Conflicting Interpretations of the 1955-58 Inflation in the United States

On the extreme side of the demand-pull explanation we find Professor Alvin Hansen. In his note UA Neglected Factor in Infla tionary Pressures 1955 -57," 1 he says, «the evidence seems to me overwhelmingly clear that the inflationary pressures were caused mainly by an excessive splurge of investment in plant and equip ment. This indeed has been the main cause of inflationary pres sures in boom periods throughout history. Yet there is no case in history, I believe, in which the increase from an already high base was so large as from 1954 to 1957." Gone are the days of secular stagnation. There is-rightly, I believe-no mention of administered prices as a cause of inflation. Inventory accumulation might have been mentioned as an inten sifying factor. That monetary factors and conditions of inflation are not stressed is not surprising. On the other hand, it is strange that nothing is said about wage push, because in his A Guide to Keynes) 2 Hansen has shown that he is well aware of the inflationary danger posed by aggressive labor unions.

Money wage rates (wage units) tend to rise before full employment is reached owing to pressure from labor groups whenever profits rise. Such ,vage-rate changes are liable to be discontinuous-a succession of "semi-critical points." To the extent that this occurs the increase in Aggregate Demand is unnecessarily dissipated on higher prices with correspondingly less effect on output and employment. In so' far as marginal cost rises as qutput increases, some part of the increase in Demand 1 Review of Economics and Statistics} May 1959, pp. 184-85. 2 New York, 1953, p. 193. [ 38 ] must be dissipated in higher prices. But if in addition money wage rates also rise, employment suffers as a result of the higher wages of the already employed workers. (Italics supplied.) The reason for the neglect of the wage-push factor is probably that Hansen-rightly-assumes that the years 1956-57 were a period of substantially full employment while the quoted passage refers to a position before full employment has been reached. I see no reason, however, why the wage push should not continue after full employment has been reached. In fact, one should think that it will become stronger the longer the upward movement lasts.

Another writer who, before Hansen, strongly emphasized the Uneglected" role of the large volume of investment in causing infla tionary pressure is Arthur F. Burns in his lectures Prosperity W ith out Inflation,3 Burns does not forget to mention the indispensable monetary preconditions of the investment boom and he also pays attention to the wage pus~ exerted by labor unions. Burns' treat 11?-ent of the problem is comprehensive and well rounded. But for the period of 1954-57 we can probably classify him as a demand pull theorist. An outspoken demand-pull explanation of the 1955-57 inflation has also been offered by Richard T. Selden in his able and well documented essay ((Cost-Push versus Demand-Pull Inflation, 195557." 4 As a member of the Chicago School he stresses the mone tary factor. He reaches the conclusion Uthat the 1955 -57 inflation was basically similar to inflations .of the past and that the role of costs in this inflationary episode has been greatly exaggerated" (pp.

1-2) . Again, ((it seems reasonable to regard the recent boom as essentially the same sort of phenomenon that has characterized busi ness expansions of the past" (p. 16). The role of investment is hardly mentioned. This is regrettable inasmuch as stress on the great volume of investment which characterized the period under consideration would have been perfectly compatible with Selden's main thesis that the emphasis on cost push has been greatly exag3 New York, Fordham University Press, 1957. See esp. pp. 1-20. 4 The Journal of Political Economy} February 1959, pp. 1-20, gerated. In fact, explicit reference to the investment ttsplurge," to use Hansen's phrase, would have strengthened his case. There are indirect references such as ttthe feeling of optimism with which households and firms faced 1955." Seemingly a good Chicagoan must not speak aloud of investment causing expenditures and prices.

to rise, except by way of increasing M or V (which is, of course, true), much as a good Keynesian cannot admit that M or V can cause a rise in prices, except via the propensity to consume, the inducement to invest, or the liquidity preference (which also is true). Each avoids the other's terminology as though it were his toothbrush (to paraphrase Max Weber). I personally agree with Selden that prior to the downturn of the cycle in mid-1957 demand pull was important or even dominant. But I wish he had explained why wages and prices went right on rising after demand had started to decline. He could not well have avoided the conclusion that this was due to wage push. And if. this were accepted, would it not be reasonable to conclude that there existed a wage push, at least as an intensifying factor, all along· or at least for some time before the downturn? On the other side of the fence are, among many others, John Kenneth Galbraith and Gardiner Means.

