Deficits, Controls, and Unflation
Reynolds, Alan
Alan Reynolds: Deficits, Controls, and Unflation ''The policy proposals that are being made in theU S. today are all a reflection of the ideas of the late 1930s" - Milton Friedman "Faced with...
...Specifically, Keynesians do not even mention that an excess of real cash balances over the amount normally held might just possibly affect markets for goods and labor, as well as for bonds...
...If it isn't already clear that patchwork remedies do nothing to solve inflation or unemployment, it soon will be...
...B to have no effect whatsoever on total spending...
...Excluding the sore issue of food prices, non-food com modity prices have risen at a slightly faster rate under Phase Two (3 0 per cent) than in the first half of 1971 "(2.9 percent...
...If controls have done anything but reverse favorable trends (and the price indexes surely obscure hidden price increases and quality de clines), the results are far too trivial to justify the distortions, inequities, and loss of freedom (National Review, 8-18-72, 9-1-72...
...8Phelps, E. Microeconomic Foundations of Employment and Inflation Theory (Norton 1970...
...7 Cagan, P. Recent Monetary Policy and the Inflation (American Enterprise Institute 1971) pp...
...2) if reduced money holdings did raise price or output, people would begin holding more money again, because it would take more dollars to satisfy all the reasons why money is held...
...In principle, there is a 'normal" level of unemployment determined by the costs of acquiring information about job availability, the costs of moving, minimum wage laws, occupational licensing, union monopolization of trades, and so on...
...John Kenneth Galbraith We aren't all Keynesians now...
...and (3) higher interest rates reduce demand for investment funds, state and local government borrowing, and mortgages...
...3) The temporary reprieve from in flation in April was to be expected from monetarist theory, and it was predicted (National Review...
...The markets for gold and currencies should be totally free...
...The choice is between continuing crises and revaluations, or grad ual adjustments of flexible exchange rates...
...27-34...
...4 Meltzer, A. "Controlling Money" Federal Reserve Bank of St...
...On the international scene, different rates of inflation among countries will cause fixed relationships between their currencies to break down continually...
...Innovations in Tax Policy and Other Essays (University of Hartford 1972) p. 73 n...
...Keynes himself explicitly denied this, and even Galbraith correctly notes that, unemployment today involves "a complex fitting of highly diverse qualifications to highly diverse needs...
...Since Mr...
...To get people to part with more money, the government has to sweeten the deal with higher interest rates (which makes other potential claimants on the limited amount of loanable funds follow suit...
...The notion that 4 percent unemployed is normal for 1973 - and that we should budget accordingly - is a completely arbitrary assumption...
...Space limitations prohibit repeating all on my reservations about wage and price controls, so I will summarize a few past observations - with parenthetical references to the appropriate issues of National Review: (1) From October of 1970 to July of 1971, the annual rate of inflation dropped fairly steadily from 5.8 percent to 2.4 percent...
...Conversely, if we want to increase the money supply, this can be done without deficits by simply buying outstanding bonds with new money...
...In the absence of money-creation, there is a limited amount of funds available for stocks, bonds, mortgages, and the like...
...This has been the case during the 1971-72 recovery, but there are many indications that loose money is beginning to pull up prices...
...Perhaps even more important, the Federal Reserve must be expressly prohibited from its recurring habit of trying to keep interest rates low by making new money plentiful...
...The only four industrial nations which made little or no use of controls had average price increases of less than 32 percent in the same period (National Review 12-31-71...
...The demand for money is somewhat responsive to interest rates, but the effect on velocity of the comparatively minor interest rate variations associated with financing deficits is far outweighed by other effects: (1) the government's borrowing crowds out a roughly equivalent amount of private borrowing...
...Cagan, P. & Schwartsz, A. How Feasible Is A Flexible Monetary Policy...
...2Meltzer, A.H...
...Price increases in corporate manu facturing have long trended about 10 percent below the price level, and 20 percent below the prices of services...
...The main thing is for the monetary authority to pick any course and stay on it, so that people can make realistic plans...
