a note on the inflation

A Note on the InflationAuthor(s): James R. SchlesingerSource: The Review of Economics and Statistics, Vol. 40, No. 4 (Nov., 1958), pp. 419-424Published by: The MIT PressStable URL: http://www.jstor.org/stable/1926350 .

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NOTES AND BOOK REVIEWS 419 NOTES AND BOOK REVIEWS 419

TABLE 4. -JAPANESE EXPORTS AND IMPORTS AND NA- TIONAL INCOME, I956 AND I960 PLAN

(Billion current yen)

Total Exports

Including special

National Total Official procure- Income Imports version ment (2)((I) (3) *. (I) (4) + (I) ( 2(~ (3) (4) (5 () (7)

I956 7,427.0 I,I62.7 900.2 I,I16.4 15.7 12.1 I5.0 I 960

Plan 8,o88.o I,069.2 979.2 979.2 13.2 12.1 12.1

Thus even in terms of the criteria of its advo- cates, the claim that the role of foreign trade in the Japanese economy has been reduced is less impres- sive than usually believed. We shall argue below that, on the contrary, the level of trade is not high enough to achieve the condition of self-support which the Five Year Plan envisages. Before leaving the present topic, however, there is evidence in terms of more significant criteria that, as compared with prewar, Japan's postwar dependence on foreign trade has in fact qualitatively increased.

Again, the criteria to which we refer may be expressed in the terminology of the Hersey Study. Export commodities may be classified either as "dependent exports," "domestic exports," or (a minor category) as exports of agricultural products and fish other than those included in the first two categories. A dependent industry export is one in which the principal raw material is imported in a quantity at least sufficient to equal the quantity embodied in exports. A domestic industry export is one in which the principal raw material used is domestically pro- duced in quantities sufficient for exports in addition to domestic utilization.'3 Hersey's analysis shows that in 1930 less than half of Japanese exports were

TABLE 4. -JAPANESE EXPORTS AND IMPORTS AND NA- TIONAL INCOME, I956 AND I960 PLAN

(Billion current yen)

Total Exports

Including special

National Total Official procure- Income Imports version ment (2)((I) (3) *. (I) (4) + (I) ( 2(~ (3) (4) (5 () (7)

I956 7,427.0 I,I62.7 900.2 I,I16.4 15.7 12.1 I5.0 I 960

Plan 8,o88.o I,069.2 979.2 979.2 13.2 12.1 12.1

Thus even in terms of the criteria of its advo- cates, the claim that the role of foreign trade in the Japanese economy has been reduced is less impres- sive than usually believed. We shall argue below that, on the contrary, the level of trade is not high enough to achieve the condition of self-support which the Five Year Plan envisages. Before leaving the present topic, however, there is evidence in terms of more significant criteria that, as compared with prewar, Japan's postwar dependence on foreign trade has in fact qualitatively increased.

Again, the criteria to which we refer may be expressed in the terminology of the Hersey Study. Export commodities may be classified either as "dependent exports," "domestic exports," or (a minor category) as exports of agricultural products and fish other than those included in the first two categories. A dependent industry export is one in which the principal raw material is imported in a quantity at least sufficient to equal the quantity embodied in exports. A domestic industry export is one in which the principal raw material used is domestically pro- duced in quantities sufficient for exports in addition to domestic utilization.'3 Hersey's analysis shows that in 1930 less than half of Japanese exports were

included in the dependent industry category. In 1950, on the other hand, our own calculations show that 75 per cent of total Japanese exports were pro- duced by dependent industries.'4 This significant postwar increase in the proportion of dependent industry exports to total exports may be interpreted as a rise in the degree of Japanese dependence on foreign trade.

