Types of Inflation

There is first the obvious distinction between mild and severe inflations, .depending both upon the magnitude of the annual price rise and the length of time it continues. A price rise of 1 or 11;2 percent a year, even if continued for several years, need not be taken very seriously because of the inherent inaccuracy of price index num bers. For example, quality improvements of numerous commodities which evade consideration in measurement of the price level, may easily outweigh a rise in the index of 1 or 1~ percent. But let us not· forget that at other times, in war periods for example, when qualities deteriorate, the shoe is on the other foot and the price index understates the real rise in the price level.1 An average price rise of 2 or 3 percent a year, if continued several years, cannot be called negligible. It is not serious if it lasts only a few years and follows, or is followed by, a price decline of the same order of magnitude, or at least by a prolonged period of stable prices.

But, if there are no reversals of the price rise and only short spans of stable prices, even an annual price rise of 2 or 3 percent is bound to become a serious problem. This is overlooked by those who argue that inflation in recent years has not been severe by historical standards. It is true that the price rise during the last business cycle ~pswing, between Decem ber 1954 and August 1957, (8 percent for wholesale prices and 6 percent for consumer prices) was not excessive compared with what happened during pre-1914 business cycle upswings. According to 1 Also in peacetime when governments make use of direct price con trols (price ceilings) or in inflation periods when the use of direct con trols is under consideration, there are bound to be evasive actions in the form of lowering qualities (or even of quantities in packaged merchan dise) to conceal price rises. Price index makers are not always able fully to allow for these changes .

.. [ 11 ] Arthur Burns,2 the average rise of wholesale prices during the ascending phase of 18 business cycle upswings between 1850 and 1950 (not counting war years and immediate postwar periods) was 17 percent. But the special feature which made the recent price rise a serious matter is that there have been practically no reversals in the upward price trend and only short periods of stable prices. In other words, the .ju~gment as to whether there is chronic inflation must not be solely based on the local properties of the price curve during a single phase of the cycle, but on the perspective of a longer period. Human beings are, after all, endowed with memory. The crucial fact is that the price curve since the beginning of World War II presents the shape of a flight of stairs, whilst during comparable periods in the past it had the shape of a wave. A price rise of the order of magnitude of 2 or 3 percent a year is often called creeping inflation. If it lasts long, we call it chronic.

And chronic creeping inflation can be either continuous or inter mittent. It would be misleading, however, to say that this country has lived under chronic or secular inflation for. the last 100 years because the price peak of the second war was higher than that of the first, and the latter higher than that of the Civil War. We have had chronic in flation since the beginning of the Second W arid War because there has been no period of a substantial fall in prices since then. But, if the secular price curve is towered by two or three peaks produced by wars and separated by deep valleys with long flat bottoms, one should not speak of chronic inflation even if each succeeding valley is somewhat higher than the preceding one. Moreover, war inflation is likely to be regarded as an act of God and forgotten after. a while,while a much more moderate price rise in peacetime will soon create doubts about the future of the value of money.

There is, I believe,. general agreement that a price rise of 5 or 6 percent. a year in peacetime would, after a few years, become quite 2 See his remarkable lectures, Prosperity Without Inflation, New York, Fordham University Press, 1958, p. 13. [ 12 ] intolerable for an industrially highly developed country such as the 'United States. It is true that much faster inflations, of 20 percent a year and more, c,an be observed for prolonged periods in many under developed countries, especially in Latin America. But few would deny that such a condition is very bad for those countries and would be utterly disastrous for highly developed countries. From a creeping inflation we distinguish trqtting and galloping inflation. By that we mean, as the term suggests, an inflation that tends to accelerate because people expect a further rise in prices and lose confidence in the soundness of the currency. When that happens, more and more people will try to protect themselves by putting escalators (price index clauses) into wage, salary, and other con tracts. The money rates of interest, as distinguished from the Ureal rate of interest," (i.e., the money rates corrected for actual or antici pated price changes) will go up because creditors demand protection from the expected loss of purchasing power of money, and debtors think they can afford to pay higher rates in view of the expected rise in prices. While such anticipatory measures can remove some of the inequities--only a small part, in view of the great mass of outstand ing contracts-it stands to reason that they tend to speed up the inflationary spiral.