...With flexible rates, foreign buyers will (like United States citizens) accept dollars which cannot be redeemed for gold, because those dollars can be redeemed for merchandise at realistic prices...
...2) Galbraith told us that "only prices that are...
...A's wallet - to pay for the bonds - is exactly matched by the number of dollars put into Mr...
...For more detailed discussions see my 'The Case Against Wage and Price Controls" reprinted in Annual Editions Readings in Economics 72 (Dushkin 1972...
...One way of generalizing this argument is to say that velocity is higher in government bureaucracies than in the private sector.1 In reality, the government can't continually peddle billions of dollars worth of bonds, year after year, without bidding-up interest rates...
...It takes time for monetary changes to work themselves out, and workers will believe price stability if and when they see it...
...regional labor union monopolies, etc...
...The only significant effect would be to keep more equity capital tied-up in existing firms...
...The archaic theory behind this is illogical (National Review 9-24-71), and the facts are exactly backwards...
...The recovery also began in October 1970, and the index of leading economic indicators (which forecasts recovery) rose more rapidly in the six months before Phase One than in the sub sequent six months...
...Footnotes 1 Actually, velocity is higher in business than in government: R.T...
...Yeager, L. Monetary Policy and Economic Performance (American Enterprise Institute 1972...
...Food price increases were not much of a problem until controls caused the predicted diversion of demand into such uncontrollable sectors (National Review 4-14-72...
...This policy causes price-inflation and eventually raises nominal interest rates, because lenders demand higher rates to com pensate for the expected erosion in purchasing power of the dollars with which they will be repaid...
...On the face of it, one would surely expect this transfer of dollars from Mr...
...10 Harris, C.L...
...Once this inflation is anticipated, however, lenders demand higher interest rates to compensate for it, and consumers hold more cash since it now takes more dollars to satisfy all the reasons for which money is held (each dollar can now buy fewer goods, provide less security, etc...
...Nor is it obvious why the composition of spending - the division between consumption, investment, and government - should affect the total of income in the short run...
...Yet Another Look At The Low Level Liquidity Trap" Econo-metrica (7-63...
...set by unions and strong corporations need to be (or should be) controlled...
...Besides, the government has no business telling people what their labor or property is worth...
...The first to lose out under interest ceilings are the relatively "poor risks," namely, small businessmen, innovators, and low-income families...
...3Sprinkel, B. Money and Markets (Irwin 1971...
...A large body of research clearly indicates that: (1) All significant inflations and de flations have been preceded by sudden changes in the rate of growth of the money supply;3 (2) The money supply can be controll ed within sufficiently narrow limits if Federal Reserve open market sales and purchases of bonds are directed toward affecting the supply of currency and bank reserves;4 (3) The factors that cause velocity to vary are more predictable than the (non-tautological) relationship between investment and income;5 (4) Unpredicatable lagged responses and the absence of omniscience make ad hoc variations in fiscal and monetary policy counter-productive...
...The relevant distinction between a Keynesian and a monetarist is that the Keynesian believes that deficits per se will increase output or prices, while the monetarist says that any expansionary effect arises mainly from the fact that new currency or checking accounts are usually created to pay for the government's new bonds...
...Friedman, M. The Optimum Quantity of Money (Aldine 1969) Ch...
...In 1966 we had a deficit without monetary expansion and the result was a mild recession...
...By taking this heroic leap of faith, the Keynesian can also dismiss the effect of the money supply on output or prices, because Keynesians steadfastly refuse to acknowledge that the supply of money will affect spending except by affecting interest rates...
...In any case, we can discover the normal rate by observing the effect of an expansionary monetary policy...
...B's hands by the government's deficit spending: i.e., the deficits does not give rise to any increase in the money supply...
...10-20-72...
...Given congressional oppositon to freedom in labor markets, the normal rate of unemployment is higher than necessary, but it could never approach zero...
...Even fewer of us are Galbraithians...