The evaluation of dependent as contrasted with domestic industry exports, moreover, is the counterpart of the relation between retained imports and total imports. Hersey gives the following results for the ratio of retained imports to total imports (in percentages):

I930 77.2 I936 70.0

"I950 7I.0

The present writer has evaluated the same ratio for the postwar period as follows:

I950 82.0 I954 78.7

Taking the relation of retained imports to total imports, suppose we apply the ratio of 82 per cent for 1950 to the level of imports received in 1956. This gives a high estimate of 953.4 billion yen for the value of retained imports during I960. Given the Five Year Plan assumption of stability in the terms of trade, this volume of retained imports could barely be paid for by the exports planned for I960, even if the ratio of originated exports to total exports should miraculously rise to i. Moreover, the imports of 1956 were associated with a level of national income 8 per cent lower than that planned for I960. This combination of facts does not make it appear that Japan's dependence on foreign trade has been "reduced." It also makes the 1956 level of foreign trade "accomplishment" less auspicious for Japan than has been suggested.

included in the dependent industry category. In 1950, on the other hand, our own calculations show that 75 per cent of total Japanese exports were pro- duced by dependent industries.'4 This significant postwar increase in the proportion of dependent industry exports to total exports may be interpreted as a rise in the degree of Japanese dependence on foreign trade.

The evaluation of dependent as contrasted with domestic industry exports, moreover, is the counterpart of the relation between retained imports and total imports. Hersey gives the following results for the ratio of retained imports to total imports (in percentages):

I930 77.2 I936 70.0

"I950 7I.0

The present writer has evaluated the same ratio for the postwar period as follows:

I950 82.0 I954 78.7

Taking the relation of retained imports to total imports, suppose we apply the ratio of 82 per cent for 1950 to the level of imports received in 1956. This gives a high estimate of 953.4 billion yen for the value of retained imports during I960. Given the Five Year Plan assumption of stability in the terms of trade, this volume of retained imports could barely be paid for by the exports planned for I960, even if the ratio of originated exports to total exports should miraculously rise to i. Moreover, the imports of 1956 were associated with a level of national income 8 per cent lower than that planned for I960. This combination of facts does not make it appear that Japan's dependence on foreign trade has been "reduced." It also makes the 1956 level of foreign trade "accomplishment" less auspicious for Japan than has been suggested.

tional income on foreign trade. . . ." Kiyoshi Kojima, "A Survey of the Theories on International Economics in Japan," Japan Science Review - Economic Sciences, No. I, 1953, 6o.

'8 Hersey Study, I, I, xviii.

tional income on foreign trade. . . ." Kiyoshi Kojima, "A Survey of the Theories on International Economics in Japan," Japan Science Review - Economic Sciences, No. I, 1953, 6o.

'8 Hersey Study, I, I, xviii. '4 Hollerman, op. cit., I62. '4 Hollerman, op. cit., I62.

A NOTE ON THE INFLATION

James R. Schlesinger

A NOTE ON THE INFLATION

James R. Schlesinger

An attempt to appraise the relationship between cost pressures and demand conditions in inflation might well begin with the observation that the perspective of the economist has long been at variance with that of the layman. The economist - and this perhaps reflects an occupational orientation toward the assumption of competition - has tended to view an increase in the price level as a symptom of

An attempt to appraise the relationship between cost pressures and demand conditions in inflation might well begin with the observation that the perspective of the economist has long been at variance with that of the layman. The economist - and this perhaps reflects an occupational orientation toward the assumption of competition - has tended to view an increase in the price level as a symptom of

excessive demand, while the layman - who ob- serves rising costs and prices in their specific manifestations -has tended to put the onus on particular groups. An analysis of the role of cost pressures must, therefore, be designed not to persuade the too-easily-persuaded layman, but rather to over- come the traditional scruples of the economist.

excessive demand, while the layman - who ob- serves rising costs and prices in their specific manifestations -has tended to put the onus on particular groups. An analysis of the role of cost pressures must, therefore, be designed not to persuade the too-easily-persuaded layman, but rather to over- come the traditional scruples of the economist.



