Charting America's Future: Responses-3
GLASNER, DAVID
CHARTING AMERICAS FUTURE Below we present another contribution to the NL's year-long series aimed at stimulating debate on setting a new course for the country. RESPONSES-3 RELATIVE PRICES AND...
...Tyler bases his case for the first point on the old Adolf A. Berle and Gardiner C. Means "administered price" hypothesis, holding that prices in the noncompetitive sector did not fall in response to deflationary pressure during the Great Depression...
...It is ridiculous, though to believe that any sensible management sets a price based on cost or some other considerations and forgets about it, no matter what else is going on in the market...
...Because some prices rise, prices in general do not have to...
...The relationship between the money supply and the price level becomes obvious once it is understood that the price level is only the inverse of the purchasing power, or the value, of money...
...The problem with the little syllogism designed to prove why tight money is inflationary is that it implicitly assumes its own conclusion...
...As for the narrow point concerning the rigidity of prices in concentrated, capital intensive industries that Tyler tries to make, following Berle and Means, it is dubious...
...By putting downward pressure on wages, raw materials prices and profits, it is doing this even while interest rates soar to near record highs...
...The severity of its current application is such, however, that the effects have become apparent much more quickly, and have been more sizable, than they have been during less extreme tight money episodes...
...All this may not make tight money any more appealing...
...I shall restrict myself to the one that is, theoretically, the most interesting and perhaps the most difficult to confront...
...Monopolistic and oligopolistic firms are sensitive to market conditions and they do adjust their prices to changes in those conditions...
...The argument goes as follows: Interest is the cost of money...
...When demand is depressed, it is just not rational for a company to insist on recovering fixed costs at the expense of sharply reduced sales...
...Indeed, Federal Reserve Board Chairman Paul Volcker, although refusing to acknowledge its validity, once publicly admitted to his own difficulty in coping with it...
...Firms can only recover fixed costs when there is sufficient demand to allow them to do so...
...The preceding pieces in this series were: "The Great Debate"'(NL, November30, 1981), "Those New Deal Years (1933?1938)" (NL, December28,1981), "Undoing the New Deal (1939-1981) " (NL, January 25), "Responses-1" (NL, February 8), "The Roots of Stagflation" (NL, February 22), "Responses-2" (NL, March 8), and "The Politics of Productivity" (NL, March 22...
...Prices of other grades are supposed to maintain specified differentials from the list price...
...Even if true, this certainly cannot demonstrate that prices in general (what we are talking about when we speak of inflation or deflation) did not fall in response to deflationary pressure, for the price level did fall by something like 25 per cent between 1929-33...
...But since the errors Gus Tyler committed in "The Roots of Stagflation" (NL, February 22) appear to me to be both wrong-headed and widely shared, I shall risk seeming somewhat ungracious and present a forthright criticism of his diagnosis...
...Thus, there is no basis for accepting the Berle and Means position espoused by Tyler...
...But its effectiveness in reducing inflation does not seem to me open to doubt...
...He has only shown that there will be a change in relative prices...
...Tyler's further contention that prices must reflect fixed costs is plain wrong...
...An increase in interest rates will place the burden of the adjustment on the owners of productive factors, not on consumers...
...RESPONSES-3 RELATIVE PRICES AND PRICE LEVELS DAVID GLASNER Assistant Professor of Economics, Marquette University Certainly few economic problems have seemed more intractable to policy makers or more baffling to economists than what we have become accustomed to call by that singularly unattractive word, "stagflation...
...Nevertheless, the actual prices of transactions, in the spot market and in the contract market, can vary substantially (especially when various adjustments in credit terms and the like are considered) in times of excess demand or excess supply...
...At most, the Berle-Means hypothesis could suggest that stickiness of prices intensified the price decline in the competitive sectors and aggravated the unemployment of resources overall...
...His example of how a company might have to add $2 to the price of widgets to cover its fixed costs in a recession when sales are low, instead of only $1 in a boom when sales are twice as great, ignores the relationship that exists between the price the firm charges for widgets and the amount it will sell...
...Therefore whatever raises interest rates must raise the costs of all firms...
...And if the price level is determined not by costs but, say, by the money supply, which is precisely the matter at issue, then a tight money policy, by constraining the money supply, will keep prices from rising...
...Wicksell, by the way, was such a radical that he endangered his academic career by refusing to sign a petition to the king for a permanent professorship containing the phrase, "Your Majesty's most obedient servant...
