Mistakes of Inflationists

July 19, 1954

Two weeks ago I remarked here, hyperbolically, that we are all Keynesians now. But I could have said in sober truth that while most of those now controlling policy are inflationists, they are being pushed from behind by hyperinflationists.

A good example is the National Planning Association, a group of statist planners who manage to get their bizarre pronouncements on the front pages of leading newspapers. Their latest report declares 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 are merely tossing out figures, stop at a mere $25 billion? Apparently because they estimate that unemployment is still between 5 and 6 percent of the civilian labor force, that population and output per man-hour will grow, and that in the first quarter of this year the nation’s gross national product was at the annual rate of “only” $356 billion.

This pronouncement is so typical of current inflationist fallacies that it is worth a little analysis. The NPA firmly believes that what primarily caused the recent “recession” was a drop in defense spending, and therefore what can pull us out is 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.

Nor is there any reason 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 seems willing to settle for a deficit achieved through civilian public works or even a cut in taxes. It even recognizes at one point that private plant and equipment modernization might help to create employment. But it pays 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 is most characteristic of the whole NPA statement is that its proposed statist remedies for unemployment utterly ignore 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 sales. Yet in recent weeks, with the steel industry operating at only two thirds of capacity, the steel-workers’ unions fought for and got a new increase of wages which forced a further increase in steel prices of $3 a ton. This is not the way to assure full employment.

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