420 THE REVIEW OF ECONOMICS AND STATISTICS

I In conventional monetary analysis, using either

the quantity equation (MV = PO) or the income equation (C + I = Y), it has generally been hy- pothesized that causal influences flow from the left- hand or demand side to the right-hand or supply side of the equation. The price level is regarded as purely passive - a consequence of the relationship between immediate monetary demand and longer- run supply considerations. In the quantity theory prices will directly reflect changes in the money supply, while in Keynesian (income) theory, after the point of full employment has been reached, they will reflect changes in aggregate demand. To the degree that supply side influences must be considered, both the quantity and the Keynesian views are oversimplifications. Both approaches are of a type, and may broadly be set in contrast to those institutional models that provide an autonomous role for the price factor by emphasizing pressures which originate on the supply side, though they may subsequently be reflected back to the demand side. If organized group interests can acquire independent influence over prices, then real output or total expenditures must be adjusted to this pa- rameter. This would appear to give some validity to the layman's commonsense approach to the problem.

Recognition of the role played by cost elements has, however, tended to lead to one of two extremes. Either the supply side manifestations have been treated as synonymous with demand-induced inflation and the wage-price spiral viewed simply as the mechanism through which the forces of demand influence price, or the distinction between cost-induced and demand-induced inflation has been drawn too sharply and the wage-price spiral viewed as an independent phenomenon influencing the price level.' The former approach completely obliterates the significance of the spiral by incor- porating it into the traditional mode of analysis. The latter though it perceives the significance of the spiral by drawing too sharp a line between cost-induced and demand-induced inflation, fails to come to grips with the inflationary process. In con- ceptual analysis, as partial approaches to the prob-

lem, we may, to be sure, distinguish sharply between the two concepts, depending upon the original impetus toward rising prices. Models may be con- structed demonstrating that isolated events on either the cost or the demand side may under certain conditions result in price increases. But the distinction that is clear in theory is blurred in practice; we find it difficult, therefore, to discern at what point one influence ends and the other begins.

It is manifest, for example, that a secular con- tinuation of cost-induced inflation is dependent upon repeated upsurges of demand to justify those advances in costs and prices that occur "spon- taneously." If the growth of demand does not keep pace with the rising cost-price level, the cost-induced inflation must eventually peter out. Tempo- rarily, to be sure, some rise in prices may be induced from the supply side without a concomitant growth of demand, but may be associated instead with a decline in real output and employment, lead- ing to what from the traditional standpoint must be considered the paradox of rising prices and de- clining employment. But from the longer-run view, the growth of unemployment and idle capacity will bring to an end the pressures emanating from the supply side, and therefore -in the absence of sub- sequent increases in demand - a rise in prices gen- erated on the cost side must be regarded as a one- shot phenomenon.

In addition, however- and this point is insuffi- ciently appreciated - the impact of "excess demand" upon the price level in turn is dependent upon the responsiveness of the price-cost mechanism. One can conceive of circumstances in which inflationary demand, arising let us say from an expansion of investment activities, may elicit an ad- justing response from the cost-price mechanism so that a once-for-all rise in prices is sufficient to ac- commodate the expanded investment activity. More resources may be devoted to investment, if the money illusion (as Keynes envisaged it) is potent, and if the income recipient-consumers are either unaware of or unable to prevent a decline in their customary consumption standards. A rise in investment would then bring about a discrete jump in savings (through the vehicle of corporate profits), and this would free the resources to carry on the investment program. Any expansion of the Treasury surplus would tend similarly to free resources. Some such once-for-all process is what writers of the pre- General Theory era had in mind in discussing "forced saving."

At the opposite pole stands a case in which the money illusion does not hold; income recipient-consumers have access to the monetary supplements

' The notion that the wage-price spiral is an independent phenomenon unrelated to demand conditions has been pur- veyed by sources too numerous to mention - business lead- ers and associations, politicians, journalists, and the like. The more sophisticated belief, emanating from traditional doc- trine, that the wage-price spiral is simply the vehicle for demand-induced inflation, has been most ably developed by Walter Morton in his justly famous article, "Trade Unionism, Full Employment and Inflation," American Economic Re- view, XL (March I950), I4-I5.