...This reduction in inflation, despite Tyler's protestations, is quite consistent with our previous experience with tight monetary policy...
...To the contrary, one suspects that as a labor union official, Tyler would probably be even more displeased by the unemployment and lower wages resulting from a tight monetary policy than by the inflation he believes it causes...
...That is not true, and he therefore cannot claim to have shown any relationship between the policy and the general price level...
...But it is no less mistaken...
...The first is Tyler's assertion that the growth of monopolistic and oligopolistic control over the American economy has made prices in those sectors resistant to any downward pressure during periods of recession, and consequently inflation is impervious to tight monetary policy...
...The wisdom of the present approach is certainly debatable...
...Consequently, any change in the money supply that is not accompanied by a corresponding change in the demand for it must alter its value—that is to say, the price level...
...Tyler assumes that if he can show a particular policy will increase some prices, or some costs, he has proven that the policy causes prices in general to rise...
...Tyler's second major point—that tight money and high interest rates are inflationary, not anti-inflationary—is, if anything, more widely subscribed to than the first...
...Tyler goes on to observe that, in fact, reduced demand because of tight money may actually cause prices to rise, since fixed costs would have to be spread over fewer units...
...As I suggested earlier, he commits this logical slip because he fails to distinguish between particular prices and prices in general...
...According to Tyler's reasoning, airlines should be raising their fares now that ridership is declining, and the car companies should be adding surcharges rather than offering rebates...
...This argument was already so prevalent in the 19th century, that the great Swedish economist Knut Wicksell felt obliged to address it explicitly...
...He simply assumes his own conclusion...
...The second is that high interest rates (which Tyler equates with a tight monetary policy) are a cause of, not a cure for, inflation...
...In each case, Tyler has apparently been led astray by a more general error, to wit: a failure to distinguish between real and nominal prices, or between changes in individual prices and changes in the general price level...
...No inference about the general level of price can be drawn...
...On the other hand, when the reduction in demand is perceived as being short term, an immediate reduction in price would be foolish for sales at higher prices could be realized merely by waiting a little while...
...The most important work in this regard is The Behavior of Industrial Prices, by George J. Stigler and James K. Kindahl...
...Both of these arguments are refuted by the overwhelming weight of logical analysis and empirical evidence...
...Looking at actual transactions prices rather than at list prices (the source of the Bureau of Labor Statistics data Berle and Means used), Stigler and Kindahl found no significant difference in the flexibility of prices in concentrated and unconcen-trated industries...
...Given the poor record of economists in prescribing remedies, it perhaps ill behooves them to be too critical of any non-economist's effort to offer an explanation of, and presumably a cure for, the malady...
...and he was imprisoned for ridiculing the doctrine of the Immaculate Conception in a public lecture...
...Again, even if true, this merely says the price of goods produced with substantial fixed costs will rise relative to other prices in recessions and fall relative to other prices in booms...
...A good illustration of their finding is provided by opec . It sets a list price of, say, $34 per barrel for Saudi light crude...
...Furthermore, if one observes what is happening in the economy today, it is all too evident that a ferociously tight monetary policy is rapidly bringing down inflation...
...All firms must use or borrow money...
...If one wants to call this "price administration" that is all right...
...Let me explain...
...That higher interest rates add to total costs implicitly assumes the level of prices will rise...
...Subsequent research has failed to provide unambiguous support for the Berle-Means hypothesis in its narrow version either—and once more, it has no implications whatsoever for inflation...
...Otherwise, we have no reason not to assume increased interest rates will simply force down other costs, like wages...
...He offers a host of reasons to support his position...
...There are two points that I want to address, in particular, because they are typical of a class of errors one encounters ceaselessly in even the most sophisticated discussions of inflation...
...It simply has no relevance to movements in the general price level...
...Yet there is still a grain of truth in the Berle-Means hypothesis: Because of the administrative costs of decision-making and becauseof the recognition that current and future demands and current and expected future prices are all interdependent, large corporations change prices in response to changing market conditions only af ter some deliberation and some passage of time...
...In any event, Tyler has not demonstrated that tight money leads to higher prices...
...When firms' costs rise they must raise their prices...
...Tyler's view would make sense only if the same number of widgets were going to be sold regardless of the price—except then there would be no reason why the producer should settle for $1 in a boom or for $2 in a recession...
...Ergo tight money, which causes high interest rates, is inflationary...
Vol. 65 • April 1982 • No. 7
