f i c c a s e s .
I t s m a jo r t a s k would be " f o r m u l a ti o n of a p p r o p r i a t e
s t a n d a r d s " f o r p u b l i c a p p r a i s a l o f wage cla im s and markup
p r a c t i c e s . T his b a s i c a l l y " i n v e s t i g a t o r y " body would have
l-For th e view s o f G ard ner Ackley see h i s "A T h ird
Approach to th e A n a ly s is and C o n tro l o f I n f l a t i o n , " in
U .S ., C o n g re ss, J o i n t Economic Com m ittee, Compendium, . . »
op. c i t . , pp. 63 ^ -3 6 .
447
a u t h o r i t y to r e q u i r e tem p o rary p o stp o n em en t of wage and
p r i c e i n c r e a s e s p en d in g i t s stu d y o f them , b u t i t would n o t
have power to s e t l e g a l maximums and would a v o id a t a l l
c o s t s th e r o l e of " m e d ia tio n or com prom ise."
Some P i n a l P e r s p e c t i v e s on P o lic y Making
I f th e p r e c e d in g d i s c u s s i o n p o r te n d s th e p o t e n t i a l
d i r e c t i o n s o f n a t i o n a l wage and p r i c e p o l i c y , what a r e th e
f o r e s e e a b l e i m p l i c a t i o n s and co nsequences? Lewis p ro b a b ly
speaks f o r many when he ad m its t h a t th e new a n t i - i n f l a t i o n
p o l i c i e s may c a r r y th e n a t i o n i n t o an " u n f a m i l i a r , w o r r i
some a re a " w h erein i t has c o m p a ra tiv e ly l i t t l e r e l e v a n t
e x p e r i e n c e . T r u l y , t h e r e f o r e , t h e r e i s need f o r commonly
a c c e p te d g u id in g p r i n c i p l e s t h a t w i l l s a f e g u a r d th e n a ti o n
a g a i n s t th e h a z a rd s o f such a voyage i n t o w orrisom e a r e a s .
Above a l l t h e r e i s th e need to m a in ta in a se n se o f
p r o p o r t i o n betw een th e e x t e n t of i n f l a t i o n a r y p r e s s u r e s
o p e r a t iv e a t any g iv e n tim e and th e d eg ree o f a n t i
i n f l a t i o n a c t io n by governm ent. Thus i t may be j u s t i f i e d ,
as of now, to a v o id e x c e s s i v e ly d r a s t i c p o l i c y to check a
p r i c e t r e n d t h a t has a c t u a l l y been " e s s e n t i a l l y s t a b l e "
f o r th e p a s t f i v e y e a r s , as th e p r e s i d e n t h i m s e l f acknow
led g ed i n h i s r e c e n t a n n u a l econom ic r e p o r t t o th e
C o n g r e s s .1 The p r e s i d e n t a l s o l i s t e d s e v e r a l f a c t o r s —
• * ~ The W all S t r e e t J o u r n a l ( P a c i f i c C oast E d i t i o n ) ,
Ja n u a ry 22 , 1963, p . B T
4*»8
such as e x c e ss c a p a c i t i e s , i n t e n s i f i e d c o m p e titio n at home
and a b ro a d , abu ndant w orld s u p p l i e s o f prim ary p r o d u c t s ,
and i n c r e a s e d " p u b l i c v i g i l a n c e " — w hich may e n a b le c o n tin u
a t i o n of t h i s f a v o r a b l e p r i c e t r e n d .
As a m a t t e r o f p e r s p e c t i v e i t sh o u ld be n o ted a l s o
t h a t our wage and p r i c e r e c o r d f o r th e p e rio d 1953 to 1 9 6I
compares f a v o r a b ly w ith t h a t of W estern Europe and Ja p a n .
In t h a t span consumer p r i c e s in th e U n ite d S t a t e s i n c r e a s e d
only 11 p e r c e n t and wages r o s e 33 p e r cen t compared w ith
l a r g e r i n c r e a s e s r e g i s t e r e d by our m a jo r i n d u s t r i a l
c o m p e tito rs a b r o a d . 1
Loss of p e r s p e c t i v e i s som etim es r e s p o n s i b l e f o r a
m i s d i r e c t i o n o f a n t i - i n f l a t i o n e f f o r t s . R e l a t i v e l y few
d i s c u s s i o n s of r e c e n t i n f l a t i o n in t h e U nited S t a t e s have
c a l l e d s u f f i c i e n t a t t e n t i o n to th e c o n t r i b u t i o n made by
r i s i n g p r i c e s in th e s e r v i c e i n d u s t r i e s to the o v e r - a l l
r i s e i n consumer p r i c e s th ro u g h much of the p o s t- w a r
p e r i o d . The d i v e r s e s e r v i c e i n d u s t r i e s — r a n g in g from
h o u s in g , d o m e stic and p e r s o n a l s e r v i c e s , t r a n s p o r t a t i o n ,
and u t i l i t i e s t o r e c r e a t i o n and m e d ic a l c a re — c la im e d a
r i s i n g s h a re of t o t a l consumer e x p e n d i t u r e s , from 32 t o 38
p e r cent i n th e y e a r s 19^7 t o 1958, w h ile t h e i r p r i c e s r o s e
i n t e r n a t i o n a l M onetary Fund, I n t e r n a t i o n a l F in a n -
c i a l S t a t i s t i c s , XVI ( J a n u a r y , 1963)* po. 118, 122, 166,
170, 270, 274.
449
more th a n 50 p e r cen t compared w ith a r i s e of only 29 p e r
* 1
cent f o r a l l consumer p r i c e s .
The r e l e v a n t q u e s tio n th en becomes: how w i l l
m easures a g a in s t c o st-p u sh check r i s i n g s e r v i c e p r i c e s
which— w ith th e p o s s i b l e e x c e p tio n of the c o s t - o r i e n t e d ,
r e g u l a t e d u t i l i t i e s — have been i n f lu e n c e d by m arket demand
and su pply f o r c e s ( e . g . , m e d ic a l c a re ) or low er r a t e s of
p r o d u c t i v i t y — e s p e c i a l l y in th e lo w -p a id , u n s k i l l e d ty p es
of s e r v i c e s — r a t h e r than by a g g re s s iv e c o s t- p u s h f o r c e s .
A r e l a t e d r e l e v a n t q u e s tio n d e s e rv in g an answ er i s : to
what e x t e n t have r i s i n g s e r v i c e p r i c e s i n d i r e c t l y ( i f n o t
d i r e c t l y ) had an adverse e f f e c t on e x p o rt p r i c e s ?
F i n a l l y , t h e r e rem ains the q u e s tio n of f e a s i b i l i t y :
w hether the a n t i - i n f l a t i o n p r e s c r i p t i o n s ( e . g . , the g e a r in g
of incomes to some p r o d u c t i v i t y form ula) w i l l be a c c e p ta b le
t o th e r e s p e c t i v e groups and i n t e r e s t s r e q u i r e d to a d j u s t
t h e i r b e h a v io r p a t t e r n s in fa v o r of p r i c e s t a b i l i t y . For
exam ple, i f in view of i t s a n tip a th y to p r o d u c t i v i t y f o r
mulas o rg a n iz e d la b o r w i l l e f f e c t i v e l y r e s i s t or circum vent
th e l e t t e r i f n o t the s p i r i t of th e p r e s i d e n t 's g u i d e l i n e s ,
by what mandate w i l l government a s s e r t the n a t i o n a l
i n t e r e s t above t h a t of a s p e c i a l group?
^ U .S ., C ong ress, J o i n t Economic Com mittee, S t a f f
Report on Employment, Growth, and P r ic e L e v e l s , 86th Cong.,
1 s t S e s s . , 1959, pp. 130-36.
450
In t h i s c o n n e c tio n i t may be n e c e s s a r y to e n a c t th e
p r o p o s a l o f A. F. Burns and G. L. Bach t h a t C ongress amend
th e Employment Act o f 1946 t o in c lu d e " r e a s o n a b le
s t a b i l i t y " of consumer p r i c e s among i t s o b j e c t i v e s . 1 One
o f i t s f i r s t b e n e f i t s would be a d i s p e l l i n g o f the "w ide
s p re a d b e l i e f " t h a t o u rs i s an age o f i n f l a t i o n in which
government i s e x p e c te d to behave a c c o r d i n g l y . In s u p p o r t
o f t h i s c ru sad e th e n a t i o n c o u ld be in fo rm e d o f the f i n d
in g s of Bach and o t h e r s (n o t u n d is p u te d ) t h a t , a t l e a s t in
r e c e n t y e a r s , i n f l a t i o n a r y "income s t r u g g l e s " have y i e l d e d
" i l l u s o r y g a in s " t o th e m ajor econom ic g ro u p s , w h ile th e
r e l a t i v e l y p a s s i v e or f ix e d incom es— e s p e c i a l l y o l d e r
p e o p le and em ployees in governm ent and n o n - p r o f i t i n s t i t u