In later stages of galloping inflation, the stage of ((hyperinflation," the velocity of circulation of money goes up because people reduce cash balances to a minimum and eventually shorten contract periods. Thus, at the height of the German inflation after World War I in 1923, wages and salaries were paid out twice a day (instead of weekly or monthly) to protect them against complete depreciation by the rapidly rising price level.a 3 Because of the tremendous speed-up in the turnover of money, money incomes and prices rose much faster than the quantity of money. Hence, the gold value of the monetary circulation fell sharply. It is amusing that this fact induced some German economists to deny that the increase in the quantity of money \vas the basic cause of the inflation! The German case has been fully analyzed by Frank D. Graham, Exchange, Price and Production in Hyperinflation: Gern1any, 1920-23, Princeton, [ 13 ] The economics of hyperinflation, a chapter in economic pathology, is fairly well known and not very controversial. Hyperinflation is not likely to develop in the United States and I shall, therefore, not discuss it. But a trotting inflation is surely not an impossibility. It is difficult to say at what speed or after how many years a creeping inflation is likely to turn into a trot or a gallop. Much depends on past history. Countries that have gone through periods of rapid inflation, the memory of which is still vivid, such as most continental European countries, react quicker than the United States or the United Kingdom which have been spared the ordeal of hyperinfla tion and complete depreciation of the currency.

Another very important distinction is that between uopen " and urepressed" inflation. 4 The inflations after W orId War I were largely of the open or uncontrolled kind. Attempts then made to suppress the symptoms of inflation by price control, rationing, and exchange· con trol were amateurish and ineffectual. The situation has, however, changed profoundly since World War 1. The trend towards regi mentation and control of the economy by governments, greatly stimu lated and accelerated by the two world wars and the intervening Great Depression, has led to the development of more effective and, on the administrative level, more efficient direct controls than existed 20 or 30 years ago. It is true that the actual apparatus of price control, rationing, and allocation built up during the war has been dismantled to a large extent in all Western countries. But there can New Jersey, Princeton University Press, 1930; and by Constantino Bres ciani-Turroni, The Econolnicsof Inflation, London, 1931.

4 As Professor W. Roepke has pointed out, it is better to speak of "repression" than of "suppression" because what is suppressed are only some symptoms, not inflation itself. What is controlled is the price "index" rather than the price level itself, if allowance is made for black market prices and official or unofficial rationing. But it is true that con trolling the price index, if it makes it possible to restrain the rise in wages, may slow down inflation itself-at the price, of course, of all the waste, inefficiency, and misallocation of resources inherent in the system of direct controls. [ 14 ] be no doubt that it would be immediately reintroduced in case of war, and there is great danger that prolonged inflation would lead to the gradual imposition of direct controls even in peacetime. It is probably no exaggeration to say that the time of prolonged open inflation has passed, at least in the developed industrial countries.

Even in the less developed countries of Asia and Latin America where rapid inflation is rampant, large areas such as .the foreign exchange market and public utilities are being subjected to direct control in a futile and disastrous attempt to suppress some of the more glaring symptoms and consequences of the disease. Inflation and its consequences have thus become one of the most powerful wedges for the introduction of all sorts of measures which interfere with .the smooth working of the price mechanism and undermine the free enterprise system. Still other distinctions, especially the distinction between demand pull and wage (cost) push, turn on the proximate or more remote causes of inflation and are discussed in the next section on causes. [ 15 ] CAUSES OF INFLATION MANY DIFFERENT factors and policies have been held responsible for inflation. Some say aggregate demand rising faster than aggregate supply "pulls up" prices and wages ("demand-pull inflation"). The rise in demand in turn may be due to a government deficit ("govern ment inflation") or to an expansion of bank credit for private invest ment ("credit expansion") or rising demand from abroad ("im ported inflation") or an increase in gold production ("gold' infla tion" ). Others say prices are being "pushed up" by wage increases forced upon the economy by labor unions under threat of strike ("wage-push inflation") , or costs may be raised by business monopo lies ("administered price inflation"). To these positive factors can be added negative ones-for example, the failure of overall output to grow or of savings to stay on their "normal" level-factors for which, in turn, different causes may be found.