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Fancy figures trotted out to say, 'Hold the money'

By David R. Francis / January 26, 1981



Boston

%CHG-GNPDEF equals .04 plus 1.087**CHG-MW.m That's the type of equation that turns off most people. It's an econometric equation -- one combining mathematics and economics -- of a type that the academic economic literature is full of these days.

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In this case, however, it is just one equation of many in a study done for the House subcommittee on domestic monetary policy which may cause some commotion in Washington. What this expression means, the study says, is that "inflation is virtually nonexistent, only 0.04 percent per year, when M1B growth is zero, and rises by 1.087 percentage points for every percentage point of M1 B."

Or, to simplify further, if the Federal Reserve System creates too much money (M1B), it will result in a roughly proportionate increase in inflation.

That has long been the conclusion of so- called "monetarist" economists. But this study, released today, reinforces the evidence. Staff director Robert Weintraub hopes that thew new study will be more persuasive than a 1976 study which came to somewhat the same conclusion, because the new study employs a somewhat more sophisticated model of the economy -- one with a "structure" in the equations.Most monetarists have worked with "simple" single-equation models. But nowadays it tends to take rather fancy econometrics to convince economists of the validity of a study.

In a press release, Rep. Parren J. Mitchell (D) of Maryland, chairman of the subcommittee last year when the study was done, said that "the staff report provides clear and powerful evidence showing that most, not all but most, of the inflation which has afflicted our economy since the middle 1960s can be attributed to the money supply policies of the Federal Reserve." He added that "in the post-Korean war period, current-year inflation closely tracks M1B growth two years earlier, and that over three-year periods money growth has been fully dissipated in higher prices."

That conclusion is significant. It means that if the Fed stops "printing" so much money, the rate of inflation will come down. That's just what did happen during the early-1975 to late-1976 period.

"Few believed, in early 1975", the study notes, "that our economy could achieve vigorous recovery of production from the 1973- 75 slide, and realize a substantial decine in unemployment, if money growth was held below 6 percent per year. And not many persons believed that this could happen while at the same time the rate of inflation fell sharply."

Well, money growth was maintained at nearly the economy's long-run growth potential, estimated at 3.5 to 4 percent yearly. Yet the nation's real output of goods and services rose handsomely (6.5 percent between the second quarter of 1975 and the second quarter of 1976); unemployment fell from 8.9 percent at the peak in May 1975 to 7.7 percent in September 1976; and inflation as recorded by the broadest measure, the so- called gross national product deflator, fell from 11.6 percent in the fourt quarters ending with the first quarter of 1975 to 4.8 percent in the four quarters ending with the third quarter of 1976.

What this means for the present, Mr. Mitchell maintains, is that "we do not have to fight inflation with recession and unemployment or with balanced budgets. Indeed, these policies won't work."

He adds: "What is required is that money growth be reduced to 2 to 3 percent per year and kept there." But he held that this should be done gradually. The growth of the money supply should be dropped only 1 to 1.5 percent a year. "Trying to do it faster will generate intolerable recessionary pressures and thus boomerang by leading to a reacceleration of money growth."

Staff director weintraub emphasizes another conclusion of the study which is important for economic policy makers: An increase in the supply of money to the economy will give the output of goods and services a short-lived shove. Over the long haul, however -- about three years -- accelerated money growth tends to be fully dissipated in faster inflation. In other words, the temporary shove to gross national product (GNP) is fully offset by a later retreat in growth as inflation picks up.

That means it is pointless to try to stimulate the economy by monetary means. Creating surplus money eventually just results in more inflation -- not more output.

The study does show that OPEC's price increases have had a temporary effect on inflation rates. But it has done nowhere near the damage that the Carter administration used to claim.

The study finds that the massive increase in the price of imported oil in 1974 accounted for about 3 percent of the nearly 10 percent rise of the GNP deflator that year. It added about 0.9 percent last year.

OPEC's price hikes, however, did depress the economy. The study reckons it pushed GNP down 4 percent in 1973-74 and 1.3 percent last year.

Another conclusion of the study is, "Neither a balanced budget nor high unemployment is necessary to reduce inflation." That is contrary to widespread economic beliefs.

"What must be done," it says, "is to reduce money growth and keep it down. Reducing the deficit might make it easier to reduce money growth and keep it down, but the job is doable in the presence of high and even increasing deficits."

And another basically hopeful conclusion: ". . . low unemployment and low inflation are compatible long-run goals. However, because it will take time before inflation falls in response to reduced money growth, some rise in unemployment must be expected in the short run, but it will be temporary. In fact, unemployment will be substantially lower in time if we reduce money growth to fight inflation than it will be if we fail to fight inflation."

So the Fed's fight against inflation deserves persist ence.