t i o n s — have s u f f e r e d m o st.^
Summary and C o n c lu sio n s
In t h i s c h a p t e r . i t was seen t h a t w h ile t h e r e i s
g e n e r a l agreem ent t h a t an excess-d em an d i n f l a t i o n i s b e s t
c o u n te r a c te d by modern m o n e t a r y - f i s c a l s t a b i l i z a t i o n
p o l i c y , t h e r e i s s u b s t a n t i a l d is a g re e m e n t a b o u t th e most
d e s i r a b l e method of ch ec k in g c o s t - p u s h i n f l a t i o n .
■^Arthur 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 ty P r e s s , 1 9 5 7 ), P» 71; B ach,
"How Im p o rta n t Is P r i c e S t a b i l i t y i n S t a b le Economic
Growth?" o p . c i t . , pp. 33, 46.
^Bach, I n f l a t i o n , o p . c i t . , p p . 2 4 -2 5 , 99« F o r
s p e c i a l t r e a tm e n ts o f th e " c o n s ta n c y " of th e wage s h a r e see
W ein tra u b , A G e n e ra l Theory . . . , op. c i t . , pp. 4 -4 2 , and
"A Law That Cannot Be RepealedY^ C h a l l e n g e , X ( A p r i l , 1962),
451
F or tho se who p r e f e r s p e c i a l supplem entary or
a l t e r n a t i v e m easures to c o u n te r c o s t- p u s h p r e s s u r e s , th e
main reaso n i s th e f e a r t h a t th e r e q u i r e d degree o f demand-
d e p r e s s in g m o n e t a r y - f i s c a l a c t io n would— on th e assum ption
o f d e m a n d - in s e n s it i v e , c o s t - o r i e n t e d wages and p r i c e s —
p ro v e too c o s tly t o th e community: th e degree of e x ce ss
c a p a c ity and unemployment t h a t would be r e q u i r e d to induce
a m o d e ra tio n or r e s t r a i n t of wage and p r i c e p r e s s u r e s
would be to o g r e a t a p r i c e to pay f o r re d u c in g p r i c e s t o a
c r e e p .
Thus the b a s i c i s s u e i s n o t w hether m o n etary -
f i s c a l t o o l s can check s p i r a l l i n g p r i c e s — w hether caused
by e x c e ss demand o r c o s t-p u s h — b u t w hether i t i s d e s i r a b l e
to u se such t o o l s f o r checking s tu b b o rn c o s t-p u s h fo r c e s
by in d u c in g e x t r a - l a r g e unem ploym ent. Hence a r i s e s th e
"dilemma" c o n f r o n tin g p o lic y m akers: i n f l a t i o n or
unemployment.
pp. 17-19; U .S ., D epartm ent of Commerce, O ffic e o f B u sin e ss
Econom ics, " C o rp o ra te P r o f i t s and N a tio n a l O u t p u t ,” Survey
o f C urrent B u s i n e s s , XLII (November, 196 2 ), pp. 19-27.
F o r s t u d i e s i n d i c a t i n g a lo n g -ru n tendency f o r l a b o r ’ s
r e l a t i v e s h a r e to i n c r e a s e see R ob ert M. Solow, "A S k e p ti
c a l Note on th e C onstancy of R e l a t i v e S h a r e s ," The American
Economic Review, XLVIII (S e p tem b er, 19 5 8 ), pp. b l d - 3 i , and
I r v i n g B. K r a v is , '^R elativ e Income S h ares in F a c t and
T h eo ry ," The American Economic Review, XLIX (December,
1 9 5 9 ), pp. 917-^9.
452
T his dilemma has prom pted an Im p o rta n t s h i f t i n th e
l i n e of a t t a c k : f o r th o se who a re u n w i l l i n g to a c c e p t
c re e p in g i n f l a t i o n o r s u b s t a n t i a l unemployment t h e r e i s
th e a l t e r n a t i v e " s t r a t e g i c ” approach c a l l i n g f o r a s h i f t
from m ajo r r e l i a n c e on t r a d i t i o n a l m o n e t a r y - f i s c a l t o o l s to
g r e a t e r r e l i a n c e on more d i r e c t (and more o r l e s s a c c e p t
a b le ) i n t e r v e n t i o n s i n t o p r i v a t e wage- and p r i c e - s e t t i n g
p ro c e d u re s in o rd e r to a s s u r e t h a t wages and o th e r c o s t s
do n o 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 .
The s t r a t e g i c approach r a i s e s two la r g e q u e s t i o n s :
(1) What i s th e most a c c e p ta b le means of i n t e r v e n t i o n i n t o
p r i v a t e wage- and p r i c e - s e t t i n g ? and (2) W ill such means
( e . g . , p r o d u c t i v i t y fo rm u la s f o r income in c re m e n ts ) be a b le
to a s s u r e a h a l t t o i n f l a t i o n a r y p r e s s u r e s , open o r
r e p r e s s e d ?
These q u e s t io n s a re r e l e v a n t m ainly b ecau se th e
im p le m e n ta tio n and s u c c e s s o f such key p r o p o s a ls as the
p r o d u c t i v i t y fo rm u la o r " g u id e p o s ts " depend p r i m a r i l y on
t h e i r a c c e p ta n c e and ad h erence by l a b o r and management and
on th e r e a d i n e s s of governm ent to e n fo rc e such a d h e re n c e .
Im p le m e n ta tio n of s t r a t e g i c wage and p r i c e c o n t r o l
e f f o r t s i n t h e name o f p r i c e s t a b i l i t y i s c o m p lic a te d by
g o v e rn m e n t's commitment to o t h e r m ajor econom ic g o a l s —
e s p e c i a l l y th e m ain ten a n ce of employment and incom e--w hose
f u l f i l l m e n t may, u n d e r e x i s t i n g m ark et s t r u c t u r e s and
453
e c o n o m i c - p o l i t i c a l i n s t i t u t i o n s , p r e v e n t i t from f u l f i l l i n g
th e p r i c e o b j e c t i v e .
In exam ining the econom ic g o a ls i n d e t a i l i t was
argued t h a t what m o stly made th e r e c e n t i n f l a t i o n "new" was
n o t downward i n f l e x i b i l i t y o f wages and p r i c e s — w hich h as
not r e a l l y been new s in c e 1900 a t l e a s t — but g o v e rn m e n t's
p o st-w a r commitment to b u i l d a f l o o r u n d e r employment and
demand i n o r d e r to p re v e n t r e c e s s i o n s tu r n in g i n t o p a n ic s
and d e p re s s io n s as in e a r l i e r g e n e r a t i o n s . The new f l o o r
under demand, combined w ith t h e p e r i o d i c p ric e r i s e s of
c y c l i c a l u p sw in g s, have s e rv e d to c r e a t e the lo n g - r u n
" r a t c h e t e f f e c t . "
I t i s s u g g e s te d t h a t th e p r i c e s t a b i l i t y o b j e c t i v e
r e q u ir e s a t l e a s t a fo rm al e x p r e s s io n o f g o v e rn m e n t's
commitment to " r e a s o n a b le " p r i c e s t a b i l i t y — by amendment of
th e Employment Act— n o t out o f b l i n d d e v o tio n t o t h i s one
o b je c tiv e b u t r a t h e r as a means of sta m p in g i t a s p o s s i b l y
the most d e s i r a b l e o f p r i c e - l e v e l a l t e r n a t i v e s f o r the
community as a w hole.
T h is a ls o means t h a t g overnm ent may have t o s e t t l e
f o r a p o l i c y of m e e tin g i t s m ajo r econom ic and s o c i a l
o b j e c t i v e s by means which do n o t push t h e n a tio n t o " l i v e
beyond i t s m eans." As B o u ld in g rem inds u s : c h r o n i c
i n f l a t i o n may be th e symptom of a n a t i o n t r y i n g t o p ro v id e
more money income and b e n e f i t s th a n i t s r e a l o u t p u t can
454
s u p p o r t a t any g iven t i m e . 1 I f governm ent ta k e s th e
i n i t i a t i v e i n r e s t o r i n g the b a la n c e betw een p r o d u c t i v i t y
and r e a l incom e, on th e one h an d , and th e d i s t r i b u t i o n of
m onetary c laim s on th e o t h e r , th en what p r i v a t e groups o r
i n t e r e s t s w i l l dare be out o f s te p ? But i f no such
i n i t i a t i v e i s ta k e n , what w i l l a l l a y th e im p re ss io n t h a t
p r i c e s t a b i l i t y i s e s s e n t i a l l y a seco n d ary o b j e c t i v e — a t
b e s t appro ached e x p e d i e n t l y — and t h e r e f o r e i m p r a c t i c a l to
f u l f i l l ?