NOTES AND BOOK REVIEWS 42I

which will permit them to maintain their conventional consumption standards, and the onset of inflation is not accompanied by the diminution of the consumption ratio. In this case the inflation will be sharper, demonstrating that the precise impact of inflationary pressures arising on the demand side depends upon the repercussions on the supply side. The two aspects of the problem, supply and demand, though they be aggregates, fit together in a manner reminiscent of Miarshall's scissors. Since it is not possible to predict just what the course of the inflation will be after passage of the full employment point, without knowing the response of the price-cost mechanism to be anticipated, explana- tions of the consequences of inflationary pressures from the demand side have necessarily been vague.

The standard income-consumption diagram is useful in exploring the potentialities of the situation. In Chart i, this presentation is attempted, using the simplifying assumption of Keynesian dia- grammatics that supply is elastic up to the point of full employment (YO), and any increase of effec- tive demand beyond that point will result only in increases in money rather than in real income.2 What occurs beyond the full employment point is unpredictable - depending upon the institutional structure of the economy, the responsiveness of the cost-price mechanism, and so on. Line segment AB on the diagram represents simply an extension of the assumed linear relationship between consumption and income in money terms existing at less than full employment levels. It rests upon the assumption that the money illusion holds, that people ignore the rise in price, and that expenditure pat- terns operate as if real incomes were expanding along with money incomes. It is implicit that any redistribution of income which may occur will have no significant ramifications on spending habits.

That these conditions hold is most unlikely; it is hardly conceivable in light of economic and political reality as we know it today that the citizenry will be impervious to changes in the value of the monetary unit and that their expenditure plans will re- main unaffected. Another possibility is suggested by the line segment AC, a response to inflationary pressure which is achieved by a downward adjustment. This may be considered a "successful" case of forced saving in which a moderate rise in the price level is the sacrifice that is made to achieve

CHART I

K

0 YO y

a more rapid rate of capital formation.3 A reduction in consumption is extracted from income recipients. Such conditions are associated with what was tradi- tionally known as the wage lag, and, at least ac- cording to official union statements, this is still the characteristic response to inflationary pressure. Even under unionism the cumbersomeness of the bargaining makes it a distinct possibility that some savings may be forced through the inflationary process.

A third possibility is suggested by the line segment AD; here the citizenry is not deceived by a money illusion and is determined to maintain real consumption. By drawing upon liquid assets or by making use of the defensive capacities of group or- ganization, the public attempts to maintain and succeeds in maintaining the same allocation between consumption and savings that prevailed at the full employment point (AYO/AI). If all incomes were to become escalated in accordance with price jumps, such a response seems probable. A final possibility is conceivable (as in line segment AE) in which the proportion of consumption in the total rises. Such may be the case when there exist direct controls on investment and the state throws its weight behind employee demands for higher wages and salaries. It might also occur during hyperinflation as a result of the deterioration of faith in the currency and the desire to move from liquidity to goods; this would help to explain the so-called "shortage of investible funds" noted during the final stages of severe infla- tions.

2The figure here employed differs from the conventional one in that the axes measure the aggregates in money terms. Usually real consumption is viewed as a function of real income. The use of variables in money terms makes no differ- ence so long as the monetary unit remains fixed in value, so that up to the point of full employment money income is the same as real income.

This was the position of Sir Dennis Robertson in his Banking Policy and the Price Level. It should be noted that in the first illustrative case above, involving the money illusion, forced saving would occur but to a lesser degree.




Each of these consumption line segments will have associated with it an aggregate demand curve in which the other components of demand are superimposed on the consumption portion. In Chart i, these aggregate demand lines (HF, HG, HK) will emanate from point H, with the distance IH taken to indicate the original excess of demand or "inflationary gap." The greater the resistance of the cost-price mechanism to the downward adjustment of consumption, the greater will be the slope of the aggregate demand curve (HF will be associated with AC, HG with AD, HK with AE, and so on). At the points that the aggregate demand curves cut across the 450 line or aggregate supply curve, posi- tions of temporary equilibrium will be indicated (points I, 2, 3 in Chart i). As can be seen the smaller is the retrenchment of consumption, other things being equal, the higher will be the point of equilibrium; the higher will be money income; and, since real income is unchanging, the higher will be the price level or the rate of inflation.

