Causes of Inflation

It is not difficult to think of conditions under which one or the other of these hypotheses would be valid and for several of these possibilities actual examples can be found in recent economic history. But let me try to give a somewhat more orderly and systematic analysis of the primary cause. Let us start from the basic fact that there is no record in the economic history of the whole world, any where or at any time, of a serious and prolonged inflation which has not been accompanied and made possible, if not directly caused, by a large increase in the quantity of money. This generalization holds for developed as well as underdeveloped countries, for capitalist, pre capitalist, and even centrally-planned economies. It is true that the velocity of circulation of money' changes. It has a cyclical pattern usually going up during prosperity phases of the cycle and falling during depressions. During the Great Depression of the 1930's the velocity of circulation of money (the ratio of money income to the money stock) fell, and during the war it reached an abnormally low level. Since the end of the war it has gradually returned to a normal level. It also seems, at least in the United States, to have a slight downward secular trend; the economy has become more "liquid."

The ratio of the money stock to national income has been larger [ 16 ] during the last 20 or 30 years than it was early in the century and much larger than in the 1870's or 1880's. But except in periods of hyperinflation (which could not develop without a sharp and sustained rise in the quantity of money) a rise in velocity by itself has never caused, or substantially intensified, serious inflationary trouble. When judging this statement, it should be remembered that I define inflation as a rise in prices and not as an increase in MV. During depressions V falls and the economy becomes more liquid. Recovery from a depression can, therefore, be financed to some extent by a more intensive utilization of the existing money stocks. The Great Depression and the ensuing war have produced an unusual accumulation of idle funds; hence the postwar expansion could be financed to an unusual extent by a more active use· of the existing stock of money. But these facts do not invalidate the state ment in question because·in such circumstances the increase in velo city is matched by an increase in output. I do· not claim that there must be an exact parallelism between the rise in output and the increase in V, so that any rise in prices must be attributed to an increase in M. The increase in V may exceed, or fall short of, the rise in output. What I say is that a prolonged serious inflation (price rise) has never been caused by an increase in velocity.l 1 On some occasions, a mild· price rise can be financed entirely by an increase in V . For example, in the United States the aetive money supply (demand deposits adj usted plus currency outside the banks) was at the end of 1957 exactly the same ($13H.2 billion) as at the end of 1955, but consumer prices had risen 6 percent. But this incident does not constitute an exception to the statement in the text because I would not regard the price rise during that particular period as a case of serious and persistent inflation~ It is not contradiction to take a serious view of that price rise, if it is taken not in isolation but in conj unction with the fact that it is a sub-period of a longer. span of time. during which prices have risen seriously. If we take any longer period-say, 1953 or 1954 (or any earlier year) to 1957~we find a sharp increase in currency plus demand deposits. Moreover,even for the period of 1955 to 1957 we find a significant increase in M if we include, as we probably should, time deposits in the quantity of money.

[ 17] It follows that in every inflation the quantity of money is a causal factor, either active or permissive, and none of the factors and policies mentioned above can produce serious inflation unless they cause or induce or are accompanied by an increase in that quantity. Some times the connection between anyone of these factors and the quantity of money is direct and noncontroversial. In other cases it is indirect and subtle. The mechanism of inflation is clear when, in the advanced industrial countries in times of war or in many under developed countries even in times of peace, the government has a large deficit which is financed directly or indirectly by the central bank. If in peacetime the central bank is obliged to hold the interest rate down by pegging government securities at low yields (as the Federal Reserve System was forced to do before it regained inde pendence through Hthe accord" with the Treasury in 1951 )-it becomes an engine of inflation. If in a world-wide inflation any single country does not wish to appreciate its currency in terms of inter national money-it must undergo inflation.

2 In all these cases the diagnosis is clear and simple. But the prob lem of chronic, intermittent, creeping inflation which confronts the United States and most Western European countries at present is not quite so clear-cut-precisely because the pace of iriflation is slow and intermittent rather than rapid and continuous. Let us return to the distinction made between demand-pull and cost-push inflation. Economists both here and elsewhere have been divided into two groups, those who stress demand pull and those who emphasize cost push, with several nuances in each group and quite a few occupying an intermediate position. There are obviously a number of powerful factors that have oper ated to keep aggregate demand rising during the postwar period, even after the 'pent-up demand and piled-up liquidity inherited from the war and the prewar depression-the Great Depression2 It should be observed, however, that even a single small country, if it lets its currency go up in terms of foreign currencies, cannot be forced to share in an international inflationary orgy. Nor is there any neces sity or even probability that it will hurt itself by staying out.

