economic condition characterized by a rise in prices that causes their
reciprocal, the purchasing power of money, to fall correspondingly.
In this general sense, inflation is the exact opposite of deflation
- namely, a decline in the price level, causing the purchasing power of
money to rise. In the more specific sense, inflation is a general rise in
prices not accompanied by a rise in production of goods and services.
concepts of inflation are based on the demand-pull type, i.e., the monetary
type in which the supply of money increases without an accompanying increase
in the supply of goods and services, so that prices rise. Herewith are several definitions based on this concept.
above demand-pull concept of inflation stresses aggregate excess monetary
demand as the causal factor. According
to this view, inflation can be controlled by applying conventional monetary
and fiscal restraints on the money supply; even if business activity should
be dampened in the process, the result will be relative stability in real
terms. Such control of the
money supply, in this view, will be effective whether the proximate cause
of inflation is excessive money supply or cost-induced rise in prices,
as the latter also must be "financed" by money supply.
A variant of demand-pull theories is the Keynesian view that spending
decisions, not the money supply per se, are the primarily causative factors
of demand-pull inflation.
second major concept of inflation in recent years in the United States
is the cost-push view of inflation.
According to this view, prices have risen persistently in recent
years (creeping inflation) in the face of a relatively stable money supply
because of "autonomous" upward advances in wages, beyond labor
productivity, especially in labor union-dominated industries, and higher
costs for other factors of production.
(On the other hand, organized labor's view is that the "new"
inflation is caused by deliberate increases in "administered"
prices by management, unjustified by increases in wages or other costs.).
group of cost-push theorists believes that cost-push inflation can be
restrained by several restrictive monetary and fiscal policies causing
business recession and substantial unemployment, but that this is too
high a price to pay for stability. Hence, as the late Dr. Sumner H. Slichter proposed, we should
adjust to creeping inflation as inevitable and counteractive by policies
designed to maintain maximum output, productivity, and full employment.
Another group's remedy for cost-push inflation would be to seek
flexibility in prices and wages by rigorous application of the antitrust
laws to business and even labor, in an effort to break up "administered"
pricing and wage fixing, an approach deemed unrealistic by Slichterian
group in view of the "political facts of life."
another concept of the nature of creeping inflation in the United States
is factor price inflation. This
kind of inflation can occur without either an excess aggregate demand
or an autonomous cost push (Dr. Charles L. Schultze, Recent Inflation
in the United States, 1959).
This "originates in excess demand in particular sectors of
the economy and spreads via cost increases to other sectors in which demands
are not excessive, and indeed to those in which there is unused capacity
and unemployment." The
boom in business investment and the substitution of fixed costs and breakeven
points, so that even at lower operating rates, price increases attempt
to recapture the higher fixed costs in particular sectors of industry. In this view, conventional aggregative monetary and fiscal
policies, by restricting already low aggregate demand in these sectors,
would worsen the situation; instead, selective monetary and fiscal measures
aimed at particular sectors where demand for factors is excessive would
be necessary to control this type of selective inflation.
the 1960s, the U.S.S experienced both a demand-pull and a subsequent cost-push
inflation. In 1965, the full employment economic policy of the early 1960s
led the economy to a full utilization of its resources.
This led to price increases.
In effect the economy was becoming overheated with labor shortages
in key industries. In an attempt to prevent wages from rising at a faster rate
than productivity, the Johnson administration re-emphasized the wage guideposts
originated in 1962. The purpose
of the guideposts for wages was to keep the annual rate of increase of
total employee compensation per manhour worked equal to the national trend
rate of increase in output per manhour.
Wage increases, however, outstripped rise in productivity throughout
the latter half of the 1960s, leading to a serious rise in the pace of
cost-push inflation. The
GNP price deflator began to rise soon after unemployment fell below 4%
at the end of 1965. Demand kept rising rapidly after the end of 1965, reducing
the unemployment rate below 4$ and pushing the pace of inflation still
higher. Under those circumstances,
"the proper course of policy was clear" (Council of Economic
Advisers, Annual Report, 1971)
restrictive policy to restrain inflation, which would carry little if
any cost in the form of rise in unemployment.
But by early 1970, rising unemployment rates began to accompany
rising inflation rates. The
dilemma of policy as of early 1971 was concisely stated by the Council
of Economic Advisers as follows.
Confining the economic expansion to a pace that would keep unemployment
in the neighborhood of 5.5% to 6% would permit a significant decline in
the rate of inflation during 1971 and 1972, but allowing so high an unemployment
rate to persist for so long a time would be inconsistent with the Employment
Act of 1946, and "undesirable even if there were no act."
