Boston — What causes inflation? * President Carter puts much of the blame on big oil companies. * Other politicians accuse OPEC, the Orgranization of Petroleum Exporting Countries, of being the chief culprit.
* Defense critics charge that all the billions spent for military salaries and weapons have made prices rise.
* Businessmen often claim that excessive wage increases are pushing up their costs and thus prices.
* Trade union leaders sometimes point the finger at business as "price gougers."
* Conservatives usually allege that government deficit spending prompts inflation.
Over the years, few issues have been more controversial, so widely misunderstood, or so muddled by midguided rhetoric as the inflation issue.
Economists also often disagree on the causes of inflation. But there is a sort of negative consensus among them that goes like this: Rapid inflation will not occur wihtout the creation of sufficient money by a nation's central bank to permit general price increases.
So-called "monetarist" economists put the prime blame for inflation on a too-easy monetary policy. If the Federal Reserve System, the nation's central bank, pumps up the money supply too much (the basic money supply is currency in circulation plus bank deposits used for transactions), that money will tend not only to buy more goods and services but to push up prices as well. too muhc money is chasing too few goods and services.
Practically all economists agree that the amount of new money injected into the economy acts as kind of roof to the growth in the output of goods and services in current dollars -- called nominal gross national product. What is less certain to them is how much of that growth will occur as a real increase in the volume of goods and services and how much will be merely higher prices -- inflation.
Whatever, most economists reckon that the recent years of high inflation got their stat when President Lyndon Johnson tried to have both guns and butter, enlarging the Vietnam war and the war on poverty without hiking taxes to pay for them. The result was a larger budget deficit, which was financed to come extent by the Fed's creation of new money. This soon produced more inflation, reaching 12.2 percent in 1974. That basic problem was compounded by the devaluation of the US dollar in 1971 and 1973.
Then to fight inflation, the Fed tightened money, bringing on the "Great recession" of 1973-75, the worst economic slowdown since 1930s. Inflation dropped to a 4.8 percent rate by 1976.
Believing that the high level of unemployment and surplus industrial capacity would restrain prices, the Carter administration and the Fed stimulated the economy in order to reduce unemployment by stepping up federal expenditures and once more boosting the rate of money creation. It half worked. Gross national product rose at a rapid rate in 1976 and 1977 -- 5.7 and 5.5 percent. Employment levels rose to record proportions of the populace.
However, as monetarist economists (those believing strongly in the importance of money supply growth rates to the business cycle and inflation) forewarned, prices once more began to rise faster.
By this past winter, inflation had reached a level that was causing alarm. For instance, Felix Rohatyn, a partner in the investment banking firm of Lazard Freres & Co., predicted "national bankruptcy" if inflation were not halted. The bond market collapsed as interest rates rose to record highs to offset inflation and restrain demand.
With money tight once more, the economy slipped into a recession earlier this year. Interest rates plunged rapidly. Inflation once more began to mod erate.
Other nonmonetarist economists tend to put much blame on other factors for the current inflation:
* "External shocks," such as crop failures that boost world grain prices or OPEC-prompted petroleum price hikes, can accelerate inflation.
(According to monetarist theory, if the money supply is unchanged, the extra money spent on food or oil is not available to spend on othe rproducts, restraining prices in these products. But in the process of this adjustment, there might be more slowdown and unemployment. So the US government and some others accommodated the quadrupling of oil prices in 1973-74 by printing more money.)
* Money can turn over faster.
This so-called "velocity" of money has normally increased around 3 percent per year as the financial system has become more efficient with the use of credit cards and other modern innovations. But there are variations around that average which can permit more inflation as money runs after goods and services faster.
* Insttutional changes may permit more inflation.
The classical measure of money -- commrcial bank deposits and currency in circulation -- no longer covers all the quick means of making trans actions. Today there are interest-bearing checking accounts, money market mutual funds, telephone transfers from savings to demand deposits, and other ways to pay bills.
* Productivity growth has slowed in recent years and actually declined last year. So the normal growth in output-per-worker does not offset higher wages. The costs of production -- and eventually prices -- rise faster.
* Higher prices become built into the system. Wages and pensions are more often indexed to the consumer price index. Contracts often include an escalation clause based on some price measure.
It is not easy to deal with these inflation factors. The government can only urge the OPEC countries not to boost prices so frequently. It can hope the weather does not cause crop failures. Federal Reserve officials can take new forms of money into calculation in deciding on monetary policy. The administration can try to boost productivity by encouraging the savings and capital formation needed to buy more modern and efficient plant and equipment. It can hope that somewhat slower prices will discourage people from socking away their money in nonproductive gold, diamonds, antiques, and other collectibles. In a limited way, the government could try to limit "indexation," say in social-security pensions, since the consumer price index tends to exaggerate price rises for th emajority of senior citizens by including mortgage interest rates in the calculation.
There is no easy cure for inflation.
Basically, what the Carter administration and the Federal Reserve System have done is impose the standard cure for inflation on the US economy: a recession.
This remedy is uncomfortable. It prompts higher unemployment, profit declines, and even business bankruptcies. But most economists see no better way to slow down the rise in prices.
Pollsters indicate that a majority of the public believes wage and price controls are effective anti-inflation weapons. Most economists disagree. A freeze or controls may hold prices down temporarily, they admit. But once loosened or removed, prices bounce back up to where they would have been without the controls, or perhaps even worse. That's because the controls, while in effect, make the economy less efficient by distorting the price sys tem and thus production levels in various industries or firms.
A business slowdown certainly does not quickly kill inflation. It often takes 18 months or so to have any impact. In fact, economists caution that it may take years of slower growth to reduce inflation to, say, the 3 percent level. But at least it does work. Businessman find it harder to raise prices because of slack demand. Employees, especially the majority that are not unionized, have less leverage for insisting on pay increases. Even union workers tend to dampen their demands.
Indeed, Geoffrey H. Moore, an economist with the National Bureau of Economic Research, examined the postwar years and found that declines in inflation were associated only with business slowdowns.
What usually prompts a recession is tight money. The Fed, the nation's central bank, provides commercial banks with fewer new reserves through the purchase of government securities on the open market. Thus, the banks have less money to lend. There is less money available to consumers and businessmen to bid for the supply of available goods and services. Price pressures subside.
This is the reverse of the procedure which accelerates prices.