^ B ou lding , o p . c i t . , pp. 249-50,
CHAPTER VIII
SUMMARY AND CONCLUSIONS
This study i n th e th e o r y of i n f l a t i o n has a n a ly z e d
i n f l a t i o n as a p r i c e phenomenon, a lth o u g h i n f l a t i o n may
a l s o be "h id d en " in th e form of q u a l i t y d e t e r i o r a t i o n o r in
th e g u is e of " l e s s work f o r th e same p a y ," o r be ’’rep ressed "
in th e form of p o stp o n e d c o s t - p r i c e a d ju s tm e n ts .
In r e g a r d in g i n f l a t i o n as a p r i c e phenomenon, i t
was n e c e s s a r y to a n a ly z e th e f o rm a tio n of p r i c e s on b o th
m acro- and m i c r o - l e v e l s . On th e m a c r o - le v e l th e stu d y con
s i d e r e d such p r i c e - i n f l u e n c i n g f a c t o r s as e x c e s s demand
( a g g r e g a te and s e c t o r a l ) and p e rm is s iv e m o n e t a r y - f i s c a l
e n v iro n m e n ts , on th e one hand, and a g g re g a te su p p ly c o n d i
t i o n s ( i n c l u d i n g th e r a t e of p r o d u c t i v i t y ) , on th e o t h e r
hand.
On th e m i c r o - l e v e l i t had to a n a ly z e wage- and
p r i c e - s e t t i n g p r o c e d u r e s , as w e ll as th e w orkings of
re s p o n se and t r a n s m i s s io n m echanism s, b o th o f which e x e r
c is e d d i r e c t and i n d i r e c t e f f e c t s on c o s t s and demand.
In e f f e c t , t h e r e f o r e , i n f l a t i o n was t r e a t e d as a
dynamic p r o c e s s em bracing n o t only th e o p e r a t io n of th e
f a m i l i a r " c a u s a l" f o r c e s of demand and c o s t s , b u t a l s o th e
455
456
c o o p e r a tin g re sp o n se and e n v iro n m e n ta l f a c t o r s w hich s e rv e
t o s u p p o r t or fe e d th 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 .
In s t r u c t u r e , t h i s stu d y e v o lv e s around a s e r i e s of
a n a ly s e s o f th e f o u r p o p u la r c a u se s of i n f l a t i o n — money,
demand, w ages, and p r i c i n g (C h a p te rs i i - v ) — and c u lm in a te s
i n C hap ter v i , which view s 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 en com passing n o t a s i n g l e p red o m in an t cause
o r o r i g i n b ut an i n t e r r e l a t e d s e t of i n f l a t i o n a r y f o r c e s .
F i n a l l y , i n C hapter v i i , th e p o l ic y i m p l i c a t i o n s o f t h i s
t h e o r e t i c a l a n a l y s i s a re drawn t o g e t h e r th ro u g h th e t r a d i
t i o n a l framework o f su p p ly and demand.
Althougii t h i s stu d y i s p r i m a r i l y t h e o r e t i c a l , i t
acknow ledges th e f a c t t h a t th e i n f l a t i o n problem co m p rises
s e t s of e m p i r i c a l and p o l ic y a s p e c t s as w e ll. T h e r e fo r e
i t (a) h as a ll u d e d th ro u g h o u t to r e l e v a n t i n f l a t i o n
e x p e r ie n c e s t h a t have s e rv e d t o i n s p i r e th e p a r t i c u l a r
t h e o r e t i c a l c o n s t r u c t s or m odels d i s c u s s e d , and (b) in
C h a p te r v i i h as drawn a number o f p o l i c y i m p l i c a t i o n s
d e riv e d from th e p r e c e d in g a n a l y s i s .
The Role o f Money
F o r s e v e r a l r e a s o n s money i s th e f i r s t im p o r ta n t
t o p i c i n a stu d y of i n f l a t i o n . H i s t o r i c a l l y , money s u p p ly
h a s long been re g a rd e d by w r i t e r s on i n f l a t i o n as th e key
v a r i a b l e a c c o u n tin g f o r th e lo n g - r u n r i s e in p r i c e s . I t
457
was not u n t i l r e l a t i v e l y l a t e , however, th a t the r e a l
r e la tio n s h ip s between changes in money supply and p ric e s
were adequately defined: from a d ir e c t and p ro p o rtio n a l
one to a mutually in te r a c tin g and interdependent one in
which the le v el of output and v e lo c ity of c irc u la tio n also
operated as key v a ria b le s .
Second, money i s obviously e s s e n t i a l to the process
of i n f l a t i o n because i t serves as the means of payment in
exchange tra n s a c tio n s (involving goods and fa c to r se rv ic e s)
and as the standard of value fo r the quotation of p ric e s .
But in rendering these in stru m e n ta l s e rv ic e s , as
the g re a t f a c i l i t a t o r of exchange and as the common
denominator fo r the q uotation of economic v alu es, money
plays the ro le of an "enabler" more than a d ir e c t stim ulus
of in f la t io n . Only in a world of "pure exchange" and f u l l
employment, in which money is used ex c lu siv e ly fo r spending
as soon as i t is received (so th a t v e lo c ity is i n f i n i t e ) ,
could changes in money supply be regarded as a d ir e c t
cause of changes in p ric e s .
N ev erth eless, as in d ic a te d in subsequent chapters
(e s p e c ia lly Chapter v i , on i n f l a t i o n as a "p ro cess"),
enabling conditions a c tu a lly prove to be a species of
"cause": by supporting or p erm ittin g i n f la t io n to occur,
enabling fa c to rs such as increased money supply and/or
Increased v e lo c ity are as in te g r a lly important to the
45 8
u n fo ld in g of the i n f l a t i o n process as any o r i g i n a l stimu
lu s , such as excess demand or excessive wage in c re a s e s .
That i s , even though in c re a se d money supply has t o be
'’mediated" by expenditure stream s and th e cost and price
mechanisms of the economy in order to in flu en ce th e p ric e
le v e l, monetary expansion i s , n e v e rth e le s s , the c ru c ia l
enabling f a c to r in r i s i n g demand, c o s ts , and p r i c e s . I t
remained f o r incom e-expenditure theory (d iscu ssed in
Chapter i i i ) to d escrib e the conditions under which the
e x e rc ise of expanded monetary demand was lik e ly to induce
r is in g p ric e s r a th e r than r i s i n g output and employment.
F in a ll y , by fo cu sin g on F is h e r 's tra n s a c tio n s model
of the equation of exchange, P = MV/T— which says essen
t i a l l y th a t p ric e s are a fu n ctio n of aggregate e x p e n d itu re s
(or monetary demand) and aggregate su p p ly —i t i s p o ssib le
to d escrib e a fundam entally lo g ic a l framework f o r the
a n a ly s is of the major underlying fo rc es th a t d i r e c t l y or
in d i r e c t l y impinge on the p ric e le v e l.
The Role of Demand
In the ch a p ter on demand, money in a se n se becomes
" f u l f i l l e d , " serv in g as a payments instrum ent f o r the
e x e rc ise of the dynamic fo rc e s of e f f e c t iv e demand by con
sumers, firm s , and government. Expenditures are no longer
regarded as an autom atic or mechanical ex p ressio n of
changes in money supply, bu t as a r e f l e c t i o n of th e
459
underlying spending m otives, h a b i t s , and p ro p e n s itie s of
the community, as determ ined by economic and non-economic
f a c t o r s .
As a mere instrum ent of demand, however, money
cannot d i r e c t l y a f f e c t the p ric e le v e l: the impact of
monetary demand on p ric e s depends s u b s t a n t i a l l y on how much
of i t is absorbed by h ig h e r wages and o th e r c o s ts r a th e r
than h ig h er output and employment, and on the e l a s t i c i t y of
supply a t or near f u l l employment.
In o th er words, the emergence of demand as the
channelling i n s t i t u t i o n f o r money supply r e v e a ls , in tu r n ,
the ro le t h a t c o s ts — in the form of wages and p r o f i t mar
g in s , in p a r t i c u l a r — play as the mechanism th a t "m ediates"