On the other hand, trying to restore full employment (a $4 unemployment
rate) would entail risks on the inflation side.
Council of Economic Advisers in its 1971 Annual Report
reported widespread public support for direct price and wage controls,
"even if the full consequences that these controls would have in
distortions and black markets" were not perceived.
But the council concluded that "short of an emergency of a
kind which does not exist, mandatory comprehensive price and wage controls
are undesirable, unnecessary, and probably unworkable."
August 15, 1971, the President of the U.S. announced a 90-day price-wage
freeze, which was extended October 7, 1971, into the subsequent three
phases of compulsory price and wage controls, the first in the peacetime
history of the U.S., details of which are given in INCOMES POLICY.
term is more aptly descriptive of credit expansion and a general rise
in trade and prices on a real basis that occurs during a period of revival
or recovery following a condition of recession or depression.
The condition of inflation should be reserved for that final phase
of expansion when the economy reaches full employment of resources and
prices continue upward in speculative excesses of bidding for goods and
services, commodities, stock prices, etc., "pure inflation,"
in a splurge of aggregate demand relative to given available supplies
of factors, output, and inventories.
occurs when the economy has slowed down but inflation persists.
The U.S. economy has experienced stagflation several times in recent
terms "currency inflation" and "credit inflation"
refer to the nature of the expansion in money supply creating a condition
of pure inflation. Credit
inflation is a condition of excessive expansion of commercial bank credit,
resulting in excessive volume of bank deposits relative to supply of factors,
output, and inventories. Currency
inflation is a more primitive type of inflation of the money supply caused
by deliberate increase in the currency supply or tinkering with the money
unit. Modern inflations have
been credit inflations, i.e., expansions in the volume and velocity of
bank credit and bank deposits, constituting the bulk of the effective
money supply of modern credit system.
Both types of inflations may be effectively controlled by conservative
monetary and fiscal policies; the "revival of monetary policy"
in recent years, for example, refers to the greater effectiveness of restrictive
monetary policy when bank credit is deeply involved in financing an inflation.
manipulation undertaken deliberately by the federal government, as an
artificial means of coercing spending, was last tried in the U.S. in the
early years of the Franklin D. Roosevelt administration in an extraordinary
attempt to stimulate recovery from the severe 1932 depression.
This manipulation was intended to raise commodity prices, ease
the burden of public and private debt, decrease the claims of creditors
in terms of commodity prices considered abnormally low in comparison with
prices at the time the credits were extended, prevent further bankruptcies
and permit unfreezing of frozen bank assets, protect gold (or other metallic)
reserves, and stimulate demand for the nation's products (by lowering
the exchange rates of the currency) in world markets.
The general objective was to force up the general price level by
deliberate alteration of the money side of the equation of exchange, either
by increasing the quantity of money, impairing its quality (denying its
redeemability, lowering the standard monetary metallic content of the
unit, and introducing fiat money or greenbacks), coercing an increase
in velocity of circulation, or all three.
The grave calculated risk involved was loss of general confidence
in the dollar. That a risk
involved was loss of general confidence in the dollar.
That a rampant flight from the dollar and a raging currency inflation
did not occur was due to the fact that the Roosevelt administration was
more conservative monetarily than its actions bespoke; for example, the
gold profit of $2 billion resulting from devaluation of the dollar was
not fed to the credit system, the $3 billion authority to issue greenbacks
under the Thomas Amendment of 1933 was never used, and the monetary nationalization
of silver was subsequently repealed.
the era before the modern credit systems developed, the common form of
currency manipulation was debasement of the coinage.
A sovereign, hard pressed for funds and not willing or able to
impose heavier taxes, had only to substitute baser coins for those outstanding
or reduce their metallic content.
The assignat inflation of the French Revolution, usually regarded
along with the German currency inflation culminating in 1924 as the most
disastrous in history, was a deliberate paper money inflation.
Types of Currency Manipulation.
in the currency unit designed to produce inflationary consequences include
of gold payments is an extraordinary procedure for protecting gold reserves
or temporarily stimulating export trade and may be initiated as a defensive
measure without inflationary intent.
England's suspension of gold payments on September 21, 1931, was
designed in furtherance of these ends.
Another major purpose of England's suspension of gold payments
was to experiment with MANAGED CURRENCY, a policy of releasing the currency
unit from the anchor of a fixed gold price, and allowing the currency
unit to seek lower levels in the foreign exchange markets, protected against
sharp or sudden fluctuations by operations of the EXCHANGE EQUALIZATION
speaking, therefore, the mere suspension of gold payments, without other
changes in monetary practice, is not, ipso facto, an inflationary step.
