What You Should Know About Inflation

In every year of the past quarter-century of inflation articulate individuals or groups have insisted that we were in fact in a depression or a deflation, or on the verge of one, or at the very least that our “economic growth” was not as fast as the adoption of their particular inflationist schemes could make it.

A typical example is a “report” of the National Planning Association (a group of statist planners who frequently manage to get their pronouncements on the front pages of leading newspapers) in mid-1954. This report declared that the country must step up its production of goods and services by “at least $25 billion” over the next twelve months to keep the economy healthy. Why, as long as they were simply talking about what was desirable, they stopped at a mere $25 billion, I do not know.

The pronouncement, however, was so typical of current inflationist fallacies that it is worth a little analysis. The NPA firmly believed that what primarily caused the “recession” from mid-1953 to mid-1954 was a drop in defense spending, and therefore what could pull us out was a boost in defense spending. Such a judgment, however, finds no support in either economic theory or experience. In the fiscal year 1944 the Federal government spent $95 billion; in the fiscal year 1947 it spent $39 billion. Here was a drop in the annual Federal spending rate in this three-year period of $56 billion. Yet, far from there being a recession in this three-year period, there was a substantial increase in employment, wages, and prices.

I may add that there was a very sharp increase in industrial production and employment between mid-1954 and mid-1955—though in that fiscal year total Federal spending, instead of being increased (as recommended by NPA), was further reduced by more than $3 billion.

This fact did not escape the notice of observers at the time. In a column in The New York Times of September 8, 1955, Arthur Krock drew attention to official statistics which showed that private spending in the United States had been steadily replacing, and in fact exceeding, the billions cut from the budget by the Eisenhower Administration over a two-year period. The following table shows the comparison:

What is really compared in the foregoing table is the second quarters of 1953, 1954, and 1955. The figures are expressed, however, in billions of dollars at seasonally adjusted annual rates. They show that while government spending was running at an annual rate of $3.4 billion less in the 1955 quarter than in 1954, and $15.8 billion less than in the corresponding 1953 quarter, nongovernmental activity was running in the second quarter of 1955 at a rate $30.6 billion higher than in the same period of 1954 and $31.3 billion higher than in 1953.

There is really nothing astonishing in such figures except to those who tenaciously hold to a quite erroneous preconceived view. Yet again and again in recent years we find it stated or assumed by business “forecasters” that the future of business activity depends primarily on the government’s defense-spending program. If that rises, we are told, business activity and prices will rise; but if it declines, there is no telling how much business will deteriorate.

This assumption would lead to the absurd conclusion that the more resources we are forced to devote to making planes, carriers, submarines, nuclear bombs, and guided missiles, the richer we become. Indeed, many amateur economists have not shrunk from this conclusion, and tell us with a knowing air how lucky we are to have a constant threat of Communist aggression—for if this threat were suddenly and miraculously to disappear, what would become of prosperity, “economic growth,” and full employment? Every new Communist act of aggression, on this theory, does us an economic favor.

The fallacy consists in looking only at the government’s defense payments and forgetting that the money for these comes ultimately from taxes. If defense payments suddenly dropped from $46 billion to $16 billion, taxes could also be cut by $30 billion. Then the taxpayers would have $30 billion more to spend than they had before, to make up for the $30 billion drop in government spending. There is no reason to suppose that the over-all volumes of output or activity would decline.

The whole theory that defense spending is necessary for prosperity, as I pointed out previously, got a crushing refutation at the end of World War II. Immediately after Japan surrendered in August 1945, there was a sweeping cancellation of war contracts. Government economists predicted that unemployment would reach 8 million by the following spring. Nothing of the sort happened.

In sum, there is no reason whatever to suppose even in theory that wages and employment should depend primarily on the volume of defense spending, or government spending for any other purpose. If the government spends $10 billion less on defense and reduces taxes by the same amount, then the taxpayers have as much more to spend as the government has less. The total volume of spending is unchanged. It would be a monstrous as well as a foolish doctrine that we must increase the volume of wasteful expenditure on armament, not for the sake of defense, but for the sake of “creating prosperity.”

So far as the inflationary effect is concerned, what counts is not the amount of defense spending or total government spending, but the size of the deficit and, even more directly, the amount of new money supply. Even the NPA statement at one point seemed willing to settle for a deficit achieved through civilian public works or even a cut in taxes. It even recognized at one point that private plant and equipment modernization might help to create employment. But it paid scant attention to the fact that only the continuing prospect of profits, and only the ability of the profit-earners to retain enough of these from the income-tax collector, can make possible that continued investment of new capital which is essential to put better and better tools in the hands of the workers and constantly to increase their real wages.

What was typical of the NPA statement was that its proposed statist remedies for unemployment utterly ignored the effects of wage rates. No matter how much we are inflating, no matter how high the absolute level of national income or “purchasing power,” we can always bring about unemployment by pushing wage rates too high in relation to prices and productivity.

This points to the error in the Keynesian propensity to look only at such huge over-all money aggregates as “national income” and “purchasing power.” Maintenance of employment depends on expectation of profits in each industry. This expectation depends on the relationship of costs to prices, which means the relationship of prices to each other and wage rates to prices.