It may thus be seen that the inflationary process cannot be discussed without careful consideration of the institutional relationships prevailing in the society at large. The theory of inflation must be left sufficiently general to take into account the stage of development which a society has attained at a certain period in time. If inflationary symptoms are to be a permanent feature of the environment, cost and demand conditions must mutually contribute. To analyze inflation from the side of either demand or of cost exclusively is almost as misleading as to treat the two sides of the problem as synonymous. To overstress either side of the problem is misleading rather than wrong, for it is desirable to discern the distinctive contributions of cost conditions and demand conditions, yet it is erroneous to emphasize one exclusively.

II In the United States today the critical issue of

inflation control arises from the fact that we have been building inflationary potential along institutional lines into both demand and cost conditions. At the same time that we have taken steps to insure high level demand, we have been perfecting institutional arrangements that allow costs to be much more responsive than formerly to upward shifts in demand. To be sure, the determination of wage rates through collective bargaining permits wages to be set at a level either higher or lower than that which would prevail in a competitive labor market. During wartime, of course, the strength of patri- otic appeals makes it possible that the wage level will be less sensitive to increases in demand than

would be the case in a competitive market, but under normal conditions with over-all demand permis- sive of wage increases, the employment of collective bargaining raises the likelihood that the wage level will swing upward too readily and pass beyond the level tolerable for noninflationary wage increases. If, in addition, farm prices are protected through parity and de facto protection of profit margins exists, cost inflation may pass over into demand inflation. Inflation becomes mandatory, since the volume of expenditures contemplated by the several sectors of the economy are mutually inconsistent and add up to more than potential output at the current price level. If the institutional framework is such that each component of the economy is in a position to insist upon the monetary incomes to im- plement its spending program, then inflation will be continual.

On the demand side the inflation would grind to a halt were it not for the fact that the make-up of our contemporary monetary structure permits the continued expansion of credit which sustains inflation. The Federal Reserve System must cope with conflicting objectives - in addition to attempting to preserve price stability it is obligated to prevent disorderly conditions in the government securities market and recognizes its obligations for the maintenance of full employment. Even if price stability were the paramount objective, it is doubtful whether the System as a question of political reality possesses the power to permit the growth of unemployment which would bring the rise in costs to a halt.

Good markets, moreover, make assets liquid or salable which under ordinary conditions would not be considered to possess the attribute of liquidity. In inflation the continuous exchange of assets among the different categories of owners creates additional liquidity. Under pressure from rising inter- est rates, the network of financial institutions serves as a mechanism for the efficient mobilization of the liquid reserves of the economy, and in this process the federal debt serves as an emollient to facilitate the flow of funds.

Most significant also is the fact that within a monetary framework relying largely upon private debt, the inflationary process is partially self-sus- taining, since in itself it is creative of liquidity. The course of inflation does not affect debtors and creditors symmetrically. It is almost tautological to observe that debtor spending units make a dis- proportionate contribution to the flow of expenditures. Maintenance of demand depends in large measure upon the willingness of some spending units to incur additional debt, but as the burden of debt



NOTES AND BOOK REVIEWS 423

rises, the willingness of active spenders to make use of the resources provided by savers may decline. The course of inflation, however, provides automati- cally for the gradual alleviation of the debt burden of the most active spenders. By reducing the il- liquidity of debt, inflation adds relatively to the liquidity of the economy by shifting liquidity to those spending units that will make use of it.4 The more rapid the pace of the inflation, the greater becomes the impact of this factor. It may also be that debtor units, in particular business concerns, are much more sensitive to the implications of changes in the value of the monetary unit than are creditors - possessors of insurance policies, savings and loan shares, savings bonds, and the like -who are much more apt to suffer from the money illusion.