It may or may not lead to inflation, and it may or may not lead,
after a period of trial and de facto stabilization, to a revaluation of
the monetary unit at a new but lower gold par value.
Experience with managed currency in the 1930s, however, indicated
that any temporary advantage derived thereby internationally by a nation
is soon vitiated by defensive measures by other countries of the same
type, leading in turn to countermeasures and further retaliation, establishment
of EXCHANGE RESTRICTIONS, trade barriers, etc., so that the end result
is reduced international trade and financial relations.
A basic aim of the INTERNATIONAL MONETARY FUND for the post-World
War II was the stimulation of such relations by establishment of par values
for currency units, removal of exchange and trade restrictions, and an
ending of manipulative paraphernalia of managed currency in its international
aspects. Domestically, any
exercise of monetary and fiscal policy is management, but this is conventional
and expected in modern credit system.
like suspension of gold payments, does not per se assure a price rise
is the statutory adoption of a new monetary unit of less metallic weight
(and value) than that which preceded it.
France, Belgium, and Italy are examples of countries that devalued
their units in the years 1924-1928 by from 75% to 80% after being off
gold a number of years. The
inflation in these countries occurred previous to devaluation so that
actual devaluation was intended to stabilize prices at the higher levels.
Led by the 30.%% devaluation of the pound sterling, 28 countries
by October 18, 1949 had devalued their currencies, including most Western
European nations, countries in the sterling area, and Finland, Canada,
Argentina, and Uruguay. The immediate reason for this devaluation of the pound sterling
was the heavy loss in monetary reserves of the United Kingdom.
In contrast to the previous wave of devaluations in the 2930s,
this series of devaluations was motivated primarily by the dollar balance-of-payments
problem, and most countries devalued to approximately the same extent
as the United Kingdom, thus maintaining exchange values relative to the
pound sterling, but like the UK assuming new positions relative to the
dollar. The devaluations
were accompanied by adoption of policies designed to control inflation
in the devaluing countries but at the same time maintain the competitive
advantage in selling to dollar markets.
Devaluation provides new pars in foreign exchange, affords the
government an opportunity to utilize the gold profit, and provides a basis
for controlled credit expansion.
crudest and most direct method of achieving inflation, whether voluntarily
by intent or involuntarily through inability to meet obligations, is by
the issuance of fiat or irredeemable paper money.
Issuance of irredeemable paper is considered the grossest form
of debasement of the currency, a deliberate injection of additional claims
for goods or serves of the economy without justification of commensurate
increase in supply of goods and services.
The deliberate expansion in the money supply that will be accompanied
by discrimination against the fiat currency will cause prices to rise
and purchasing power to decline. If the issue of fiat paper money continues, the rise in prices
and depreciation in purchasing power will be aggravated, leading to the
necessity for additional issue, causing utter worthlessness of the currency.
This will ruin the creditor classes, owning claims to fixed sums
of money that will now be pensioners, annuitants, insurance policy owners,
bank depositors, and all holders of claims in currency units.
The continental currency of our preconstitutional government, the
inflation in France in the years 1790-1796, and the German paper money
inflation of 1920-2924 are the frequently cited examples of paper money
hyperinflation that developed to the ultimate extreme of worthlessness.
Our Civil War greenback history furnished an example of a paper
money inflation that was limited and controlled.
Continental Currency Inflation.
American Revolutionary War was financed largely by the printing of continental
dollars on the authorization of the Continental Congress, with the "faith
of the Continent" as the only backing.
The Continental Congress had no power to tax and could only lay
levies upon the states for revenues that were progressively more difficult
to collect; thus the Congress was obliged to resort to additional issues
of continentals for payment of federal expenses.
Over a five year period, 1775-1779, 40 issues aggregating $241,552,780
were resorted by the Congress. Redemption
of the continentals was placed by the Continental Congress upon the states,
but instead of honoring redemption of the continentals, the states issued
paper money of their own, aggregating $209,424,776 in the period 1775-1789,
including additional issues after the continentals became worthless in
of the early histories tells the story in these words.
"During the summer of 1780 this wretched Continental currency
fell into contempt. As Washington
said, it took a wagon load of money to buy a wagon load of provisions.
At the end of the year 1778, the paper dollar was worth 16 cents
in the northern states and 12 cents in the south.
Early in 1780 its value had fallen to two cents, and before the
end of the year it took ten paper dollars to make a cent.