5 Means has resurrected and refurbished for the purposes of explain ing the inflation from 1955 to 1958 the theory of «administered prices" or Holigopolisticpricing" in ttconcentrated industries" which he had helped, most prominently, to develop and to make popular in the 1930's. Then the theory was used to explain the rigidity of the prices of the concentrated, oligopolistic industries (mainly steel, machinery and vehicles, other metals and metal products, 5 J. K. Galbraith, "Market Structure and Stabilization Policy," Review of Economics and Statistics) May 1957, and numerous appearances before Congressional committees. See Gardiner C. Means' Statement before the Senate Antitrust and Monopoly Subcommittee, January 24 and March 10, 1959, and before the Joint Committee on the Economic Report, Feb ruary 16, 1959. See also his brochure. Administrative Inflation and Public Policy} Washington, 1959, in which he summarizes his statements before the Congressional committees.

chemicals, fuel, and power). The failure of these prices to fall, or to fall as much as other prices, was put forward as one of the strategic factors responsible for the severity of the depression. In the 1950's, the alleged upward flexibility of these same prices was made responsible for the 195 3-57 or 1958 phase of the inflation. 6 Means distinguishes three types of inflation. First, there is the classical type of !tdemand or monetary inflation" under full employ ment, characterized by !ttoo much money chasing too few goods." This type of inflation occurred during the Second World War and again during the Korean ·War. During such an inflation all prices, !tmarket-determined" (competitive) prices as well as uadministered" (oligopolistic) prices, rise more or less parallel. The second type is reflation}when prices rise during recovery periods following cyclical depressions. In that case, market-determined prices rise from the depth to which they had fallen during the preceding depressions while inflexible administered prices, which did not fall much dur ing the depression, participate only little in the price rebound.

Third, there is the so-called ((administrative inflation" which involves a rise in the uinflexible," administered prices in uthemore concen trated areas." In his various testimonies before Congressional committees, Means presents statistics about changes in wholesale prices by product groups which lead him to the following conclusions. Dur ing the period from 1942 to 1947 market-determined prices rose more than administered prices-indicating a case of ureflation." From 1947 to 1953 7 there is no clear preponderance of price rises in either group-a case of monetary or demand inflation. From 1953 to 1957 and even more so from 1953 to 1958 price rises 6 Means' figures relate usually to the 1953-58 rather than the 1955-58 period. 7 He offers four charts, the first giving the price changes from 1942 to 1947, the second from 1942 to 1953, and the third and fourth from 1953 to 1957 and from 1953 to 1958, respectively. (See especially his State ment before the Senate Antitrust and Monopoly Subcommittee, January 24, 1959.) [41 ] were heavily concentrated in the administered area, while several of the competitive, market-determined prices actually declined-a clear case of administrative inflation.

It would be unfair to subject the preliminary statements before Congressional committees to an exhaustive criticism inasmuch as the author promises a more detailed presentation of his views in a book. But that makes it the more helpful to point out a number of serious defects. As indicated in the preceding section, I question the basic assumption of the widespread existence of monopoly power in the numerous industries designated as concentrated by Gardiner Means. Competition there is not atomistic, but is nonetheless very real. 8 The expressions Hadministered" and Hmarket determined" are severely question begging. Surely market demand has much to do with the Hadministered" prices and the so-called Hadministrative inflation" could never develop without an expansion of monetary demand. But all I wish to show here is how, without the assump tion of arbitrary administrative discretion in price fixing, the price behavior sketched by Gardiner Means can be _explained.

The first period, 1942-47, was, of course, characterized by price control which naturally was more effective in the case of concen trated industries. (To a large extent, the price stability was spuri ous, reflecting quality deterioration and informal rationing.) Since, according to Means' figures, the second period, 1947-53, did not bring a readjustment, the rise of uadministered prices" relative to other prices during the third period can, therefore, be regarded to some extent as a belated readjustment. (To the extent that the price stability during the earlier period was spurious, the later price rise was not real either.) 8 It is largely competition through "product differentiation" (C'ham berlin). Temporary quasi-monopolistic positions in new products are natural and essential for the entrepreneurial and innovational process. This has been persuasively argued by Schumpeter. Similar ideas were later expressed by Galbraith in his American Capitalt'sm, Boston, Hough ton-Miffin Co.

[42 ] More important, perhaps, the so-called area of administered prices comprises the very industries where boom demand is concentrated steel, machinery, metals, and metal products. Moreover, these are industries with strong and aggressive unions. Hence, it is not at all surprising that during a very vigorous-according to Hansen, unprecedentedly strong-boom, prices in these industries should rise more than elsewhere. It is true that they did not fall much during the following recession. But the recession was mild and unusually short and nobody would deny that these prices are s011l:e what inflexible downward in the short run, partly because of the inflexibility of wages. Burns, Hansen, and Selden have called attention to the facts that the period from 1953 to 1957 was a classical boom periodcharac terized by a large and rising volume of investment and a rise in aggregate monetary demand, attended and made possible (some would say ((caused") by a rise in M and V, in combination with a strong wage push by labor. These facts seem to be entirely sufficient to explain the observed price behavior.