[ 18 ] had been worked off more or less. These factors include: a huge government budget-a multiple of what it was before the Great Depression, not only in absolute terms, but also as percent of GNP a large-part of it for unproductive purposes; a large welfare estab lishment; a high though fluctuating level of private investment; and above all a profound change in overall economic policy: a firm resolve to maintain full employment and not to tolerate any depres sion going beyond a mild, temporary drop in output and employment. This sounds very persuasive and seems quite sufficient to explain postwar inflation, although it must be insisted that it is not enough to point to ((pent-up demand," i.e., the urge of governments (na tional, state, and local) as well as of private producers and con sumers to invest in order to make good war and depression-pro duced deficiencies of the capital stock (including houses and con sumer durables) and the wish or necessity to spend for welfare purposes or defense. These forces could not produce inflation but only high interest rates and tight money, unless the quantity of money was continuously increased. Even the piled-up liquidity inherited from war and depression, insofar as it consisted (as it largely did) of Government securities, could be turned into effective demand for goods and services only because the Federal Reserve Banks stood ready to buy those securities at fixed prices, that is, .to ((monetize the debt" as the phrase goes. Only excess balances con sisting of money (currency and bank deposits) can be spent directly without a helping hand from the central bank. But surely this source could not have sustained inflation for long. Moreover, the activation of idle currency and deposits could have been counter..

acted by central bank policy. (1 do not now discuss what should have been done but only state what was done and what could have been done.) To summarize, given the active cooperation or passive collusion or failure to take counteracting measures on the part of the mone tary authorities, prima facie the demand theory of inflation sketched above seems to be perfectly capable of explaining the inflation that has happened since the war. [ 19 ] That wages rise in the process of demand inflation is natural and would in fact be inevitable, even if there were no unions and if perfect competition ruled in the labor market. Moreover, unions or none, wages would rise in excess of average productivity, that is to say, faster than average output per head (or per man-hour). That money wages rise faster than average output per head (pro ductivity) is sometimes cited as proof that there is cost-push and not demand-pull inflation. This is not so. Even in a pure demand pull inflation (unless wages are artificially frozen and labor rationed) 3 wages must rise faster than real average productivity (output in physical terms divided by the number of men-or man hours) . Furthermore, in a progressive economy in which (mar ginal) productivity of labor gradually increases and consequently real wages go up, money wages must rise faster than prices.

What then, is the nature of cost-push inflation? Can it be dis tinguished from demand-pull inflation and, if so, what are the criteria that permit us to distinguish one from the other? One point shoulq be clear. If there were free competition in the labor market, wages would be determined by demand and sup ply and there could be no such thing as a ((wage push." Only if there are monopolistic organizations, i.e., labor unions,4 can we speak of a wage· push. 3 It has, in fact, been argued (not by union spokesmen but by liberal economists-using the word liberal in the original sense of laissez-faire liberal-such as Milton Friedman and Lionel Robbins) that the existence of unions, due to the delay in wage negotiations which they entail, some times leads to the maintenance of wage levels below the level that would prevail under perfect competition. Under war conditions with direct controls over wages and prices, this may be true. Also, in an uncon trolled peacetime economy at the beginning of an unexpected inflation the existence of union wage contracts may temporarily delay wage adjust ments. But in a prolonged inflationary period these delays will rapidly disappear through shortening of contract periods or the introduction of escalator or escape clauses.

4 I shall use the word "labor monopoly" without any ethical overtones. But there can, of course, be no question that modern labor unions are [ 20 ] The argument of the wage-push theorist as, for example, developed by S. H. Stichter with unsurpassed force and clarity, can be stated as follows: In many countries labor unions have become so power ful that they are able to get periodic wage increases (including fringe benefits) greatly in excess of the overall average increase in output per man-hour. Even if in some industries the wage increase is not greater than the increase in productivity of that particular industry and could possibly be granted without raising the price of the products of that industry,5 these wage increases, to the extent monopolies in the sense that they seek, and usually succeed in, the sup pression of competition among the sellers of labor and claim exclusive representations of all workers whether all members of the group like it or not. On the other hand, the application of the word "monopoly" to unions should not lead to the conclusion that they behave exactly as industrial monopolies are supposed to behave in economic textbooks.

They do not simply n1.aximize the collective income of. their members. Their strategy and aspirations are more complicated than that. 5 Here an important qualification must be made to which I shall return later. It is obviously not true that any increase in output per man-hour in any ~ne industry, regardless of how brought about, can be passed on to labor in the form of higher wages without necessitating a rise in the price of the product. Suppose output per man in a particular industry increases sharply, because the industry in question has installed a' rot of costly machinery (mechanization or automation), which will be done whenever a sufficient number of workers can be dispensed with ("replace ment of labor by capital"); if in that case wages rose in proportion to the rise in output per man, the price of the product would have to go up, because otherwise not enough would be left to cover capital cost. There are other cases where the situation is different. Machines sometimes become more efficient without becoming costlier, or improvements in the process of production can be· made that require no additional machin ery ("capital saving iqnovations").

