Inflation in Europe

May 18, 1964

Even economists who originally favored a tax cut as an economic stimulus are beginning to express fears that the recent one was excessive and may touch off an inflationary boom in the current year. Many of them had assumed that the tax cut in the first year would be between $4 billion and $5 billion. The cut of $11.5 billion (or even $13 billion as estimated by some economists) may, they fear, be so large as to “introduce a destabilizing force.”

These misgivings are not unjustified, and could be based on more than the tax cut itself. It is obvious that the government intends to finance the deficit by borrowing from the banks, i.e., by inflation. In fact, the U.S. money supply was being increased with unusual rapidity even before the tax cut took effect. If we define the money supply as demand deposits plus currency, it grew at an annual rate of 4.2 percent from August 1962 to March of this year, compared with an average annual rate of 2.2 percent from 1951 to 1963. If we define money supply to include time deposits, it has grown over the last three years at an annual rate of 8 percent, far above its long-term average.

DIFFICULTIES

A number of European economists, in these last three years, have been telling us that we are not inflating enough; that we ought to have even bigger deficits, and increase our money supply even faster, if we want to “increase effective demand,” and bring “full employment” and a “higher rate of growth.” But the First National City Bank of New York, in a series of four tables in its May letter, shows that the chief European countries have now got themselves into serious difficulties as a result of pursuing just such policies. These tables show, respectively, the increase in consumer prices, wages, money supplies, and industrial output, in 1961, 1962, and 1963, over the preceding year, and the cumulative increase over the three years 1961–63, in each of eight countries. I have condensed three of these into a single table (right) showing the cumulative three-year increase.

Several significant conclusions may be drawn from this table. Europe’s recent inflation has been attributed to wage increases and other “cost-push” factors, but it is quite clear that neither the wage nor the price increases could have taken place without an increase in the money supply to permit or promote them.

It is true that, in one sense, Europe in the last few years has had an “imported” inflation—built on gold and dollars from the United States. But the European central banks were not obliged to build a pyramid of credit on this imported gold and dollars. They could simply have allowed these imports to build up their reserve ratios, or they could have correspondingly reduced holdings of domestic assets.

This European inflation has not helped European economic growth. It has undermined the competitive position of several countries. Because of the rise of wages beyond marginal productivity, it is estimated that wage costs per unit of production increased from 1959 through 1963 by 17 percent in the Netherlands, 20 percent in Germany and France, and 28 percent in Italy. The increase was about 10 percent in the United Kingdom and nil in the U.S.

True, this European inflation has hurt the exports of some of these countries and sucked in imports, giving France and Italy, for example, deepening trade deficits. One incidental result has been to make our own balance-of-payments problem less than it would have been.

Percent increase 1961–63 in . . .

But it would be folly to assume that the problems brought about by our own inflation can be solved by European inflation. These inflations may help to encourage and prolong each other; but the prospects of international long-term stability and growth are only hurt by them.