Excerpts: Charles L. Schultze, 1959

 

STUDY PAPER NO. 1

RECENT INFLATION IN THE UNITED STATES

BY

Charles L. Schultze

 

MATERIALS PREPARED IN CONNECTION WITH THE

STUDY OF EMPLOYMENT, GROWTH, AND PRICE LEVELS

FOR CONSIDERATION BY THE

JOINT ECONOMIC COMMITTEE 

CONGRESS OF THE UNITED STATES

 

SEPTEMBER -, 1959

 

 

What happens when you fight cost-push by reducing demand?

"When, as in recent years, prices are rising during a period of growing excess capacity, a further restriction of aggregate demand is more likely to raise costs by reducing productivity than it is to lower costs by reducing wages and profit margins."
[page 2, item 11]

 

Something I never thought of, the second sentence here:

"Prices and wages have a dual nature when considered in the aggregate: they are costs to buyers and incomes to sellers. Thus an increase in the general level of prices does not automatically mean a reduction in the quantity of goods and services demanded as it normally would in the case of a single commodity. The increased cost of purchasing any article or any factor of production is matched by the higher incomes received by the seller. So long as the increase in prices is accompanied by an equal increase in money expenditures, real purchases of goods and services will not be affected and employment will not be reduced."
[page 5] [but watch out for indirect effects, Schultze says.]

Okay. If prices go up and money is spent faster, money is also received faster and people have money to buy everything they planned to buy before prices went up. So... First thoughts:

• Inflation isn't a problem? Wrong. The value of the dollar is still affected.
• You still need to raise interest rates? Yes because otherwise there is nothing to stop the inflation. But then, Schultze points out that 

  "With a constant money supply, higher prices normally lead to a tighter money market, which in turn has some depressing influence on investment demand."

  Interest rates would tend upward on their own. // Note also that Schultze is not yet thinking in terms of household demand for credit. It was 1959, after all.
  

I consciously didn't say above that "we spend more". I said "money is spent faster". We don't have more money, so we can't spend more. Velocity goes up instead. This presumes, however, that we're not yet spending money as fast as we can. You can't spend it faster than you get it.

Still on page 5, Schultze finishes his thought:

"If these and other indirect effects are important, their depressing influence on demand must continually be offset by demand increases from other sources, if the rising price level is not to result in rapidly growing unemployment."

This one clearly applies to cost-push inflation in general: A rise in prices unaccompanied by a rise in the money supply will depress demand. So will prices that are held steady by restricting money growth. For demand-pull inflation that's the goal. But for cost-push it's a problem.

Schultze asks: "Do labor unions and monopolistic firms largely disregard the state of the market in setting prices and wages?" One answer:

"The possibility that strongly organized groups can push up their cost prices in the absence of ex ante excess aggregate demand is not 'an empirically important possibility,' according to these demand-pull theorists."
[page 6, quoting Milton Friedman.] [Surprise!]

Schultze continues:

"Further, according to this theoretical approach, the existence of inflation implies that the excess demand must be an aggregate excess. If prices and wages are responsive to demand conditions, excess demands in particular areas of the economy, balanced by deficient demands in other sectors, will merely lead to a realignment of relative prices."
[page 7]

That's right... The demand-pull view insists that all price increases are relative, except when all prices are going up because there is too much money.

Schultze is single-handedly demolishing Friedman! What a treat it is to read this stuff!

I can use this one:

"No one would deny that there is some level of unemployment and excess capacity which would halt a price-wage spiral."
[page 7]

I like what he says, because creating unemployment and excess capacity (and recession) does not solve the cost-pressure problem. This is a problem that can bring civilization to its knees, and everyone ignores it.

How not to identify cost-push:

"The fact that in recent years wages have risen faster than productivity, for example, is often cited as evidence that we have been experiencing a cost-push inflation. But this relationship tells us absolutely nothing about the nature of inflation. In the purest sort of demand-pull inflation, wages would also rise more rapidly than productivity. By the same sort of "reasoning" we could cite the fact that money expenditures rose more rapidly than output as a proof of demand-pull inflation. An equally strong condemnation applies to demonstrations which point to the rise in the money supply or its velocity as proof of the demand-pull nature of inflation."

Exactly right: If cost-push pressures convince the central bank that "accommodation" is necessary, that doesn't make the resulting inflation demand-pull. I like this guy.

"Even the timing of wage and price increases cannot be offered, by itself, as evidence of the nature of the inflationary process. Suppose, for example, that prices are marked up mainly in response to rising wages. Then an excess demand inflation will first lead to a rise in wage rates through its impact on the labor market, and only thereafter in a price rise. The historical data would indicate that the increase in wages preceded the rise in prices, yet the inflation would be one which was initiated by excess demands."

Yeah okay: if excess demand for labor leads to the wage hikes, that can get the ball rolling. I get what he's saying. Schultze offers another example:

"A cost-push inflation need not arise solely from an autonomous upward push of administered wages or prices. If prices are set by applying a constant margin to costs, and if wages are determined by movements in the level of consumer prices, then an initial general price rise, stemming from any source, can perpetuate itself, as wages and prices successively adjust upward to each other."

This last paragraph is good! And the one before. Schultze is concerned about how cost-push gets started, not only about how it continues. Too many explanations are of the "turtles all the way down" variety, offering no hint of what it was that got the ball rolling in the first place. 

(Hint: It was the cost of finance. It's always the cost of finance. And that's always my answer.)

All of that is from page 7, by the way... page 14 of 144.

In that last example Schultze says an initial price rise from any source can perpetuate itself, as wages and prices successively adjust upward in response to each other. Agreed. So how come everybody on the internet says cost-push inflation is temporary and rare???

Art walks away, mumbling to himself.