How to cure stagflation
The present "anti-inflation" austerity policy is one of cutting total spending in the economy by balancing the government budget and tightening the supply of money and credit. It will not work because it makes no sense.Skip to next paragraph
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It would make sense if the inflation were due to "too much money chasing too few goods," i.e., if the prices were being bid up by our trying to buy more than we are able to produce. But the reverse is true. With our unused productive capacity, and our eight million unemployed, we are able to produce much more than we are buying. It follows that we could increase total spending, employ another million or two of the unemployed, and produce more output. There would be no bidding up of prices because we would still be buying much less than we are able to produce.
What logic there is behind the austerity policy rests on the completely different theory that prices are rising because of rising costs, while wages are being raised by workers' attempts to keep up with the rising prices.Prices and wages are chasing each other in a vicious circle -- the famous wage- price spiral. The logical reason for the austerity program is that it increases the unemployment and that is expected, by reducing the wage demands, to slow and to perhaps even break the vicious spiral.
This will not work because the workers will not stop trying to keep up with prices unless the induced unemployment is much greater than our society is prepared to stand. We would have to make the workers hungry enough to start undercutting each other by offering to work for less money than the other workers. But our society has given up the use of starvation as an instrument for holding down wage increases.
To avoid admitting that the austerity policy could work only through hunger, the authorities keep on repeating the official slogan that the inflation must be due to too much money (meaning by that too much total spending); and they point to the indisputable fact that the quantity of money has been increasing -- as it always has in all inflations.
But they have this the wrong way around. It is the increase in wages and prices that causes the increase in total spending. Without an increase in total spending less and less could be bought at the increasing prices. The economy would be pushed into a deep depression. The government always has to give in to the pressure for more total spending to keep the economy going.
There are three elements in the vicious spiral. Wages have to keep up with prices, prices have to keep up with wage costs, and the government has to provide the increasing total spending to keep up with prices. This is the nature of our expectational inflation.
Austerity does nothing to stop this kind of inflation. It only reduces sales , production, and employment, starving and debilitating the economy just as doctors used to weaken their patients by "bleeding" them.
We can stop bleeding the economy and restore prosperity by increasing total spending. This puts the Federal Reserve in a jam. It is asked to stop the inflation as well as to maintain a satisfactory level of employment. To increase the employment, the Federal Reserve must increase total spending, but the official slogan is that to stop the inflation it must reduce total spending. It has two incompatible tasks and keeps jumping from one to the other.