'Monetary gradualism' gains credibility in 3 nations
New Orleans — Three English-speaking nations have embarked on a crucial economic experiment -- one whose success is vital to the economic health of the Western world. This experiment could be called "monetary gradualism," and it is being tried in Canada, Britain, and the United States. It is an attempt to reduce inflation to more tolerable levels by slowly reducing the supply of new money to the economy.
Canada (which is one third French- speaking) is perhaps farthest along in this experiment. For the past five years the Bank of Canada has trimmed its rate of creation of new money by an average of about 1 percent per year. So far , the process has been relatively successful.
Canada's inflation has dropped from well into the double-digit levels to around 9 percent. This has been done without a dramatic recession, though the decline in the United States economy should now push Canada into an economic slump.
Unemployment has been running somewhat over 7 percent. In Canadian terms, that is not extreme. It is close to what economists sometimes call the "natural rate" -- that prompted by job changes, people deciding to take unemployment insurance for a while rather than working, and so on.
In Great Britain, gradualism was launched under the previous Labor government of former Prime Minister James Callaghan. This process has been continued and intensified by the government of Margaret Thatcher. It also involves "fiscal gradualism" -- reducing the growth of public expenditures and trimming the deficit.
Federal Reserve Board chairman Paul A. Volcker has also promised to gradually slow monetary growth in the US. As well, President Carter and many in Congress have been making similar promises on the fiscal side to balance the budget and slow the growth of government.
An alternative technique for tackling inflation would be a "shock treatment." Central banks would drastically slash the growth of the money supply -- which in the US is defined as currency in circulation plus demand deposits. This would soon plunge a nation into sharp recession or depression. No one knows how deep the economy would fall. Such a shock would cure inflation, but at the expense of high levels of unemployment and bankruptcies. Much of the nation's industrial and service capacity would go unused until the system adjusted to the new lower level of money creation.
But, as one high Fed official noted here at the International Monetary Conference administered by the American Bankers Association, a shock treatment could be counterproductive. It could create a political reaction so great that the Fed -- or other central banks -- would be forced to swing to the opposite extreme of creating money at a rapid pace. The result would be an inflationary expansion that likely would leave the economy in worse shape than before. Inflation could well move higher than in the previous boom. Unemployment might stay relatively high, despite the expansion.
Unfortunately, gradualism has its disadvantages too.
Notes Herbert Stein, a former chairman of the Council of Economic Advisers under President Nixon: "Gradualism does not have a good name, either in the United States or in Britain. It is considered to have failed repeatedly. It is taken to be synonymous with weakness and vacillation."
But Mr. Stein sees Mrs. Thatcher's policy as gradualism with a difference. "It is committed gradualism; that is, gradualism from which retreat is difficult. The commitment is expressed in the form of specific quantitative plans for the next four years for expenditures, for government borrowing, and for the money supply."
These targets make departure from the plans more difficult for the government by making the departure a clearly visible sign of surrender, states Mr. Stein.
"A great defect of gradualist anti-inflation policy is that governments have been prepared to abandon it when the first hint of trouble appeared, usually in the form of unemployment," he adds. "Indeed, 'everybody' knew that was the case and, therefore, was exceedingly skeptical about the persistence of that policy. . . . Businesses and unions would not count on the success of the policy and would continue to seek large price and wage increases."
That is the problem Canadian officials face now. They are asking if wage increases will moderate enough to permit a further lowering of the rate of money supply growth without causing politically unacceptable unemployment. Nonetheless, Canada remains committed to monetary gradualism.
In Britain, the US, and to a lesser extent Canada, the inflation rate has been exaggerated by the sharp rise in petroleum prices. The large boost in value-added taxes further boosted the price level in Britain. By now, these factors are being left behind. Inflation should moderate.
But, Mr. Stein notes, the test will be whether a firmer monetary policy will now bring down inflation without too much unemployment.
"No one can tell whether the policy will work in this sense," he says. "There are cases -- [West] Germany, Japan, Switzerland -- where a successful disinflation has been accomplished. But analysts are divided about whether structural conditions in those countries are so different from those in Britain -- or in the United States -- that their example provides little hope for us."
In the US, there is much more doubt in the business and labor communities of the commitment of government to anti-inflationary gradualism.
"Our commitment is still to flexibility," said Mr. Stein, "and our policy is to dash for home plate while keeping one foot on third base."