What holds for an individual industry, strictly speaking holds also for the economy as a whole. That is to say, we cannot accept as a dogma that if the average wage level rises in proportion to the average rise in output per worker the price level can remain stable-for precisely the [ 21 ] that they exceed the overall increase in productivity for industry as a whole, must lead to inflation, if the level of employment is to be maintained. The reason for that is simple enough. If in the progressive industries output per man rises by, say, 10 percent and wages also go up by 10 percent, the cost and price of the product, as well as the volume of sales, will remain unchanged. Since the same out put can now be produced with less labol\ some of the workers will be thrown out of work. And in order to reabsorb the unemployed (in this particular industry and elsewhere) demand in general and prices will have to be inflated (or else wages be cut in the non progressive sectors). What will probably happen, as was pointed out above, is that the wage· increase in the progressive indus tries will 'be, to a large extent, generalized over the less progressive sectors which cannot absorb it without a rise in the price of their products. But it should be stressed once more that even if the spread of wage increases from progressive industries to the less progressive sectors did not happen, a failure of the sales prices of same reason, namely, that the increase in labor productivity may be attributable to the application of a greater amount of capital per unit of labor rather than to greater efficiency of labor itself (improved skills, better education) or other improvements not requiring larger capital outlays.

But there is this difference. For the economy as a whole there is a better chance than for any individual industry that capital-saving im provements of all sorts offset, on the average, those increases in output per unit of labor which are due to an increase in the capital-labor ratio. That such an offset has actually taken place to a considerable extent is suggested by the fact that the percentage share of wage and salary incomes in national income has remained fairly stable over considerable periods. This historical accident (it is by no means a theoretical necessity as some people think) makes it possible to lay it down as an approximation, as a rule of thumb rather than as a precise law, that the price level can remain stable when the wage level rises roughly in proportion to the over all increase in output per man. [ 22 ] the progressive industries to fall (either because wages have gone up in proportion to the increase in productivity or because profit mar gins have permanently risen) must entail unemployrnent or inflation.

To sum up, when the wage level rises faster (say, by 5 percent or more per year) than overall productivity (which, on the average of good and bad years, rises probably not more than by 1Y2. or 2 per cent a year), prices must go up if the level of em'ployment is to be maintained. If by monetary policy (the same holds for fiscal policy) the price level is kept stable, if, that is to say, the monetary authorities prevent the increase in aggregate demand (MV) that would be necessary to sustain the higher price level (either by refusing to let M go up or by reducing M so as to· counteract a pos sible rise in V) then the inescapable consequence will be unemploy ment. At some level the pressure of unemployment would presum ably become strong enough to prevent a further rise in the wage level. We thus find ourselves, according to the cost-push theory, facing the dilemma: either let prices rise or permit a c~rtain amount of unemployment. Slichter openly, others somewhat less candidly, argues that the former alternative is the lesser evil and that a Hlittle" inflation is really not so bad. That question I shall take up later. At this point, we are concerned with the question whether and under what circumstances the indicated wage-push mechanism really operates.

It is undoubtedly a true and important statement that when overall output per worker rises by, say, 1 ~ to 2 percent a year and money wages go up by 5 percent or more per year, the price level must rise if unemployment is to be avoided. G But the mere fact G A squeeze of other incomes-not so much of profits but rather of the income of bond holders, owners of savings deposits, pensioners, school teachers-is, of course, possible. But in view of the large share of national income going to wages and salaries, it cannot amount to very much and it cannot go on for very long; for even the so-called "fixed incomes" will after some delay be adjusted to the rising price level. In a long-lasting inflation adjustments of "fixed incomes" become more and more a matter of routine, [ 23 ] that during a given period of inflation wages have outrun produc tivity .or that wages have outrun prices, is in general not sufficient proof that wage push rather than demand pull has caused the infla tion. Only under certain circumstances is the conclusion unques tionably valid-for example, if wages outrun productivity, or in fact if they rise at all, during a period of depression and unemployment' when aggregate demand stagnates or contracts. Thus when wages and prices rose during the recession of 1957-58, we had a clear case of wage.,push inflation. Moreover, during a period which cannot be regarded as a depression period, because overall output and employment are rising-if wages rise in any particular industry where there still is much unemployment, we would have to speak of wage push; surely under these circumstances a wage rise could not happen in a competitive labor market. Thus the labor con tracts in the automobile industry in 1958 and in steel in 1960 would seem to be casesof·wage push.