October, Indian corn sold wholesale in Boston for $150 a bushel, butter
was $12 a pound, tea $90, sugar $10, beef $8, coffee $12, and a barrel
of flour cost $1,575. Samual
Adams paid $2,000 for a hat and a suit of clothes.
The money soon ceased to circulate, debts could not be collected,
and there was a general prostration of credit."
final result of this inflation is best summed up in the old saying, "not
worth a continental," which has come down to even modern times as
an expression of worthlessness.
French Assignat Inflation.
French assignats that were issued between 1790 and 1796 are an outstanding
example of deliberate inflation.
The French revolutionary government was confronted with the problem
of both raising revenue and overcoming a condition of business depression.
In response to the demands of the inflationists, the Constituent
Assembly in April, 1790, authorized the issuance of assignats to the amount
of 400 million livres, to be legal tender and to bear interest at 3%.
the currency was to be secured by church lands recently seized.
the beginning, the effect was to relieve the Treasury of some of its burdens
and to stimulate trade. As
soon as the assignats began to circulate, however, they depreciated to
the extent of about 5%. The 400 million livres of paper were soon exhausted, and there
was an immediate agitation for the issuance of additional currency.
It was even claimed that the first issue had been a success.
Mirabeau, a leading inflationist of the day, advocated that currency
be issued equal to the amount of the whole national debt and insisted
that such action would bring prosperity to the nation.
The Assembly in September, 1790, by a vote of 508 to 423, approved
the issuance of additional assignats up to a total of 1.2 billion livres.
This issue bore no interest and was payable to bearer but provided
that as fast as the assignats were paid in for land they should be burned.
the latter stages of the issuance of assignats, the printing presses were
run t the will of the executive authority, blanket authorization being
given for the re-issuance of such amounts as might be needed.
Within a year, the discount on assignats ran from 18% to 20%, and
within two years it amounted to 44%.
About that time there was a temporary rise in their value, but
in 1795 a rapid depreciation commenced.
By February, 1796, it required 288 paper francs to equal one gold
franc. Prices of various
necessities soared, that of sugar rising 69 times and soap 44 times.
Finally the populace joined in a public burning of the printing
press machinery on which the assignats had been printed.
October, 1795, a new government was established, the Directory.
It tried to restore order out of the currency chaos by issuing
in February, 1796, a new kind of paper money called mandates, secured
only by choice public lands. One
mandate was made worth 30 assignats.
The mandates immediately depreciated to 30% of face value, then
fell to 15% and finally to 5%. On
July 16, 1796, the inevitable happened; the Directory decreed that all
paper could be accepted at its real value, which meant at nothing.
The people cased even to compute the depreciation after that.
When Bonaparte took the consulship, the largest loan available
in the land would not meet the government's expenses for a single day.
to do business in such rapidly depreciating money, the market women of
Paris had marched on the Assembly and made an appeal, famous among economists,
that "laws should be passed making paper as good as gold."
The Assembly's actions included the following:
in April 1793, a forced loan of 1 billion livres was levied upon
the rich; in July of that year, the estates of the nobility were confiscated,
and these lands, estimated at 3 billion livres, were also pledged behind
the paper money to make it more valuable.
1793, 6 years in prison was made the penalty for selling gold at more
than its nominal value in paper. Six months later, selling assignats at less than face value
was made worth 20 years in prison.
Two years later, the guillotine was provided for any Frenchman
who made investments in a foreign country.
Bonaparte saw enough of paper money inflation in the years 1790-1796 to
convince him of its fallacious and dangerous nature.
When he took the consulship, conditions were appalling.
The government was bankrupt, the troops were unpaid, the further
collection of taxes appeared impossible.
Nevertheless, when asked at his first cabinet meeting what he intended
to do, Napoleon replied: "I
will pay cash or nothing!"
("cash" meaning specie), and he carried out that promise
to the letter. "While
I live," he declared, when he was hard pressed on another occasion,
"I will never resort to irredeemable paper."
German Post-World War I Inflation.
was involved in budgetary difficulties after World War I.
Its national expenditures had increased fivefold during the war
period, and its national debt, sixfold.
The paper money in circulation had increased from less than 3 billion
marks at the beginning of the war to 29 billion at the end of November,
1981. Wholesale prices in
Germany more than doubled during the war period.
Considering the large expansion of currency, the rise in prices
up to the time of the Armistice was moderate.
German government had borrowed from the Reichsbank during the war by the
process of discounting Treasury bills.
This was done to an increased extent as it became necessary to
meet deficits in the postwar period.
By the time the stage of hyperinflation was reached toward the
end of 1923, the volume of Treasury bills held by the Reichsbank totalled
nearly 200 quintillion marks.
happened during 1922 and 1923 was unlike anything that had ever occurred
in the world's monetary history.