the impact of demand on p r ic e s . Indeed, the expansion of
demand cannot be the sole In fluence on p ric e s to the e x te n t
th a t I t a lso induces in c re a s e s in wages and o th e r costs
and, In t u r n , r i g i d markup responses by firm s.
The im portant im p lic a tio n here is th a t In a world
c h a ra c te riz e d by ad m inistered p rice s and wages, in which
wages and p r o f i t margins may be more responsive to r i s i n g
costs than to r i s i n g demand, i t becomes d i f f i c u l t to
determ ine whether or to what ex ten t demand-pull or c o s t-
push "causes" are o p e ra tiv e in any given p ric e r i s e .
Another im p lic a tio n is th a t in a world where c o s t-
push fo rc es have the power to operate "autonomously,"
460
cost-push i n f l a t i o n is not p o ssib le without the
"perm ission" of compensatory or expansionary monetary
demand. Without such " r a tif y in g " monetary demand, c o s t-
push fo rc es would merely spend themselves out in reduced
s a l e s , o u tp u t, and employment as a r e s u l t of p ric in g them
se lv es out of the market. In o th e r words, expanded demand
i s a necessary co n d itio n not only f o 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 .
Another im portant c o n s id e ra tio n is the lik e lih o o d
th a t in a peacetim e economy the le v e l of demand w ill tend
to be excessive not in the "aggregate" sense— which means
th a t a l l or most se cto rs of the economy are enjoying excess
demand— but in the " s e c to ra l" se n se, in which only some
s e c to r s enjoy excess demand while o th ers s u f f e r slack
demand.
This has a s p e c ia l relevance f o r policy-m aking:
the o b je c tio n to the use of a n t i - i n f l a t i o n a r y monetary and
f i s c a l to o ls in cases of s e c to r a l excess demand (which may
be accompanied by s e c to r a l unemployment) cannot lo g ic a lly
be on the ground th a t " o v e r-a ll" demand is not e x c e ss iv e ,
but must be on the ground th a t g e n e ra l demand-depressing
monetary and f i s c a l a c tio n s would tend to f u r th e r depress
the le v e ls of output and employment, a s o c ia l cost which
the n atio n may not wish to pay.
hSi
F in a lly , i t is im portant to note the e x p l i c i t
g e n e ra liz a tio n made by income t h e o r i s t s th a t the p rice
level behaves e s s e n t i a l l y as a r e s u l t a n t of the fo rces of
aggregate demand and supply ( i . e . , P = D/S) in which the
numerator D r e f l e c t s the lev el of employment and income
(e sp e c ia lly wages) while the denominator S r e f l e c t s the
lev el of output and ra te of p ro d u c tiv ity .
The Role of Wages
The chapter on wages is the f i r s t of two on c o st-
push fo rc e s , the second dealing w ith p ric in g p o lic ie s of
firm s. But the s tr a t e g i c a l l y im portant fa c t about wages—
the la r g e s t sin g le component of costs and income in the
community— is t h a t , lik e a l l c o sts and income sh a re s, they
c o n s titu te a "two-edged sword": a source of demand as well
as c o s ts . Every wage increase comprises a p o te n tia l source
of p ressu re on the p ric e le v el from two s id e s : from the
cost s id e , depending on the prevalence of o f f s e ts such as
increased p r o d u c tiv ity , la y - o f f s , o r reduced p r o f i t
margins; and from the demand s id e , as a "wage-pull" fo rc e ,
depending mainly on the p ro p en sity to consume and the
p r i c e - e l a s t i c i t y of demand of w age-earners.
One major im p licatio n of t h i s f a c t is th a t wage-
p u ll c o n s titu te s a p o te n tia l " s p i r a l" mechanism th a t
enables w age-increases to provide the in creased demand
462
req u ired to support the higher p rice le v e l, assuming p rice
ris'es have not exceeded w age-increases. I t should be
added, however, th a t in order to be able to serve as a
"propagator" of wage-price s p i r a l s , wage-pull must be
nourished by a "perm issive" m o n e ta ry -fisc a l environment or
business a b i l i t y to pay th a t can help finance the higher
wage b i l l s .
A second im p lica tio n is th a t even i f the wage-push
does not exceed the average r a te of p ro d u c tiv ity fo r the
n a tio n , enabling average p ric e s to remain sta b le from the
side of c o s ts , the a d d itio n a l wage-pull exerted by the
w age-increases may, n e v e rth e le s s , c o n s titu te a source of
i n f l a t i o n from the side of demand.
As a consequence, wage-pull has great sig n ific a n c e
fo r policy-m aking. Whereas wage-push can be o f f s e t only
in s o f a r as demand-depressing s t a b i l i z a t i o n measures induce
lower le v e ls of output and employment— a policy th a t may
not be p a la ta b le to policy-m akers— wage-pull remains
s u sc e p tib le to the in flu en ce of the autom atic s t a b i l i z e r s
and d is c re tio n a ry m o n e ta ry -fisc al r e s t r a i n t s on the
ex e rc ise of demand.
In the d iscu ssio n of major wage determ inants ( i . e . ,
s tim u li and inducements to wage in c re a s e s )— such as the
le v e l of employment and demand, p ro d u c tiv ity , a b i l i t y to
pay, wage comparisons, the cost of liv in g , and the market
463
power of unions and employers— the s i g n i f i c a n t f a c t o r was
the o p era tio n of wage determ inants in "p o te n t" combinations.
For example, larg e gains in p ro d u c tiv ity may by them selves
not be s u f f i c i e n t to induce a s ig n i f ic a n t impact on wages;
but when combined with a f i r m 's market power ( e .g ., based
on hig h ly d i f f e r e n t i a t e d products) and aggressive union
le a d e rs h ip , t h i s combination of determ inants may e f f e c
tiv e ly enable wages to in c re a se f a s t e r than the n a t io n a l
average r a te of p r o d u c tiv ity .
These "p o ten t" combinations of wage stim u li have
an im portant im p lic a tio n fo r a n t i - i n f l a t i o n p o lic y : since
lab o r groups th a t are more fav o rab ly s it u a te d with re s p e c t
to p ro d u c tiv ity r a t e s , union s tr e n g t h , and employer
a b i l i t y - t o - p a y w i l l not p r e f e r to r e lin q u is h the f r u i t s of
th e se d i f f e r e n t i a l advantages to the less favorably s i t u
ated la b o r groups, and sin ce the l a t t e r w i l l try t h e i r
b e s t— by means of " im ita tiv e " wage in c re a s e s — not to f a l l
too f a r behind th e le a d e r s , average wages w i l l tend to r i s e
f a s t e r than the average r a te of p r o d u c tiv ity . Only by
inducing unions to avoid doing "what comes n a tu r a lly " to
them can p o licy makers prevent wage-push p re ssu re s f o r
i n f l a t i o n .
In t h i s connection i t i s re le v a n t t o note th e
a s s e r tio n th a t wage and p r ic e adjustm ents may be th e mani
f e s t a t i o n of an underlying s o c ia l tu g -o f-w a r over th e gains
464
of p r o d u c tiv ity and th e d i s t r i b u t i o n of income not only
between la b o r and management but also among w age-earners
themse Iv es.
Also noteworthy in Chapter iv were the follow ing
c o n s id e ra tio n s : (a) the o p eratio n of v a rio u s wage-
tran sm issio n mechanisms and response p a tte r n s th a t c o n s ti
tu te key components of the i n f l a t i o n pro cess analyzed