Galbraith has tried to give very much needed theoretical under pinning to Means' .thesis. His theory is that there existed in the late 1950's what he calls ((unliquidated monopoly gains." That is to say, the concentrated industries had their prices set below the level which would maximize their profits. The reason for the policy of ((under pricing" (underpricing-. -from the monopoly standpoint, not of course compared with a hypothetical competitive norm) is either fear of government intervention or fear that labor unions might cap ture a large part of the profits that would result from full exploitation of monopoly power, which in view of the downward rigidity of wages may involve a considerable riskEor the future. A general inflationary situation then provided a welcome camouflage for pushing prices ,loser to the monopolistic ((optimum." 9 An earlier attempt by R. C. Harrod in his The Trade Cycle) Oxford, Clarendon Press, (1936) to use theoroms of market structure for the ex planation of cyclical phenomena was equally unsuccessful and has appar ently been abandoned by its author.

[43 ] The trouble with this theory is that it builds too much on flne points of highly conjectural price strategies and equally uncertain and unverified lags in price adjustment. u The elemental forces of the tremendous expansion of monetary demand stemming from the up surge in investment and concentrated on the products of the Hcon centrated industries" and of strong union pressure for high wages are mentioned,IO but the former factor is played down and accorded only minor importance. It is not quite clear when the Hunliquidated monopoly gains" have been accumulated. Is it a regular feature of every inflation period or of every cyclical expansion that Hmonopoly power" piles up during the earlier phase and is then used up later when the economy ap proachesfull employment? Or were Hthe unliquidated monopoly gains" a special feature of the recent inflation, a legacy of the price control during the Korean War (or possibly during the Second World War)?

Like Means, Galbraith exaggerates the monopoly power of the so-called concentrated industries and greatly underrates the strength of competition in that area as between firms, products and, increasing ly, from imports. If there had been a delayed utilization of pre existent monopoly power, this would have shown up in a huge rise in profits. Aggregate profits, to be sure, did rise from 1953 to 1957, as they invariably do during business cycle upswings, but they promptly and drastically declined in 1958-and rose sharply in the first half of 1959. (As pointed out earlier, the cyclical variability of corporate profits is a very potent built-in stabilizer of the United States economy.) But the rise in profits during the 1954-57 upswing was very uneven, also as between the so-called ttoligopolistic" in dustries. l1 According to the National Income Accounts, corporate 10 The former on A. Hansen's urging. See Review of Economics and Statistics} May 1957, p. 130.

11 On this point see the able paper by Otto Eckstein, "Inflation, the Wage-Price Spiral and Economic Growth," The Relationship of Prices to Economic Stability and Growth} Compendium, Joint Economic Com mittee Print, 85th Congress, 2nd Session, 1958, pp. 370-71. [44 ] profits rose only about 5 percent from 195 1 to 1957 while GNP went up by 30 percent. More important than the movement of aggregate profits is the behavior of profit margins. Profit margin on sales in manufacturing -the series most readily available and most relevant for the purpose on hand-for obvious reasons varies much less over the cycle than do aggregate profits. From 1953 to 1957 this margin remained fairly stable. 12 Over the period from 1948 to 1957, profit margins show a considerable downward drift apart from year to year fluctuations. Whatever may be true of particular industries, the overall picture provides not a shred of evidence of a delayed utilization, or an in crease of monopoly power, or of a continuous' rise of mark-ups.

The conclusion must be that the administered price theory of in flation makes at best a minor contribution to the solution of the inflation problems, a contribution which definitely becomes negative, if one considers that it diverts attention from the basic issues demand pull and wage push. 12 The figures as given by Otto Eckstein (loc. cit., p. 368) are as follows: Per Cent* 1948 11.1 1949 9.3 1950 . . . . . . . . . 12.6 1951 12.2 1952 . . . . . . . . 9.2 1953 9.2 1~4 8A 1955 . . . . . . 10.2 1956 9.7 1957 .. , 9.3 *Profit Margin on Sales Before Taxes, Manufacturing. SEC data. [45 ] SOME CONSEQUENCES OF INFLATION DISCUSSING THE economic and social consequences of inflation, I shall again concentrate in the main on creeping chronic inflation, for two reasons. First, this type rather than rapid inflation is relevant for the United States and most other industrial countries, at least in peacetime, and secondly, it is a more controversial and insidious process than the rapid inflation that is rampant in other parts of the world. But by way of introduction, a few words should perhaps be said about the latter.