In periods when wages, prices, and aggregate demand all go up more or less parallel-short lags and discrepancies are difficult to ascertain and hard to interpret-it is not easy to diagnose which is the active and which the passive factor. The crucial question to which we should like to have an answer is this: Suppose aggregate demand stops rising or is brought under control by monetary or fiscal measures so as to keep the price level stable; will that bring the wage rise to a halt? If so, we have a case of demand pull. If, on' the other hand, wages go on rising and if it requires a sizeable amount of unemployment to bring the wage rise to a halt, we are confronted with a case of wage push. The best way to find out is to try. Bring demand under control by monetary (or fiscal) measures and see what happens. But even if the experiment is actually made, if the expansion of demand is brought to a halt or stops by itself, the results will usually not speak for themselves but require judgment and interpretation. The tran sition from inflation to a stable price level, even if all goes well, may require a certain amount of temporary unemployment or even a moderate .amount of more ·or less permanent unemployment. The reason is that inflationary periods are often characterized by ~~over[24 ] full employment," i.e., a level of unemployment lower than the normal frictional unemployment which is needed for a smooth functioning of the economic system. Hence the appearance of a little unemployment after inflation has been stopped cannot always be taken as a sure sign of the existence of wage push. Moreover, in periods of inflation, labor unions get accustomed to large annual wage increases and they should be given some time to adjust. them selves to non-inflationary conditions.

How much unemployment and for how long would be required to make the diagnosis of wage push certain, is difficult to say in general. It depends on one's estimate of the nnormal" amount of frictional unemployment in the economy. The amount of frictional unemployment is, of course, always open to some doubt and dispute and it should not be assumed that it is the same percentage for dif ferent countries or that it does not change over time in anyone country.7 There are, of course, clues and indications which suggest a tenta tive answer to the crucial question without actually putting the theory to a test. For example, the fact that the test has once been made, when in 1957 demand ceased to grow and wages and prices continued to rise, is very strong indication that the wage push had existed for some time. Another indication is supplied by studying the attitude and policies of labor unions. That a scholar of the late Professor Slichter's rank, whose know ledge of the institutions and policies of labor unions and whose insight into the psychology, aspirations, and strategy of labor leaders were unrivalled among economists, said flatly that the unions are responsible for creeping inflation, must carry great weight, even jf some of the arguments 7 In some countries or in son1e periods the n10bility of labor is low, e.g., because of a scarcity of housing under rent control. Sometimes the structure of demand corresponds fairly closely to the existing structure of production and distribution of the labor force. At other times, the correspondence benveen the t\VO structures is not so close. In the first case there is less frictional unemployment than in the second case.

[ 25 ] which he adduced and some conclusions which he drew from his diagnosis were not convincing. S Another clue might be the behavior of profits. A demand infla tion, one should think, would result in large profit margins, at least for some time until wages and salaries begin to catch up. A wage-push inflation, on the other hand, would encroach on profits or at least be characterized by unchanged profits. But the difficulty with this test is that profits fluctuate very widely over the cycle. In fact, the amplitude of the swings of corporate profits over the cycle is much greater than that of wage and dividend payments made by corporations, which makes corporate profits a powerful built-in stabilizer of the American economy. This cyclical volatil ity of profits makes the interpretation of short-run changes very difficult. Disregarding cyclical fluctuations, one can probably say that in the United States profit margins have shown a tendency to decline since the Korean War boom. That boom was clearly a case of 8 For example, the following statement I find unacceptable: "The prin cipal reason the price level has increased and that inflation must be expected to continue more or less indefinitely is the strong tendency for labor costs to rise faster than output per man-hour. Durin g the past ten yearJ, for exarnple, hourly conzpenJation of enzployeeJ in private induJtry outJide agriculture has riJen tnore than ttvice as fast aJ output per nJan-hour." ("Argument for Creeping Inflation," New York Times, March 8, 1959. Italics supplied.) For the reason given earlier, the mere fact that wages have risen faster than output per· head does not,' in my opinion, prov~ that wage push was throughout the ten years the initiating factor. His categoric assertion that nothing can be done to stop the wage push except to create an intolerable· amount of unemployment, I find much,too pessimistic and entirely unwarranted. On the other hand, his theory that chronic creeping inflation of 2 to 3 percent a year is not so bad and can be continued indefinitely without ill effect is overly opti~ mistic, to put it mildly. These matters will be discussed in the following sections.