f u r t h e r in Chapter v i ; (b) W eintraub's fo rm u latio n of the
b a s ic supply and demand equation in the form of P -• kwN/Q
or P = kw/A. On the assumption of a co n stan t margin fo r
non-wage incomes and a constant r a te of p r o d u c tiv i ty , the
p ric e le v e l can be d efin ed by the siz e of the wage
increment in the num erator; the p o licy im p lic a tio n is
obvious: in order t o keep p ric e s in check, w age-increases
must be kept in check; (c) th e th e s is th a t environm ental
f a c to r s such as the full-em ploym ent "guaranty" or th e
maintenance of high le v e ls of employment, which induce
excessive wage demands and downward i n f l e x i b i l i t y of wages
and p r ic e s , are incom patible with the goal of p ric e
s t a b i l i t y ; and (d) th e fa c t th a t in th e name of th e "p u b lic
i n t e r e s t " in c re a s in g a t te n t io n i s being given by govern
ment t o the r e s u l t s of key wage and p r ic e n e g o tia tio n s .
The Role of P ric in g
In th e ch ap ter on p r ic in g the main purpose was to
determine approxim ately how the p ric e s s e t by firm s in the
465
r e a l world of o lig o p o ly and m onopolistic com petition
respond to changes in demand and cost c o n d itio n s, as com
pared to the p r ic e r e a c tio n s of firm s under assumed pure
com petitive c o n d itio n s. Such an a n a ly sis would make i t
p o ssib le to a s c e r ta in to what ex ten t the "mediated" p rice s
se t by price-m akers approximated the au to m atica lly f le x ib l e
p ric e s c h a r a c t e r i s t i c of a to m is tic com petition.
In t h i s connection two main fin d in g s were (1) fo r
a v a r ie ty of reaso n s— such as the prevalence of u n ce rtain ty ,
a d e s ire to assu re the f ir m 's s u r v iv a l by m ain tain in g
" s ta b le r e la tio n s h i p s " among r i v a l s , and a reg ard f o r
" s o c ia l p r e s s u r e s " — changes in c o sts tended to become a
more im portant c o n s id e ra tio n in p ric e -d e te rm in a tio n than
changes in demand; in the case of demand changes, a d eclin e
in demand would sooner lead to a p r ic e -c u t than an in crease
in demand would lead to a p r i c e - r i s e , u n le ss firm s were
o p eratin g at or n ear 100 p e r cent ca p a c ity ; and ( 2 ) the
prevalence of c o s t-p lu s and markup p ric in g p r a c tic e s
tended to induce c o s t- o r ie n te d p ric e s to r i s e sooner or
l a t e r in response to r i s i n g wages and o th e r c o s ts , depend
ing on demand c o n d itio n s. In t h i s sense markup p ric in g
c o n s titu te d a " s p i r a l " mechanism akin to l a b o r 's markup
response to a r i s e In the cost of liv in g ,
A s e r ie s of im portant im p lic a tio n s follow . F i r s t ,
i f In p erio d s of slack demand, or even p a r t i a l or s e c to r a l
466
excess demand, any r a is i n g of p ric e s would presumably be
made mainly in response to a r i s e in c o s ts r a th e r than
demand, then any demand-depressing a n t i - i n f l a t i o n p o licy
designed to check r is in g p ric e s would face the dilemma of
inducing f u r th e r d e c lin e s in demand and employment th a t
may be to o moderate or weak to check ag g ressiv e r is e s in
wages o r other co sts.
On the o th e r hand, the e x te n t of the dilemma need
not be exaggerated: the d isc u ssio n on c o s t-p lu s p ric in g
also re v e a le d the s u b s t a n tia l degree to which price-m akers
must co n sid er th e s ta te of demand as w e ll as c o s ts in
e s ta b lis h in g and a d ju s tin g t h e i r p r ic e s . To th e extent
that price-m akers are responsive to sla c k demand, the
amount of cost-push t o le r a te d or supported by them may be
minimal, reducing the weight of the p o lic y dilemma confront
ing th e n a t io n 's policy makers.
A th ird im p lic a tio n is the dilemma fo r p o licy
makers posed by the apparent downward r i g i d i t y of p ric e s in
re c e ssio n p e rio d s. I f i t is t r u e , as A. H. Hansen suggests,
that th e re s is ta n c e of p r ic e s and wages to sagging demand
in re c e s s io n p erio d s is 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 to the
"new environm ent" of economic p o lic y —which se rv e s to p la c e
a " f lo o r " under demand in d e fla tio n a ry tim es— then the
long-run upward b ia s or " r a tc h e t e f f e c t " in p r ic e s may be
an in e v ita b le concomitant of governm ent's own commitment to
46 7
m aintain employment and demand. This foreshadows the d i s
cussion of the gen eral problem of co m p a tib ility among the
s > -
n a tio n 's major economic goals in Chapter v i i .
Fourth, the s t r a t e g i c p o s itio n of wages in the
p ric e -d e te rm in a tio n p ro cess— as the tr i g g e r fo r applying
p r o f it - p r o te c tin g markups— has prompted the form ulation of
a " s tr a te g ic " approach to a n t i - i n f l a t i o n policy (discussed
in Chapter v i i ) which seeks to keep wage adjustments down
to n o n -in fla tio n a ry proportions by adherence to a produc
t i v i t y "g u id e lin e ."
F in a lly , A ckley's markup "engine of i n f l a t i o n , "
which weds the two s t r a t e g i c s p ir a l mechanisms of wage and
p ric e markups, and which i s motivated by mutually incom
p a tib le claim s fo r la rg e r shares of the r e a l income pie
( i . e . , la rg e r than can be s a t i s f i e d without a r i s e in
p r i c e s ) , has the v ir tu e of g r e a te r g e n e ra lity : i t is the
most prominent example of the more gen eral p e re n n ia l
stru g g le among income and o ther groups in so c iety to main
ta in or enhance t h e i r economic p o s itio n by a r e d is t r ib u t io n
of the gains of n a tio n a l p r o d u c tiv ity , which i s discussed
at length in Chapter v i.
I n f la tio n as a Process
The culm inating Chapter vi on the "process" of
i n f la t io n accomplishes the follow ing th re e main o b je c tiv e s .
468
In the f i r s t p la c e , i t t r e a t s the m ethodological problem
r a is e d by the fa c t th a t each of the key "causal" v aria b les
—money, demand, wages, and p ricin g p r a c t ic e s — does not
operate as a sole cause of r is in g p r ic e s . On th e co n trary ,
i t was a s s e rte d th a t each is s ig n if ic a n tly dependent on
one or more of the o th e rs— as w ell as on response and
tran sm issio n mechanisms and environm ental agencies—in
o rd er to a f f e c t the p rice le v e l; thus any "ultim ate" r i s e
in p ric e s i s a c tu a lly the composite r e s u l t of two or more
c o n trib u tin g in fla tio n a ry pressures or channels, including
the o r ig in a l stim ulus. In a sense in creased money supply
a n d /o r v e lo c ity may be regarded as the most s t r a t e g i c and
pervasive of the four key v a r ia b le s , i n view of th e ir
omnipresent ro le as an "enabling" agent for the exercise of
demand-pull and cost-push p re ssu re s.
In the second p la c e , the ch a p ter was able to
develop a g e n e ra liz e d , in te g ra te d model of a continuous
I n f la tio n process by lin k in g , in a more e x p lic it and
system atic fash io n , the th ree main types of components
req u ire d to bu ild such a model: a s e t of s tim u li or
o r ig in a l impulses ( e . g . , the four key v a r i a b l e s ) , the
a p p ro p riate response and transm ission mechanisms ( e . g . ,