Paper marks depreciated more rapidly than the continental currency
of the U.S. in Revolutionary War days, or the assignats of France, also
in the latter part of the eighteenth century.
The expenditures of the German government increased from 145 billion
marks for the year ending March 31, 1921, to more than 8 trillion marks
two years later, and to 49 quadrillion marks the next year.
It was impossible to keep up with expenditures by levying more
taxes. Currency in circulation,
which amounted to 252 billion marks in August, 1922, increased to 2 trillion
marks in January, 1923, to 28 quadrillion marks in September, 1923, and
finally reached a total of 497 quontillion marks at the end of 1923.
November 20, 1923, one gold mark was regarded as equal to 1 billion paper
marks. New Rentebank notes
that were issued at about that time as an intermediate step toward stabilization
were exchanged at the rate of one for 1 billion paper marks.
Subsequently when the Reichsbank was re-organized in October, 1924,
it issued new gold reichsmarks, one of which was equivalent to 1 trillion
old paper marks.
the inflationary period the gold value of the mark as quoted in foreign
exchange dropped from an original par of 23.82 cents to about one-half
cent in December, 1921; one-hundredth of a cent in December, 1922; and
three-trillionths of a cent in December, 1923.
business of accumulating and investing capital in Germany was completely
demoralized by the inflation. No one wanted to keep money in the banks.
In 1922, all savings in Germany amounted to only 3 billion goldmarks,
against 20 billion reported by the savings banks alone two years earlier.
Speculation was rampant, resulting in excesses in various field. How much of this capital was remunerative may be judged from
the fact that dividend payments 1922, measured in the gold value, were
only one-fiftieth of what they had been before the war.
Russian Post-World War I Inflation.
was plunged into currency inflation by efforts to finance governmental
deficits through the issuance of fiat money.
Early in World War I, the Russian Treasury was allowed to discount
its short-term obligations at the state bank to any extent desired, previous
restrictions being removed. The currency was on an irredeemable paper basis.
As early as 1916, there was only paper money in circulation.
The government obtained enormous amounts from the bank.
Between January 1, 1917, and January 1, 1923, the quantity of money
in circulation increased two hundred thousand times, while prices rose
ten million times. The depreciation
was more rapid than the rate of issuance of currency.
A new Soviet state bank issued notes to meet deficits of the Treasury
during 1922 and 1923. Finally
in 1924, a new ruble was issued in exchange for 50 billion of the old
Types of Price Changes.
are two basic types of price changes:
a technical sense, inflation refers to changes in the general price level.
When the general price level increases, the dollar loses purchasing
power - the ability to purchase goods or services.
The opposite situation is referred to as deflation. Holding monetary assets and liabilities during periods of inflation
or deflation results in purchasing power gains or losses.
Monetary items are assets and liabilities that are fixed in terms
of current dollars and cannot fluctuate to compensate for the change in
the general price level. Monetary
assets include cash, receivables, and liabilities.
in the general price level can affect, adversely or otherwise, almost
every business decision. Changes
in the general price level can affect organizational planning, controlling,
and evaluating functions:
price index is used to measure changes in price levels.
A price index is a series of numbers, one for each period, representing
an average price of a group of goods and services, relative to the average
price of the same group of goods and services at a base period.
The consumer price index for all urban consumers, published by
the Bureau of Labor statistics of the Department of Labor in the Montly
Labor Review, is perhaps the most widely
used price index. Current
cost information is needed to deal with changes in specific prices.
Replacement costs are commonly used in current cost systems and
for decisions involving specific prices.
appended table shows the purchasing power of the dollar:
1950 to 1987, for producer and consumer prices.
examples of currency hyperinflation are not intended to be alarmist, but
their lesson is plain, particularly illustrated by the experience of Germany,
a financially most advanced nation with a modern credit system:
the problem originates with budgetary deficits of the government;
an easy solution therefor is instead of forcing the Treasury to finance
in the open market. Although there were extenuating circumstances in the German
post-World Ear I situation, direct financing of Treasury deficits through
direct financing by the Treasury through the Federal Reserve banks is
authorized by Congress only for renewable periods and with limits on such
direct financing. In practice,
the Treasury resorts to such financing to tide it over low tax collection
periods. But even though
conventionally financed, persistent federal budget deficits monetize the
debt and add to inflationary pressures by increasing the money supply
through the banking system.
P. and LIPSEY, R.E. "The Financial Effects of Inflation."
National Bureau of Economic Research.
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