[ 26 ] demand-pull inflation.!) But since then wage push seems to have been on the ascendency.t° H See the follo\ving section for son1e evidence. It has been argued that the price rise during the Korean War was not a case of classical demand inflation, on the ground that prices were "pushed up" by speculation in anticipation of expected shortages and price freezes. But it surely is misleading to say prices are "pushed up" by specula tion. "Demand pull" does not exclude speculative demand and specula tion is perfectly compatible with perfect competition. It should be clear on the other hand, that no large and long-lasting inflation could arise, with all the speculation in the world, without an increase in the quantity of money. An increase in the velocity of circulation can finance some price rise but hardly a large and lasting one. 10 This is also the conclusion which Professor Robbins reaches for· the development of inflation in Great Britain. (See his masterly "Thoughts on the Crisis" in LloydJ Bank Reviet-tJ,April 1958, esp. pp. 5 and 6.) He thinks that the first part of the postwar inflation until about 1954 can be explained by demand pull. Since then, wage push has become more important. Lord Robbins believes, however, that the excessive wage demands by the labor unions are a hangover from the period of demand inflation and will gradually subside.

In the British discussions, two criteria have been much used (e.g., by Robbins and in the "Cohen Report") for the purpose of deciding whether cost push or demand pull are responsible for a given price rise. If the number of vacancies is comparatively large or rising compared with the number of unemployed, demand pull is indicated. Cost push would tend to bring about the opposite movement. The other criterion is the rela tion of weekly earnings to standard national wage rates. Demand pull operates on the former and cost push on the latter. These criteria have not been used in the American discussion because of the different institutional setup. But even under British conditions the two tests seem to me not quite conclusive. They prove perhaps the existence of demand pull, but hardly the absence of wage push. Wage push inflation presupposes, of course, expanding demand; otherwise wage push would quickly lead to depression.

The developments in Great Britain since the middle of 1957; when energetic monetary measures were taken to bring aggregate demand under control, provide a better test of Robbins' thesis. Until now they [ 27 ] There can be hardly a doubt that wage push, in conjunction with demand pull and full employment policies, has been a powerful factor in the postwar inflation. The wage push is overt during periods of slack, but masked and difficult to evaluate and separate from other factors during periods of prosperity. Even those who are inclined to discount the wage-boosting power of labor unions will admit that unions make wages rigid in the down ward direction. It can be shown that mere wage rigidity combined with full employment policies go a .. long way to explain chronic though intermittent inflation, that is.to say, why the price curve in the postwar period shows the general shape of a rising flight of stairs. During business cycle upswings, wages and prices are pulled up. During the downswing, unions block any reduction of wage rates 11 and anti-depression policies (whether· in the form of auto matic stabilizers or of ad·hoc measures of reflation) quickly relieve the contraction. Thus by a sort of uratchet effect" the price level is pushed up intermittently.

llCost-push" or llseller's inflation" is often said to stem not only from wage push exerted by labor unions, but also from cost and price increases brought about by business monopolies and oligopolies. This theory usually takes the form of a theory of umark-up or ad ministered price inflation." A desire to be llimpartial" as between different social groups undoubtedly contributes to, the widespread habit of blaming business monopolies along with labor unions for inflation. seeln to give some support to his interpretation, since the rise of prices and wages has been slowed down without causing much unemployment. But it may be too early to form a definite opi~ion. 11 It is true that even if wage rates remain unchanged, wage costs are somewhat reduced. Overtime is eliminated, inefficient workers are laid off (as far as seniority rules permit), discipline is tightened and wastes eliminated, and inefficient equipment retired or scrapped. All this results in a reduction of hourly earning and an even greater reduction in wage costs per unit of output and fall of "efficiency wages." As far as it goes this is a salutary by-product of mild depression, but it is surely not enough to bring prices down appreciably.

[ 28 ] However, it seems to me that there are basic differences between the operation 0'£ Uindustrial monopolies and oligopolies" on the one hand and of ulabor monopolies" on the other hand-differences which make the impact of the two on the price level fundamentally different. But let it be said emphatically that the following anal ysis of these differences does not imply any ethical or moral dis crimination whatsoever between management (business) and labor. The first difference is connected with the" fact that unions make wages rigid downward. We have seen that this rigidity through the Hratchet effect" jacks up the price level in prosperous years and prevents it from falling during recessions. No doubt some prices, too, are rigid downward (especially those subject to public regula tions) . But wage rigidity is certainly more widespread and endur ing than price rigidity. Secondly, it will hardly be denied that in the United States and many other den10cratic countries business monopolies are in a much weaker position than labor monopolies. They lack the physical coercive power, rigid discipline, and intense loyalties of their mem bers, which many unions have developed. Moreover, in many countries, especially in the United States, industrial· monopolies are subject to special controls from which labor· unions are de jure or de facto exempt.