co st of liv in g and markups), and the perm issive environ
m ental agents or i n s t i t u t i o n s ( e .g ., th e m o n e ta ry -fisc a l
system s, th e fu11-employment commitment). The l a t t e r
469
components, in c o n tra s t to the f i r s t two ty p e s , are f o r the
f i r s t time tr e a te d with s u f f i c i e n t e x p l ic i tn e s s and
emphasis. Above a l l i t is the monetary and f i s c a l systems
t h a t provide the c o n tro llin g i n s t i t u t i o n a l frameworks and
agencies f o r the o p eratio n of the s t r a t e g i c a l l y pervasive
money supply and v e lo c ity v a r ia b le s .
On the b a sis of im p lic a tio n s drawn from th is and
preceding c h a p te rs , the meaning of "cause" had to be
e x p l i c i t l y broadened so as to embrace the I n te g r a l response,
tra n s m is s io n , and environm ental f a c to r s as w e ll as the
i n i t i a l s ti m u li. This lo g ic a l e la b o ra tio n , epitom ized by
Schumpeter’ s concept of "mechanism as cause," gives
f u r t h e r s ig n if ic a n c e to the above p o in ts about the opera
t i v e interdependence of the fo u r key "c a u se s," by showing
t h a t , as en ab lin g f a c to rs and as tran sm issio n mechanisms,
they can sh a re in the u ltim a te p ric e r is e as much as the
" i n i t i a t i n g " f a c t o r s . t
The f i n a l and most f a r-re a c h in g d iscu ssio n
centered around the qu estio n whether the "g e n eralized "
i n f l a t i o n model could be explained by a sin g le a l l -
embracing concept th a t (a) i s deducible from th e dominant
or c h a r a c t e r i s t i c types of s ti m u li, resp o n se s, and
environm ental f a c t o r s , and (b) encompasses th e la r g e s t
number of p a r t i c i p a n t s — in c lu d in g government— and not only
th e more f a m i l i a r p ro ta g o n is t groups of wage-earners and
470
p r o f i t - r e c e i v e r s . L e rn e r's model of " s e l l e r s ' in f l a t i o n "
and A ckley's "markup" i n f l a t i o n , which were m otivated by a
tu g -o f-w ar between wage and non-wage groups fo r presumably
f a i r shares of income, were regarded as p ro to ty p es of a
more g e n e ra l type of skirm ishing and jockeying among
s o c i e t y 's groupings over the d i s t r i b u t i o n of income and
w ealth, in c lu d in g a government seeking to m aintain or
enhance i t s share of the t o t a l r e a l income.
In t h i s context i t was a lso necessary to e x p l i c i t l y
recognize the p o l i t i c a l system as a s t r a t e g i c environ
mental dimension. Because i t serves as the "extra-m arket"
■ source of p r o te c tio n par excellen ce fo r a l l s o r ts of
i n t e r e s t s and p re ssu re groups, re p re s e n ta tiv e government
can be beseached to generate or support excessive claim s
upon the n a t i o n 's aggregate output (with the aid of the
m o n e ta ry -fisc a l systems) fo r uniquely p o l i t i c a l m otives.
To the e x te n t th a t government responds by en actin g l e g i s
la tio n th a t adds to the community's costs more than i t
enhances i t s p r o d u c tiv ity , i t c o n s titu te s an independent
source of i n f l a t i o n a r y p re s s u re . The p ro sp ect fo r i n f l a
tio n a ry p re s s u re s from the sid e of government i s made
r e a l i s t i c by notin g i t s commitments to the goals of high-
le v e l employment and economic growth, d iscu ssed in d e t a i l
in Chapter v i i , on p o lic y .
471
This p ersp e ctiv e is c o n s is te n t with th e view of
some economists th a t i n f l a t i o n is to be regarded u ltim a te ly
as a p o l i t i c a l - s o c i o l o g i c a l phenomenon—cen terin g on the
r e d i s t r i b u t i o n of income and wealth— as much as an
economic one, i f not more so.
Im p licatio n s fo r A n ti- I n f la tio n Policy
Modern monetary and f i s c a l th e o rie s and p o l i c i e s ,
p a r tic u la r ly those which were developed since 1940, have
viewed i n f l a t i o n mainly as a condition of aggregate excess
demand, and have th e re fo re emphasized general demand-
r e s t r i c t i n g measures as the lo g ic a l p r e s c rip tio n fo r
checking r i s i n g p ric e s .
In recent y e a rs , e s p e c ia lly since 1955, as peace
time p rice s continued to r i s e even in periods of slack
demand in apparent response to cost-push fo rc e s (as w ell as
demand-pull f o r c e s ) , the " t r a d i t i o n a l " m o n e tary -fisc al
approaches were c r i t i c i z e d as being u n d e s ira b le —even
though e f f e c t iv e — f o r countering the "new" i n f l a t i o n .
In essence the c r i t i c s said: m o n e tary -fisc al p re
s c rip tio n s f o r checking excess demand are d e s ira b le as
w ell as e f f e c tiv e only i f i t can be presumed th a t the
sources of income and demand ( i . e . , p rices and wages) are
" s e n s itiv e " to the d e fla tio n a ry p ressu res o f these s ta b
i l i z a t i o n measures and would cease to ris e a t the f i r s t
induced reductions in demand, output, and employment.
H72
On the other hand, i f p rices and wages are r e l a
tiv e ly " in s e n s itiv e " to moderate d e fla tio n a ry p o l i c i e s ,
and continue to r is e even in the face of re s tra in e d demand,
then the degree of excess capacity and unemployment
req u ired to be induced by m o n e ta ry -fisc a l r e s t r a i n t s (as
d e te rre n ts to f u rth e r stubborn r is e s in p rice s and wages)
might be too g re a t to be p o l i t i c a l l y acceptable to policy
makers. In o th e r words, in the context of o b stin a te co st-
push fo rc e s , i n te n s if ie d m o n e ta ry -fisc a l r e s t r a i n t s on
demand might involve to o great a s o c ia l cost— in depressed
output and employment— before wage- and p r i c e - s e t t e r s
would be d e te rre d from f u rth e r in f la tio n a r y a c tio n s.
The dilemma of I n f la tio n or unemployment has stim u
la te d a tendency to develop an a lte r n a tiv e approach which
th is study has la b e lle d " s t r a te g ic " : I t c a lls fo r a
g r e a te r r e lia n c e on more or le ss acceptable forms of i n t e r
vention by government— in the name of the "public
i n t e r e s t " — In to s e le c te d "key" wage- and p r ic e - s e ttin g
procedures in order to prevent average wages from r is in g
f a s t e r than the n a tio n 's average p ro d u c tiv ity .
The s t r a t e g i c approach ra is e s two basic q u estio n s:
What is the most acceptable form of in te rv e n tio n by
government? Can such in te rv e n tio n s assure an e f f e c tiv e
h a l t to in f la tio n a r y p ressu res? For example, our recen t
experience with the implementation of the p r e s id e n t's
473
p r o d u c tiv ity "guideposts" has served to show the relev an ce
of both th e se q u e s tio n s , p a r t i c u l a r l y concerning the degree
of acceptance and adherence o f the la b o r unions, in the
f i r s t in s ta n c e , and the re a d in e ss of government to enforce
such adherence.
A r e a l i s t i c skepticism concerning government’s
re a d in e ss to follow through on i t s s t r a t e g i c approach may
be j u s t i f i e d in the lig h t of governm ent's commitments to
o th e r major economic goals. The d e ta ile d an a ly sis of th e
i n t e r r e l a t i o n s between the governm ent's economic goals in
th e areas of employment, income, and growth concluded t h a t ,