...Our hypothetical stubborn Keynesian is thus forced to conclude that this rise in interest rates, resulting from financing the deficit, will not reduce private spending, because investors and consumers will want to borrow just as much no matter what the cost (don't ask where they will get the money, after the government takes its slice...
...Kessel, R. The Cyclical Behavior of the Term Structure of Interest Rates (N.B.E.R...
...In September of this year, the CPI rose by 6 percent...
...The related idea that inflation automatically cures unemployment (The Phillips Curve) is based on the unlovely art of deceiving people...
...Fairly high interest rates have been a necessary part of all periods of prosperity - they allocate a limited amount of loanable funds to the most productive uses (government's inexcusable interest-subsidies to the contrary notwithstanding...
...A could care less whether he sits on money or bonds (because he expects the capital loss from falling bond prices to exactly offset the bonds' yield in interest), the government can unload bundles of bonds on the poor fellow and get those "speculative" holdings of "idle money" rolling again...
...When inflation is new, many job-seekers mistake a general rise of wages for a high relative offer...
...The Keynesian prophecies that expansionary monetary policies will not raise prices, simply because unemployment is above 4 percent, are therefore based on some sort of upside-down Say's Law: i.e., that demand automatically creates its own supply...
...Better still, replace the Fed's Open Market Committee with a computer programmed to achieve such monetary stability...
...If we are serious about eliminating inflation, Congress must limit the Federal Reserve Board's propensity to tinker with interest rates and bounce the money supply up and down...
...This shift of relative prices, with fixed exchange rates, made German goods cheap in the United States, and made American goods costly for Germans - hence, a balance of payments problem...
...Alan Reynolds: Deficits, Controls, and Unflation ''The policy proposals that are being made in theU S. today are all a reflection of the ideas of the late 1930s" - Milton Friedman "Faced with the choice between changing one's mind and proving that there is no need to do so, almost everyone gets busy on the proof...
...Yet, we have drifted into policies based on these quaint old notions, even though the underlying theories are contradicted by simple logic and complicated research...
...A was sitting on a specific type of "liquidity trap" full of "idle money...
...Lewis, W. Federal Fiscal Policy in the Postwar Recessions (Brookings Institute 1962...
...6 (5) Various interest rates move up and down together, and do affect several types of spending.7 TOWARD MEANINGFUL REFORM: It follows that Congress should pass a law instructing the Federal Reserve to keep increases in the money supply within, say, a zero-to-four percent range...
...Asch-heim, J. Techniques of Monetary Control (Johns Hopkins 1961...
...Federal employees, far from facing Galbraithian predictions of "distress and turmoil," have had 15 percent larger wage increases from 1965-71 than the corporate sector (National Review 6-9-72...
...WHAT IS FULL EMPLOYMENT...
...From 1964 to 1969 the West German wholesale price index remained the same, while ours rose by over 12 percent...
...When the economy first receives an injection of new money, interest rates fall because funds are abundant...
...Since supplies are relatively fixed, this boost in total demand creates general price inflation...
...The truth is that business activities have done a surprisingly good job of stabilizing the government cycle...
...To separate "fiscal" from monetary effects, let's assume that the money removed from Mr...
...This is because at higher interest rates it becomes more costly for people to hold money (which earns no interest), so they hold less of it and the rate of spending (velocity) increases...
...Even if there were some evidence for a "liquidity trap" - which there isn't2 - the amount of idle dollars would not be infinite...
...A to Mr...
...1965...
...For deficits to be financed by sales of bonds to the public, however, interest rates on government bonds would have to be much more attractive than has been possible under law and Federal Reserve policy (Professor Gordon Tullock has calculated that the real value of federal debt held by the American public has actually fallen from $252 billion in 1948 to $152 billion in 1971-expressed in 1963 dollars...
...1965...
...minimum wage laws to keep southern blacks from competing with the unions...
...The Meany-Samuelson proposal to control dividends, incidentally, would simple leave firms with more funds for re-investment, so that stockholders would receive more of their income in the form of capital gains rather than as dividends...
...Louis Review (May 1969...