In addition to these two differences between the operation of labor unions and industrial monopolies, there is another one which can perhaps be best brought out by a mental experiment. Compare two hypothetical situations, one characterized by the existence of many «business monopolies" but with the prevalence of competition (absence of monopolies) in the labor market, the other by the exist ence of ulabor monopolies" but with the prevalence of competition (absence of monopolies or oligopolies) in the commodity market. Suppose first that there exist no industrial monopolies or oligopo lies or that such monopolies or oligopolies are regulated· as public utilities actually are,12 but that labor is organized in powerful unions. 12 Ideally in such a way that their pricing systen1 conforms as far as possible to the competitive norm. [ 29] It will be agreed, I believe, that this would not essentially change the facts of cost inflation through wage push. It is true that some unions would have to change their strategy. It would no longer be pos sible for a union to pick out a particular firm and force it by strike to pay higher wages which are later generalized over the rest of the industry. This would not work because a single firm in a com petitive industry cannot afford, even for a short period, to pay much higher wages and charge higher prices for its products than the rest. But as unions in competitive industries in this country (e.g., in the textile or coal industries) and abroad have amply demon strated, competition in the product market is not an insuperable obstacle to the formation of very powerful unions whose bargaining power and ability to strike the whole industry is just as great as that in oligopolistic industries.

13 Now make the opposite assumption that there is competition· and no union monopolies in the labor market, but that there are numer ous business monopolies and oligopolies. A brief reflection will show, I believe, that in this case there is no reason to assume that there will be a continuing pressure on the price and cost level resulting from monopoly prices being pushed up higher and higher, confronting the .economy with the disagreeable dilemma of either letting prices rise continuously (inflation) or blocking the expan sion of demand and stopping the rise of prices by monetary and fiscal measures which would imperil growth and impair the level of employment. 14 13 The fact that in small countries unions have not much bargaining power in industries which have to sell in highly competitive world mar kets where no tariff protection is possible confirms what is said in the text. Striking against such an export industry is like striking against a single firm in a highly competitive industry. That is the main, though perhaps not the only, reason why labor unions are so "reasonable" in small countries such as Switzerland or the Netherlands, a fact which has often puzzled foreign observers.

14 A third' possibility would, of course, be the prevention of monopo listic pricing. This has its counterpart in the previous case where wage push could be eliminated by preventing monopolistic practices on the · ' It is true, of course, that business monopolies (to the extent that they in fact exist and are not effectively regulated) .keep prices at a higher level than would prevail under competition; but there is no reason to' assume that such monopoly prices would be pushed higher and higher~ To put it differently, the introduction of numerous monopolies where there existed competition before, would lead to higher prices and could be called inflationary. But .the existence of monopolies or oligopolies does not .. lead .to continuing pressure on prices. I find it difficult to believe that anybody would seriously want to argue that, unless the government steps .in and stops the process, there is a tendency for mark-ups to be continuously in creased or of uadministered prices" to. be continuously raised.

A minor qualification ought to be added. It is possible that after. a change the monopoly price which in the opinion of the monopolist .. under the given circumstances, maximizes his profits the ((optimum" from the monopolist's standpoint-.-,will not be reached all at .once, in other words that for a limited period of time individual monopoly prices tend to rise. until the uoptimum" has' been reached. Also, there may be an· interaction of labor and business monopolies operating so that the occasion of wage increases forced by unions is used by management as an excuse or occasion for bringing the price of the product closer to the monopolists' uoptimum." The reason ·for this behavior might be that monopoly power was not fully utilized by the firms because they were afraid to arouse public opinion and to provoke government action. Wage increases then give management the opportunity to put the blame for the price rise on labor. However, these fine points of price strategy, ofwhich some writers on inflation have made much, should not be allowed to obscure the essential difference between the import of business and labor monopolies for inflation.

15 part of the unions. My argument is, however, that unregulated business monopolies have different implications for inflation than unregulated monopoly power of labor unions, i.e., that they do not lead to a continuing cost push as unions do. 15 For further discussions of the "administered price" problem see the following section.

It is perfectly natural, on the other hand, that strong unions should try to force large wage increases every year or every·other year and to endeavor to push continuously beyond the level set by the general increase in output per man-hour, especially in industries where productivity rises faster than elsewhere. Union power is, of course, not unlimited. The main limiting factor, besides restraining influences on the part of the government or of public opinion which come into play only in extreme cases, is the elasticity of the demand for the product of the industry (or firm) in question. The mo~e elastic the demand the greater the threat of shrinking employment when .wages are pushed Up.16 In this connection, the fact that in the short run elasticities of demand (for product as well as for labor) are likely to be much lower than in the long run, because it takes time for substitutes to be developed and for demand to shift to substitutes, is of very great importance.