on b alan ce , the n e t impact of the implem entation of these
g o a ls —given the e x is tin g p a t t e r n of p re ssu re group
a c t i v i t i e s and the i n c l in a tio n to p o l i t i c a l expediency-”
was p r o - in f la tio n a r y .
BIBLIOGRAPHY
Books
Ackley, Gardner. Macroeconomic Theory. New York: Mac
m illan Company, 1961.
Anderson, William H. Taxation and the American Economy.
New York: P re n tic e -H a ll, I n c . , 1951.
Bach, George Leland. Economics. 3d ed. Englewood C l i f f s ,
N. J . : P re n tic e -H a ll, I n c ., I960.
_________ . I n f l a t i o n . Providence, R. I . : Brown U n iv ersity
P re s s , 1958.
Bain, Joe S. I n d u s t r i a l O rganization. New York: John
Wiley and Sons, 1959.
Blaug, M. Economic Theory in R e tro sp e c t. Homewood, 1 1 1 .:
Richard D. Irw in, I n c . , 1962.
Boulding, Kenneth E. P rin c ip le s of Economic P o lic y .
Englewood C l i f f s , N. J . : P re n tic e -H a ll, I n c ., 1958.
Bowen, William G, The Wage-Price Is s u e . P rinceton:
Princeton U niversity P ress, 19^0.
Brown, A. J. The Great I n f l a t i o n , 1939-1951. London:
Oxford U niversity P re s s , 1955.
Burns, Arthur F. P ro sp e rity Without I n f l a t i o n . New York:
Fordham U niversity P re s s , 1957.
Chandler, L ester V. An In tro d u c tio n to Monetary Theory.
New York: Harper and B ro th e rs, 19^0.
C lark, John Maurice. The Wage-Price Problem. New York:
American Bankers A sso c ia tio n , i 960.
Day, A. C. L ., and Beza, S te rie T. Money and Income.
New York: Oxford U niversity PreslsT 19$0.
471 *
c
475
D illa r d , Dudley. The Economics of John Maynard Keynes.
London: Crosby Lockwood and Son, L t d , , 1958.
F e lln e r , W illiam , and Others. The Problem of Rising
P r i c e s . P a ris : O rganization f o r European Economic
C o-operation, 1961.
F is h e r , Irv in g . The Purchasing Power of Money. New York:
Macmillan Company, 1911.
G a ris , Roy L. P rin c ip le s of Money, C re d it, and Banking.
New York: Macmillan Company, 1934.
H ab e rle r, G o ttf rie d . I n f l a t i o n , I t s Causes and C ures.
Washington, D. C .: American E n te rp rise A sso c ia tio n ,
1 9 6 1.
Hansen, Alvin H. Economic Issu e s of the 1960s. New York:
McGraw-Hill Book Company, I960.
_________ . A Guide to Keynes. New York: McGraw-Hill Book
Company, 1953.
_________ . Monetary Theory and F is c a l P o lic y . New York:
McGraw-Hill Book Company, 1949.
Hansen, Bent. A Study in the Theory of I n f l a t i o n . London:
George Allen & Unwin, L t d . , 1951.
H art, A lbert G ailo rd . Defense Without I n f l a t i o n . New
York: Twentieth Century Fund, 1951.
_________ , and Kenen, P eter B. Money, Debt and Economic
A c tiv ity . 3d ed. Englewood C l i f f s , N. J . : P re n tic e -
H all, I n c . , 1961.
Keynes, John Maynard. The General Theory of Employment.
I n t e r e s t , and Money. New York: H arco u rt, Brace and
Company, 1936.
_________ . How to Pay fo r the War. New York: H arco u rt,
Brace and Company, 1940.
______ A T re a tis e on Money. London: Macmillan &
Company, L td ., 1930. Vol. I .
K urihara, Kenneth K. Monetary Theory and P ublic P o lic y .
New York: W , W . Norton & Company, 1950.
476
Meade, James Edward. The Control of I n f l a t i o n . Cambridge:
Cambridge U niversity P re ss, 1958.
Means, Gardiner C. P ric in g Power and the Public I n t e r e s t .
New York: Harper and B ro th e rs, 1962.
Moulton, Harold G. Can I n f la tio n Be C o n tro lle d ?
Washington, D. C .: Anderson Kramer A sso c iate s, 1958.
Newlyn, W . T. Theory of Money. London: Oxford U niversity
P ress, 1962.
Robertson, Dennis H. Growth, Wages, Money. Cambridge:
Cambridge U niversity P re s s , 1961.
Robinson, Joan. In tro d u c tio n to the Theory of Employment.
London: Macmillan and Company, L td ., 1937.
S chultze, Charles L. P ric e s , Costs and Output fo r the
Post War Decade: 1947-1957. New York: Committee fo r
Economic Development, 1959.
S ie g e l, Barry N, Aggregate Economics and P ublic P o lic y .
Homewood, 1 1 1 .: Richard D. Irw in, I n c . , I960.
S irk in , Gerald. In tro d u c tio n to Macro-Economic Theory.
Homewood, 111.: Richard D. Irw in, I n c . , 1961.
S lic h t e r , Sumner H. Economic Growth in the United S t a t e s .
Edited by John T. Dunlop. Baltim ore: Louisiana S ta te
U niversity P re ss, 1961.
Thorp, W illard L ., and Quandt, Richard E. The New
I n f l a t i o n . New York: McGraw-Hill Book Company, 1959.
Weintraub, Sidney. C la s s ic a l Keynesianism, Monetary Theory
and the Price Level. P h ila d e lp h ia : C hilton Company,
1961.
_________ . A General Theory of the P rice Level, O utput,
Income D is tr ib u tio n , and Economic Growth. Philadelphia:
Chilton Company, 1959.
W i llis , H. P arker, and Chapman, John M. The Economics of
I n f l a t i o n . New York: Columbia U n iv ersity P re ss, 1935.
477
P ublications o f Government, Learned S o c ie tie s ,
and Other O rganizations
American Assembly. United S ta te s Monetary P o lic y . New
York: Columbia U n iv e rs ity , 195b.
American Assembly. Wages, Prices^ P r o f i t s , and Produc
t i v i t y . New York: Columbia U n iv ersity , 1959.
Chamber of Commerce of the United S ta te s . Administered
Prices and I n f l a t i o n . Washington, D. C .: Chamber of
Commerce of the United S ta te s , 1959.
Commission on Money and C red it. Money and C r e d it.
Englewood C l i f f s , N. J. : P ren t ice«%H a l l , I n c . , 1961.
N ational Bureau of Economic Research. Business Concentra
tio n and Price P o lic y . P rinceton: Princeton U niversity
P ress, 1955.
_________ . Cost Behavior and Price P o lic y . New York:
N ational Bureau of Economic Research, 1943.
Redford, Emmette S. P o te n tia l Public P o lic ie s to Deal with
I n f la tio n Caused by Market Power. U.S. Congress, J o in t
Economic Committee, Study Paper No. 10. Washington,
D. C .: Government P rin tin g O ffice, 1959.
S chultze, Charles L. Recent I n f la tio n in the United
S ta te s . U.S. Congress, J o in t Economic Committee.
Study Paper No. 1. Washington, D. C .: Government
P rin tin g O ffic e, 1959.
U.S. Congress, J o in t Economic Committee. Compendium of
Papers Submitted by P a n e lis ts on The R elatio n sh ip of
Prices to Economic S t a b i l i t y and Growth. 65th Cong.,
2d Sess, , 195b.
_________ . S ta f f Report on Employment, Growth, and P rice
L evels. b6th Cong., 1st S e s s ., 1959.
U.S. Department of Commerce, Office of Business Economics.
Survey of Current B u sin ess, XLII (November, 1962).
Washington, D. C ,: Government P rin tin g O ffic e , 1962.
U.S. Congress, Senate, Committee on the J u d ic ia ry , Subcom
m ittee on A n titru s t and Monopoly. Administered P r i c e s :
H earings, Part I : Opening Phase— Economists' Views.
85th Congress, 1 st S e ss.t 1957.
478
Economic Report of the P r e s id e n t. Together w i'h The Annual
Report of the Council o f Economic Advisers.
Washington, D. C .: Government P rin tin g O ffic e , 1962.
A r t i c l e s , P e r io d ic a ls , and C ollected Essays
Ackley, Gardner. "Administered P ric e s and th e In fla tio n a ry
P rocess," The American Economic Review, XLIX (May,
1959), pp. 419-30.
_________ . "A Third Approach to the A nalysis and Control of
I n f l a t i o n , " in Compendium. The R e la tio n sh ip of P ric e s
to Economic S ta b il ity and Growth. J o in t Economic
Committee. Washington, D. C .: Government P rin tin g