It should be emphasized that ultimately this process is dependent upon the expansion of bank credit and therefore upon the provision of additional reserves by the monetary authorities. Thus it goes directly to the heart of the major issues of monetary policy and monetary institutions. The monetary authorities are faced with the dilemma whether to resist further inflation at the price of unemployment. The society is faced with the fundamental problem whether our monetary framework ought to be altered to make it more restrictive and thus unable to provide for the expansion of credit which is necessary to the continuance of the inflation.

III Such is the picture of "institutionalized inflation"

about which there has lately been considerable discussion.5 A crucial question concerning the inflation is whether even mild institutionalization does not contain within itself self-aggravating tenden- cies which will gradually accelerate the pace of inflation. Economists have suggested, for example, that the "institutionalization of savings" in the advanced economies helps to provide for self-sus- taining growth; but does not the existence of institutionalized inflation militate against institutional-

ized savings, thus gradually weakening a principal safeguard of the monetary unit?

By way of de-emphasizing the significance of the present inflation, it has been observed that "broadly speaking the history of mankind is the history of rising prices." 6 Yet, since the development of the modern credit mechanism, the industrialized na- tions have had no experience with persistent inflation until World War II. What inflation there has been was intermittent -associated with war or bursts of investment activity. In contrast, under current pressures the balance of the economy is tipped toward inflation. Underlying the occasional bursts of demand inflation there exists a deep- seated tendency toward cost-induced inflation. When inflation is intermittent, it may be blamed on special circumstances, but when it is persistent and predictable, it will not be long before it becomes a factor in the calculations of the citizenry at large. Price increases are then greeted not by astonish- ment and rage, but by changed expectations,7 and eventually by the erosion of that invaluable bit of social capital - faith in the stability of the monetary unit. In the past it has been pointed out that uncertainty about prices may have unfavorable contractive repercussions on production, but today it is not the uncertainty but the certainty of price movements that has become the point of danger. Sir Dennis Robertson's metaphor of "the snake and the worm," 8 coined in the I930's to illustrate the possibility that chronic underemployment underlay and intensified cyclical contractions, may be instruc- tive here. Is there not an endemic worm of cost-inflation underlying the periodic bursts of demand inflation, and forever gnawing at the innards of our financial mechanism? If so, is not the future simply one of periods of inflation interspersed with price plateaus, forever laying to rest those capricious price

'This chain of events ought not to be confused with the so-called Pigou effect, through which a rise in liquidity is brought about by deflation. The Pigou effect refers only to net assets - private assets which have no counterpart in private liabilities. The phenomenon under discussion, on the other hand, refers only to assets which have a counterpart in private debt; it is the redistributional effect of inflation which brings about the rise in liquidity. Cf. Roland McKean, "Liquidity and a National Balance Sheet," Journal of Politi- cal Economy, LVII (December I949), reprinted in Readings in Monetary Theory (Philadelphia, I95I), 63-88.

'See for example the Annual Report of the United States Steel Corporation for I955; and the First National City Bank Monthly Letter, April I956.

6Paul Einzig, Inflation (London, I952), 26. 'Perhaps symptomatic of this changing attitude was the

distress and apprehension for the future expressed by George Humphrey during his last months in office. Until I953, a large body of "respectable" opinion might rationalize our monetary ills, blaming them all upon the irresponsibility and prodigality of the Democratic incumbents. The Eisenhower administration came to Washington pledged to restore a "sound dollar." Editorials in publications like the United States News and World Report spoke in such phrases as "old virtues are returning to the seat of government," implying that the dollar problem was one of economic rectitude rather than deep-seated forces. The administration has since dis- covered that there is more to preserving the value of the dollar than the expression of virtue. Some upright citizens who formerly felt that the dollar could and would be pre- served are losing their confidence: "If George Humphrey cannot control the budget and cannot preserve price stability, no one can."

8 D. H. Robertson, "The Snake and the Worm," in Essays in Monetary Theory (London, I940), I04-I3.




movements which have underlain the ups and downs of a century and a half of adventitious price stability?