...5Laidler, D. The Demand for Money (International Text 1969...
...Some wages usually fail to keep up with the trend of prices, thereby increasing short-run profits in these industries...
...In short, inflation cannot cure unemployment once people are wise to it.8 CONTROLLING WHAT - AND WHY...
...If we are serious about reducing unemployment, governments must clear away all the obstacles to working that they have created (licensed taxis, plumbers, and tree surgeons...
...Specifically, if new government bonds were all sold to the public (rather than to the Federal Reserve or commercial banks), there would be no increase in the money supply, and any expansionary effect would rest on the unlikely effect of deficit spending in increasing velocity...
...Controls on profits simply encourage padded expense accounts and other waste...
...4) Seven European nations have im posed wage-price controls from 1963 to 1971, and they experienced average price inflations of over 50 percent...
...2-4-72...
...So much for the theory...
...Indeed, an up-dated "Keynesian" argument says the rise of interest rates, induced by government bond sales, will not only not reduce private spending, but actually increase it...
...If unemployment is too high because of "insufficient demand," monetary stimulus will not bid up prices, but will be spent in putting idle men and machines back to work...
...Be sides, an increased share going to, say, employees in medicine or construction doesn't increase total income: the per son paying higher wages loses as much purchasing power as is gained by the recipients.10 It should not surprise anyone that wages and prices reacted slowly to the moderate monetary slow down of 1969-70 - people had just been burnt by several years of unexpected inflation...
...The course of interest rates during inflation is roughly analogous to that of wages...
...Selden, "The Postwar Rise in the Velocity of Money: A Sectoral Analysis" Journal of Finance (12-61...
...If the government insists on taxing money holdings with a 3-4 percent inflation, the economy can easily adjust to that too, by adding a 3-4 percent cost-of-living adjustment to wages, prices, pensions, and bonds...
...and governments must remove all the incentives they have created for people to remain idle (welfare that stops, and payroll taxes that start, with the first dollar earned...
...The true-blue Keynesian, however, could reply that Mr...
...As soon as inflation comes to be expected, however, employees adjust their wage demands to compensate for rising living costs...
...The initial effect is a stimulus to business and, consumer spending, both through the cheapness of credit, and through the direct effect of higher money balances (as a proportion of wealth) than people wish to hold...
...unpublished address, Charlottesville, Va...
...Cagan, P. Determinants and Effects of Changes in the Stock of Money 1875-1960 (N.B.E.R...
...in 1968 we reduced the-deficit with a tax surcharge, but the money supply continued to rise - and so did the rate of inflation...
...Prices of farm products, of most services and prices of small manu facturers are still subject to market in fluences...
...The obvious conclusion is that the expansionary impact of deficits mainly depends on whether or not they are financed with new money: i.e., that "fiscal policy" is usually a roundabout type of monetary policy...
...Business thus returns to normal profitability and many employees are laid-off or voluntarily choose to search for better "real" wages (if such searching for jobs is "unemployment," then all persons who work in employment agencies are likewise "unemployed...
...Obviously, controls don't cause inflation, but they encourage the mone tary irresponsibility that does cause inflation.9 (5) If unions or oligopolies can create inflation, why did they wait until a period of surplus money to do so...
...To spend more than it collects in taxes, the government must create or borrow money...
...The economy is remarkably resilient - it can even adjust to controls, by diverting resources from areas where they are needed, though open inflation would be much more efficient...
...They therefore cease searching for a job, and unemployment is reduced below the normal level...
...The idea that high interest rates are a sign of "tight money" is the opposite of the truth: High interest rates usually contain an inflation premium, made necessary by an earlier increase in the supply of money...
...One of the biggest myths of the century is the idea that government activities have stabilized the "business cycle...
...Artificial controls on rising interest rates must also be avoided, since they simply make more people anxious to borrow and fewer people willing to lend...
...Miller, R. & Williams, R. The New Economics of Richard Nixon (Harpers Magazine Press 1972...
Vol. 6 • December 1972 • No. 3
