|the increment of inflation will go
on forever -- reducing the value of all their future income by that percentage.
We might also note that, as a result of three
years of 4% inflation, the real income (in 1966 dollars) of Taxpayer A
has been cut to $4,400, Taxpayer B to $8,800, and Taxpayer C to $22,000.
Obviously, no one can absolutely prove that the
5% surtax of 1966 would have prevented any increase in this country's
rate of inflation. But I don't think it takes any great sophistication
in economics to recognize that fiscal measures taken early, before the
onset of real trouble, need not be as severe as those required at the height
of an inflationary spiral. And their chances of success must obviously
be much greater.
EFFECTS OF INFLATION
The tragedy of inflation is that it hits hardest
those who are in the most meager circumstances -- old people who are retired
on fixed incomes, and unorganized, low-wage workers who lack the bargaining
strength to demand higher pay. Such people find the cost of rent and of
groceries going up while their incomes remain the same.
But even people in the work force whose incomes
ultimately adjust at a higher level will find inflation exacting a high
price. Take, for example, the cost of housing. Inflation has forced successive
increases in interest rates, with devastating results.
Suppose you set out in December, 1965 to finance
a $20,000 home. Let's say you paid 10% down and signed a 25-year, FHA-insured
mortgage for the remaining $18,000. You could have obtained such a mortgage
then at 5 1/2% interest. Your payments on principal and interest would
have been $110.54 a month, or a total of $33,162 over the life of the mortgage.
Now it's April, 1969, and the purchasing value
of the dollar has declined 12.8%. You're setting out to buy an identical
house. You find it doesn't cost $20,000 anymore; the price has gone up
to $22,560. And the interest rate has jumped from 5 1/2% to 8%. After a
down payment of $2,250 you end up making monthly payments of $156.68, or
a total of $47,004 over the life of the mortgage.
In just a little over three years the cost of
financing that house will have jumped over $550 a year or $13,842 over
the life of the mortgage.
There are other ways that inflation hurts. Recently
the Southern California Edison Co. announced it was withdrawing from the
combine of power agencies planning a plant at Page, Arizona, to produce
pumping power for the Central Arizona Project. The reason they gave: rising
interest rates. Bonds that used to sell for 3.9% interest are going now
for 7.25%; this cost of doing business hurts all businessmen, large and
Or look at the Federal budget. In one sense, the
income tax is self-adjusting; when money declines in value, more taxes
are collected. But this doesn't mean there are no problems. Between 1965
and 1970 the Federal debt will have grown by 14%, but because of rising
interest rates the cost of servicing that debt will have jumped
at least 40%. This has the effect of robbing programs that provide
some service to the people.
And if that's a problem, think about all the state
and local governments that depend on real estate taxes for an important
part of their income. When the value of the dollar declines, tax rates
or tax valuations have to go up. Adjustments of this kind aren't easy,
and they don't win friends or votes. This is why it's becoming increasingly
difficult to pass local bond issues for anything, as the people of Tucson,
Yuma and Green Valley learned recently.
WHO STARTS THE SPIRAL?
An age-old argument is: who starts the inflationary
spiral? Is it labor demanding higher wages, business demanding higher profits,
Some months ago the Wall Street Journal devoted
a column to this question and came down on the side of profits. Looking
at the record of inflation since World War II, the Journal quoted
Peter L. Bernstein, president of a New York investment counseling service:
"The pattern is clear enough. Instead of labor costs pushing prices up,
what we see instead is a sort of profit-push. Profits are already well
on their way up before prices begin to rise, and prices are well on their
way up before wages begin to rise faster than output."
In truth, inflation is something like the Hongkong
flu. It's hard to trace and hard to stop. Government, ignoring the state
of the economy, orders more planes and tanks and ships than the country
can produce without running up excessive demand for labor and raw materials.
Manufacturers, faced with the opportunity for higher profits, up their
prices. Labor, faced with rising prices, demands higher wages. Using another
metaphor, we might say that inflation is like a tailspin in an airplane;
the longer it goes on, the tighter the spin becomes. Wages drive up prices;
prices drive up wages. People speed up their buying to beat higher prices
later; their buying decisions help to assure that prices will go higher.
Meanwhile, the United States finds its products less and less competitive
in world trade, and our balance of payments problem, a perennial headache,
There are obviously many forces contributing to
inflation. That's why, once it's started, inflation is so hard to stop.
But I think it's important to realize that the decisions of government
play a unique role requiring the greatest of attention. In an economy approaching
$900 billion the Federal budget of $190 billion obviously plays a crucial
part. As a customer of this country's goods and services the Federal government,
clearly, can be very helpful, or very damaging, in the spending decisions
it makes. I think, in the last three years, it hasn't helped very much.
DID THE 'NEW ECONOMICS' FAIL?
In the summer of 1965 I wrote a series of newsletters
entitled, "The Silent Revolution in Economics." It was a review of the
lessons this country had learned through 30 years of depression, war, inflation,
recession and stagnation -- interspersed, of course, with occasional prosperity,
relative price stability and growth. Comparing money to water in a river
-- water which can be used and re-used as it flows downstream -- I tried
to show how the "new economics" works. The point was that the Federal government,
through its decisions to spend more or less than it takes in during a given
year, can stimulate or retard the economy as needed.
Did the "new economics" fail? Some people seem
to think so. But significantly, this is not the view of President Nixon
or his economic advisers. In fact, this is worth noting: the "new economics"
has survived the transition in administrations. Like Medicare and federal
bank deposit insurance, I think it's here to stay. Different approaches
will surely be taken; more or less emphasis will be placed on fiscal policy
(taxes and spending) as opposed to monetary policy (regulation of credit
and interest rates). But the critical role of government fiscal decisions
in influencing the economy -- for good or for ill -- is now an accepted
fact. No longer will monetary policy be expected to carry the load alone.
A corollary is also worth noting: balance or imbalance
of the budget must still be watched, but no one is talking any more about
balancing the budget
every year as a first priority. There is great
concern about the current situation, and we certainly must