If this be true, what, if anything, can be done? Accepting our present institutional arrangements, perhaps the most favorable line of approach toward developing resistance to inflation would be the attempt to achieve a politically-negotiated compromise between the great institutional power groups. From the most recent Economic Report of the Presi- dent, this would seem to be the goal of the Eisen- hower administration. Something of this sort did, in fact, emerge during the last two and one-half years of World War II under the Hold-the-Line Order of April I943.9 This order involved an extremely delicate political balance, and present attempts to attain a similar balance would lack the support of the legal and emotional sanctions that existed during the war. Yet, on the other hand, present day inflationary pressures are extremely modest as compared with those existing during the war. Certainly we should be willing to make the attempt, but this would involve considerable rear- rangement of our thinking on economic matters- in particular it would require frank recognition of the fact that straight power-group bargaining along the lines of "countervailing power" will never achieve any sort of tolerable economic balance.

If such an attempt should fail, it would appear that a change in our institutional arrangements is inevitable. Though it might prove workable, it seems unlikely that public opinion at the present time would tolerate a return to a regime of competitive individualism (which has been romanticized by some thinkers as it has receded farther into the past). A future institutional shift is likely to take the direction of further experimentation with centralization of wage-price decisions, perhaps compul- sory arbitration and a system of labor courts. Yet, foreign experience with centralization of wage-price decisions has been far from encouraging; it is in- flexible, creates resentments, and may even be un- workable. Before we transform our present system, we would be wise to consider its advantages. Broadly speaking, the economic function of unions

in our form of free society is to help to determine the over-all allocation of resources between the satisfaction of present and future needs (i.e., consumption and investment).10 No doubt the bias is in the direction of present consumption, and from both the cost and demand sides this has been reflected in upward pressure on the price level. In view of the world situation and the growth of our population, we might be better advised to devote a higher proportion of our resources to defense re- quirements, to education, and to the more rapid building up of our capital plant. Yet the unions do serve the purpose of representing the interests and views of great segments of the population, which might not otherwise be heard from, and therefore they serve to maintain morale. In this way, we do avoid the perennial unrest and dissatisfaction of an economy operating under forced draft (i.e., the Soviet economy) wherein the unions may serve simply as state instruments for suppressing consumption and inducing greater output. From the mercantilist standpoint (which is increasingly being forced upon us by the exigencies of contemporary world politics) ," the allocation of resources between investment and consumption in such a system may be more "satisfactory," but the price paid in social malcontents is high.

9John Dunlop has briefly discussed this in "A Review of Wage-Price Stability," this REVIEW, XXIX (August I947),

I54-60. J. M. Clark has strongly advocated this institutional compromise approach, see "Criteria of Sound Wage Adjust- ment, with Emphasis on the Question of Inflationary Ef- fects," in D. McC. Wright (ed.), The Impact of the Union (New York, I95I), I-33.

10In order to evaluate the role of unions and to obtain perspective on the current rise in labor costs, one ought to refer to the conditions of the I920'S. In that era the problem was falling labor costs in light of the rise of productivity and the slow upward movement of money wages. With stable prices, the nation experienced a burgeoning of investment on a narrow consumption base. It is at least a presumption that the ebbing of union power had something to do with these developments.

" International realities make our needs today the mercantilist ones -more statebuilding, the development of resources, greater investment. From the mercantilist standpoint, however, both conventional weapons, monetary and fiscal policy, are deficient. In depression, monetary policy is of slight effectiveness in stimulating investment activity, while fiscal policy serves largely to stimulate consumption expenditures. In prosperity, when a higher level of produc- tive investment is tenable, we use (and are forced to use) a restrictive monetary policy to curtail investment activity, since it seems hopeless to obtain a higher level of savings through federal surpluses. A chief advantage of an "ideal" fiscal policy is that it can "force" additional savings, but this ideal is not in harmony with either American fiscal prin- ciples or realities. In view of the pressure for tax reduction and political logrolling on expenditures, sizable surpluses in the administrative budget seem unlikely. This merely con- firms the frequent observation that the main deficiency of compensatory fiscal policy is that it is one-legged and does not work as anticipated during inflationary periods.



a note on the inflation

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