O ffic e , 1958. Pp. 619-36.
Bach, George Leland. "How Im portant I s P rice S t a b i l i t y in
S table Economic Growth?" in Compendium, The R e la tio n
ship of P ric e s to Economic S t a b i l i t y and Growth. U.S.
Congress, J o in t Economic Committee. Washington, D.C.:
Government P rin tin g O ffic e , 1958. Pp. 33-47.
_________ . " I n f l a t i o n in P e r s p e c tiv e ," in Economic Issu es
and P o l i c i e s , edited by Arthur L. Grey, J r . and John E.
E l l i o t t . Boston: Houghton M ifflin Company, 1961.
Pp. 63- 6 9 .
Backman, J u le s . " P ro d u c tiv ity —No Guidepost fo r Wage
S e ttle m e n ts," C hallenge, X (June, 1962), pp. 24-27.
B la ir , John M. "A dm inistered P ric e s: A Phenomenon in
Search of a Theory," The American Economic Review,
XLIX (May, 1959), pp. 431-50.
Bronfenbrenner, M artin. "S ecu lar I n f l a t i o n and Shibbo
le th s ," C hallenge. VI (December, 1957), pp. 17-22.
_________ . "Some Neglected Im p lic a tio n s of S ecular
I n f l a t i o n , " in Post-Keynesian Economics, e d ite d by
Kenneth K. K urihara. New Brunswick, N. J . : Rutgers
U n iv ersity P re s s , 1954. Pp. 31-58.
Clark, John Maurice. "On Economic Problems of the Next
Twenty Y ears," in Problems of U nited S ta te s Economic
Development, e d ite d by Committee f o r Economic Develop-
ment. New York: Committee fo r Economic Development,
1958. Vol. I . Pp. 129-35.
479
Clegg, H. A. "A Policy fo r Incomes?" Lloyds Bank Review,
New S eries No. 64 (A p ril, 1962), pp. 1-16.
E l l i s , Howard S. "L im itatio n s of Monetary P o lic y ," in
United S ta te s Monetary P o lic y , e d ite d by The American
Assembly. New York: Columbia U n iv e rs ity , 1958.
Pp. 149-70.
Friedman, M ilton. "The Q uantity Theory of Money—A Re
sta te m e n t," in S tudies in the Q uantity Theory of Money,
e d ite d by Milton Friedman. Chicago: U n iv ersity of
Chicago P re s s , 1956. Pp. 3-21.
_________ . "Some Comments on the S ig n ific a n c e of Labor
Unions fo r Economic P o lic y ," in The Impact of the
Union, e d ite d by David McCord Wright. New York:
Kelley & Millman, 1956. Pp. 204-34.
_________ . "The Supply of Money and Changes in Prices and
Output," In Compendium, The R elatio n sh ip o f Prices to
Economic S t a b i l i t y and Growth. U.S. Congress, J o in t
Economic Committee. Washington, D. C ,: U.S. Govern
ment P rin tin g O ffic e , 1958. Pp. 241-56.
G a lb ra ith , John Kenneth. "Market S tru c tu re and S t a b i l i z a
tio n P o lic y ," The Review of Economics and S t a t i s t i c s ,
XXXIX (May, 1957), PP. 124-33.
H art, A lbert G ailord. "S tatem ent," in H earings, Part 9A,
Employment, Growth, and P rice L ev els. U.S. Congress,
J o in t Economic Committee. Washington, D. C .: U.S.
Government P rin tin g O ffic e , 1959. Pp. 2861-2903.
Holzman, Franklyn D. " I n f l a tio n : Cost-Push and Demand-
P u l l ," The American Economic Review, L (March, i 9 6 0 ) ,
pp. 2 0 - ^ .
Kerr, Clark. "The Impacts of Unions on the Level of
Wages," in Wages, P r ic e s , P r o f i t s , and P r o d u c tiv ity ,
e d ite d by The American Assembly. New York: Columbia
U n iv e rsity , 1959. Pp. 91-108.
L a n z l l l o t t i , Robert F. "P ric in g O bjectives in Large
Companies," The American Economic Review, XLVIII
(December, 1958), pp. 921-40.
480
L a n z i l l o t t i , Robert P. "Some C h a ra c te ris tic s and Economic
E ffe c ts of P ricin g O bjectives in Large C orporations,"
in Compendium, The R elationship of P ric es to Economic
S t a b i l i t y and Growth. U.S. Congress, J o in t Economic
Committee. Washington, D. C .: Government P rin tin g
O ffic e, 1958. Pp. 441-59.
Lerner, Abba P. " In fla tio n a ry Depression and the Regula
tio n of Administered P ric e s ," in Compendium, The
R elatio n sh ip of P rices to Economic S t a b i l i t y and
Growth. U.S. Congress, Jo in t Economic Committee.
Washington, D. C .: Government P rin tin g O ffic e, 1958.
Pp. 257-68.
Lewis, John P. "P ricin g fo r S t a b i l i t y and Growth," in
Compendium, The R elatio n sh ip of P ric e s to Economic
S t a b i l i t y and Growth. U.S., Congress, J o in t Economic
Committee. Washington, D. C .: Government P rin tin g
O ffic e , 1958. Pp. 375-96.
_________. "The Problem of Price S t a b i l i z a t i o n ; A Progress
Report," The American Economic Review, XLIX (May,
1959), PP. 309-21.
L in tn er, John. "The Theory of Money and P ric e s ," in The
New Economics, e d ite d by Seymour E. H a rris . New York;
Alfred A. Knopf, 1948. Pp. 503-37.
Lipsey, R. G. "Does Money Always D epreciate?" Lloyds
Bank Review, New S eries No. 58 (October, I960),
pp. 1-13.
Lutz, F rie d ric h A. "Cost- and Demand-Induced I n f l a t i o n ,"
Banca Nazionale Del Lavoro Q uarterly Review, No. 44
(March, 1958), pp. 3-18.
Machlup, F r it z . "Another View of Cost-Push and Demand-Pull
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, I960), pp. 125-39.
_________. "Statem ent," in H earings. P art 9A, Employment,
Growth, and Price L ev els. U.S. Congress, J o in t
Economic Committee. Washington, D. C .; Government
P rin tin g O ffic e , 1959. Pp. 2819-61.
Means, Gardiner C. "D iscussion" on "Administered P rices
Reconsidered," The American Economic Review. XLIX
(May, 1959), pp. 451-54.
481
Minsky, Hyman P. "C entral Banking and Money Market
Changes," The Q uarterly Journal of Economics, LXXI
(May, 1957), PP. 171-67.
_________ . "Employment, Growth and Price Levels: A Review
A r t ic le ," The Review of Economics and S t a t i s t i c s ,
XLIII (February, 1961), pp. 1-12,
Musgrave, Richard A. "Statem ent," in H earings, Part 9A,
Employment, Growth, and Price L evels. U.S. Congress,
Jo in t Economic Committee. Washington, D, C.: Govern
ment P rin tin g O ffice, 1959. Pp. 2757-91.
Raskin, A, H. "The Squeeze on the Unions," The A tla n tic
Monthly, CCVII (A pril, 1961), pp. 55-60.
S c h le sin g e r, James R. "The Role of the Monetary Environ
ment in C o s t- I n f la ti o n ," The Southern Economic J o u r n a l,
XXIV (Ju ly , 1957), PP. 12-27.
Selden, Richard T. "Cost-Push Versus Demand-Pull I n f l a
t i o n , 1955-57," The Jo u rn al of P o l i t i c a l Economy,
LXVII (February, 1959), pp. 1-20.
_________. "Statem ent," in H earings, Part 4. Employment,
Growth, and PivLce L evels. U.S. Congress, Jo in t
Economic Committee. Washington, D. C.: Government
P rin tin g O ffic e, 1959- Pp. 671-729.
S l i c h t e r , Sumner H. "On the Side of I n f l a t i o n ," Harvard
Business Review, XXXV (September-October, 1957),
pp. 15- 3 6 , 162- 7 0 .
W iles, P e te r. "Are Trade Unions Necessary?" Encounter,
VII (September, 1956), pp. 5-11.

Asset Metadata

Creator Shapiro, Milton Moses (author)

Core Title The Inflation Process: An Economic Analysis

Contributor Digitized by ProQuest (provenance)

Degree Doctor of Philosophy

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, theory,OAI-PMH Harvest

Language English

Advisor Anderson, William H. (committee chair), Garis, Roy L. (committee member), McDonagh, Edward C. (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c18-305402

Unique identifier UC11358802

Identifier 6402605.pdf (filename),usctheses-c18-305402 (legacy record id)

Legacy Identifier 6402605.pdf

Dmrecord 305402

Document Type Dissertation

Rights Shapiro, Milton Moses

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA

Linked assets

University of Southern California Dissertations and Theses