It means that employers give in to wage demands more easily and that before the deterrent effect of falling employment has time to restrain union demands for higher wages, wages have been-raised elsewhere a.nd aggregate demand and the whole price level have been pushed up. It is inherent in the inflationary process that it makes the earlier wage rises illusory and by the same token tolerable without .impairment of. employment. Needless ·to repeat that the process could not develop indefinitely without an expansion of the money supply..17 16 Another related factor is the share of labor cost in total cost. The lower this share, the less elastic the demand for labor and the more scope for unions to push up wages. This is the reason why craft unions, which represent small groups of specialists who are indispensable for the busi~ ness but whose wages form only a small fraction of total cost, are espe cially successful.

11 In some cases, the connection between the level of employment and the wage rate is quite clear and cannot. be overlooked by union leaders. Thus J. L. Lewis and the V.M.W. seem to have consciously preferred high wages and a low level of employment over lower wages and larger employment. In this case, union policy closely resembles the behavior of the monopolist in economics textbooks. But these are rare exceptions, I do not deny that to the extent to which unregulated industrial monopolies exist and to the extent to which it is possible by anti trust policy or otherwise to introduce more competition, such a policy would have an anti-inflationary effect. But such a reform would have only a once-for-all effect and would not remove a continuing pressure for inflation. Moreover, no large once-for-all effects can be expected for the simple reason that the American economy is very competitiv.e except in the area of public utilities (some types of transportation, communication, etc.) 18 where rates are controlled anyway. The most effective method of making sure that there will be a maximum of competition is freer trade. The large free trade area inside the United States is probably a more important factor than antimonopoly legislation, making the United States economy highly competitive compared with most other countries. But the rise of imports and of foreign competition, both in the United States and in foreign markets, in recent years has shown ,that even for a country of the size of the United States international trade is a strong antidote for inflation. Its anti-inflationary operation is, however, by no means based exclusively on its capacity to counterat least in the U.s. As a rule, labor leaders strenuously deny that higher wages may result in unemployment. They vigorously contend that higher wages strengthen purchasing power and employment and most of them undoubtedly believe what they profess. Why shouldn't they, if reputable economists support their views?

As a consequence of this situation, falling employment operates only as a tardy and uncertain brake on excessive wage demands. 18 In the long run there is, of course, a lot of competition in that area too. Railroads compete with buses and airlines, electricity with gas, etc. The statement that the American economy is very competitive does not rest on the assumption that perfect (or pure) competition in the textbook .sense (i.e., that the demand curve is horizontal for each firm as for each farm) is the typical market structure, but on the realization that Chamberlinian "monopolistic competition," which surely is very widespread, is (especially from the policy and welfare standpoint) com petition and not monopoly in the ordinary sense. This is especially true of product differentiation. [ 33 ] act monopolies. Competitive industries, too, feel the spur of for eign competition, which stiffens the employer's resistance to infla tionary wage demands and promotes progress and efficiency.

There can be no doubt that much more important than private monopolies or oligopolies are a great number of government oper ated, sponsored, or induced price maintenance and price support schemes ranging from haircuts, ufair price laws," stock piling policies, and import restrictions to the six basic farm products subject to the parity price policy. The last mentioned policy of parity prices for agricultural products is equivalent to a monopoly of gigantic magnitude dwarfing any monopoly that ever existed in the private sector. It not only keeps farm prices high, but involves a tremendous waste of resources in the form of unsaleable surpluses which a private monopoly. neither could nor would do, and adds substantially to the government budget and deficits. Like union wage push and unlike business monopolies, the farm price policy (if rigidly adhered to) 19 very likely constitutes a con tinuing inflationary force. This is the more probable if, as seems to be actually the case, agriculture belongs to the group of industries that exhibits a more. than average rate of technological progress in the form of a rapid rise in output per input. For, as has been pointed out, stability of the price level requires that prices of prod ucts of technologically progressive industries fall, while those of technologically less progressive industries rise.

From basic causes we may distinguish factors accelerating and propagating inflation. If an inflation continues for· a long period and is never interrupted by price declines or at least by prolonged periods of stable prices, more and m9re people will come to expect further price rises. Such expectations, which find their expression in higher interest rates, greater and more frequent wage demands, and ev~ntually adjustments, at shorte;r and shorter intervals, of Hfixed" incomes, obviously are an accelerating force. Cost of living escalator clauses in wage and salary contracts, and in later stages of 19 The actual policy may be modified by periodic reductions of the support price level.

inflation also in debts and securities and other contracts, are another accelerating factor. Such arrangements obviously eliminate some, though not all, injustices of the inflationary process, but by the same token tend to bring the process more quickly to a head-acceler ating the speed of inflation, if the money supply is elastic, or raising costs and thus slamn1ing on the brakes, if there is no slack in the monetary system. We shall come back to this matter in the next section on consequences. Suffice it to say at this point that a universal or near-universal adoption of escalator clauses, which oddly enough is sometimes recommended by those V!ho find a mild infla tion innocuous if not positively wholesome, would take most (though not all) 20 pleasure, profit, and stimulus out of inflation. If any group, say, labor or agriculture, or business, or the government tried to steal a march on society as a whole, it would drive up all other incomes and prices .and even the first recipients would gain only little (how much depending on the speed and frequency of the adjustments) . This state of affairs is approached, though perhaps never quite reached, under hyperinflation.

Let me now summarize the conclusions reached in this section. There can be no inflation without an expansion in .aggregate demand and there can be no large and sustained expansion in aggre gate demand without an increase in the supply of money.21 This also holds in the case of wage push. 20 The recipients of newly-created money benefit fron1 inflation, even if all prices adjust instantaneously. 21 These are not tautological statements, because we have defined inflation as a rise in prices and not as an increase in aggregate demand. The only exception to the first part of the statement is that in a con tracting economy prices could rise without an increase in aggregate demand. Until now this· has been an extremely rare· phenomenon and has never happened on a large scale. It would constitute an··exception to the second part of the statement if a large and sustained inflation could be financed by a speed-up of the circulation of an unchanged stock of money.. But it is safe to say that this has never happened except fora very limited period of time.

It follows that demand pull and expanding money supply are more basic than wage push. However, wage push by labor unions can be a potent factor in the double sense that (a) it tends to speed up demand-pull inflation (though it may also shorten the inflationary period by bringing things more quickly to a head) and ( b) in case monetary demand does not expand any more, wages may still be forced up faster than output per man-hour rises so that prices continue to creep up. The resulting unemployment and loss of output and income provide a strong inducement to expand mone tary demand and inflate prices. That wage push has become an independent inflationary factor is strongly suggested by the fact that in 1957 and 1958 wages con tinued to go up in the face of a substantial volume of unemploy ment after the expansion of monetary demand had come to a halt. How important a factor wage push is compared with demand pull, during periods of expansion when aggregate prices and wages all go up simultaneously, is difficult to say. The crucial question is a hypothetical one-if expansion of demand comes to an end, would wages go on rising faster than output per head and how much unemployment, if any, would be required to stop the excessive rise in wages?

On this question views diverge sharply. The demand-pull theorist takes the optimistic view that very little unemployment or possibly the mere threat of unemployment will stop the wage push once demand pull has ceased. The cost-push theorist is the pessi mist who believes that it will take an {(intolerable" amount of unemployment. The question is evidently quantitative-how much unemploy ment will be required? Nobody knows for sure, and even if the test is actually made, the results may be difficult to interpret due to lag effects and the difficulty of knowing what should be regarded as the normal volume of frictional unemployment. To draw policy conclusions, it is also necessary to specify what is regarded as a tolerable or intolerable amount of unemployment. That in turn requires a weighing· of alternatives. One alternative is prolonged inflation. The cost and consequences of chronic inflation will be discussed in the following section. The other alternative is to stop the wage push at the source by reducing the monopoly power of labor unions. Some observations on that problem will be offered in the last section below.

We furthermore reach the conclusion that business monopolies and oligopolies, to the extent that they really exist and are not regulated anyway, have a different bearing on inflation than labor unions. While labor unions, if they are powerful and aggressive, tend to exert a continuing upward pressure on costs and prices, the introduction of business monopolies, where there was competition before, would raise prices, but their existence does not entail a continuing upward pressure although reaching the price which suits the monopolist may take a little time. Compared with the host of government-enforced price maintenance schemes and government operated or sponsored restrictions, ranging from haircuts to the agricultural parity price policy, unregulated business monopolies pale into insignificance. [ 37 ] CONFLICTING INTERPRETATIONS OF THE 1955-58 INFLATION IN THE UNITED STATES THE DIVERGENCE of opinions on the causes of inflation is dramatically highlighted by the conflicting explanations of the 1955-58 experience in the United States which have been offered by different writers. In some cases writers belonging to the same economic school of thought find themselves on opposite sides of the fence as far as the explanation of the 1955 -57 inflation is concerned.