ECONOMICS U$A
INFLATION
To show the viewer the gradual development of inflationary pressures in the post-war U.S. economy, and to show why these pressures posed problems for policymakers and also for Keynesian economics.
OBJECTIVES:
1.. By inflation, we mean a general rise in the overall price level as measured by a price index, say the consumer price index (CPI).
2. Inflation, especially unexpected inflation, imposes costs on the economy. These costs include:
a) distortions in the tax system
b) gains by debtors and losses by creditors
c) increased uncertainty
d) losses by people with fixed incomes.
3. In the post-war period, inflation has become a problem principally because the economy has been operating close to or at the vertical portions of the aggregate supply curve.This means that boosts to aggregate demand, through stimulative fiscal policy, have not only only raised growth, but have also raised prices.
4. Because the ideas of Keynes were conceived at a time when the world economy was in a depression, he was not overly concerned with the problems of inflation. Keynesian economics implicitly assumed a flat aggregate supply curve.
When an economy is not in a depression or recession, monetary influences in the economy both on GNP and prices become more important. This was subject was given little attention by most of Keynes’ followers.
KEY ECONOMIC CONCEPTS:
demand-pull inflation, supply shocks, aggregate supply, aggregate demand
monetary policy, cost of living adjustments, expected versus unexpected inflation.
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In recent years as the rate of inflation has continued to slide, there has been more talk about deflation. The last time the U.S. suffered through deflation was in the 1930s. In modern, times the only industrial economy to experience deflation has been Japan. Why is deflation a problem? How do people behave differently when they expect prices to fall rather than rise? Is fiscal or monetary policy more effective in fighting deflation? Are all types of deflation bad? What if prices were falling because of a technology boom? |
For a complete transcript of this video program download TVpdf#7
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LBJ and the Cause of Inflation The massive tax cuts proposed by Kennedy in 1962, and signed into law by Lyndon Baines Johnson after Kennedy’s death succeeded in stimulating demand, creating growth in the economy… Business was booming, jobs were plentiful...and unemployment was near an all-time low. But as the economy heated up, the prices began raising out of control. Many economists felt a tax increase would take money out of the hands of the consumers and business… Spending would drop… inflationary pressures would retreat. While his advisors urged Johnson to increase taxes, he didn’t think he could get the votes to support it. While Johnson avowed to create a Great Society and eliminate poverty in American, the biggest item in the federal budget was not war on poverty…it was the war in Vietnam. Because Vietnam was unpopular, he wanted a silent, invisible war and so, therefore, he did not want to raise taxes. He wanted to have the domestic programs and he wanted to be able to run the war as well. The stage was set for the surge of inflation. In the absence of a tax increase or any other effective restraint, consumers and businesses kept spending. At the same time the government kept spending, so businesses operated close to capacity and labor approached full-employment. To meet the demands of the marketplace, expensive new factories had to be built and competition for workers bid up wages. In short, the demand exceeded the economy’s ability to supply and everything began to cost more. Comment and Analysis by Richard Gill In the 1960’s we had a classic go-go economy. Consumer demand ran at a feverish pitch as did government spending. The "Great Society" programs of Lyndon Johnson had been launched, as was the Vietnam War. Suddenly demand was given a big shot in the arm and the aggregate demand curve shifted up. The total effect of the increasing demand went into higher prices. Americans were already producing at the economy’s capacity so supply did not increase. LBJ shoved America into the world of demand-pull inflation. ..which began a cycle of inflationary pressures. |
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Inflation's Winners and Losers As destructive as inflation can be, there are those who benefit from unexpected rising prices such as people in debt. For example, when interest rates on existing mortgages are lower than the rate of inflation, homeowners win. They pay back their loans on cheaper, inflated dollars...At the same time, their property values rise. However, businesses do not fare well overall during periods of inflation. At the initial stages of inflation, when it’s increasing, some businesses think they are better off because profits seem to rise. But all of a sudden costs begin to soar. Among those clearly worse off from inflation are senior citizens. For the most part, they live on fixed incomes…They have no extra money to cover even a small price increase. During the inflation in the 70’s, the "seniors" had the power to organize and to make their voices heard. They succeeded in getting legislation passed that would link the consumer price index to regular increases in Social Security. Others hit hard by inflation of the times were the working poor and the unemployed. Most of the little money they had went for the necessities of life and the prices of those basics…of food, fuel and housing and health…all were rising the fastest. However, even the "organized worker" was having problems keeping up. Many union works like teachers, fireman, policeman, and sanitation workers went on strike asking for higher play, fighting to hold on to a decent living. Workers won higher settlements, but that raised costs and boosted prices. In all sectors of the economy…in all parts of the country…inflation had become entrenched Comment and Analysis by Richard Gill One thing that happens when inflation gets going is that all groups feel that they are losers. When this uncertainty about the future becomes contagious…things can get bad for everybody. But whether justified or not, this fear of falling behind can unquestionably be a major factor causing inflation to increase. The sanitation workers feel they are falling behind. They strike and get a higher wage. But now other public employees see that they really are falling behind…They demand even higher increases. But now other workers…coal-miners, assembly-line workers, sales clerks…see that they are falling behind. Up goes wages, then prices, then wages, then prices |
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Nixon President Johnson had been able to shrug off the importance of inflation, but by early 1969 when the inflation rate climbed to over 5%, it could no longer be ignored. Both the business community and consumer groups demanded that something be done. The responsibility was left to the White House and its new occupant…Richard Milhaus Nixon. Nixon was hesitant to raise taxes. And increased taxes, after all, were likely not only to cut inflation but also to slow the economy. That was a sore point for Nixon’s past. He believed the economic "slowdown" in 1960 had cost him the Presidency…and his eye was now on the 1972 elections. Also Nixon was a laissez faire conservative. He feared that increased tax revenues would increase the size and the role of government Because increasing taxes or cutting the budget were unpalatable to Richard Nixon, he looked to the Federal Reserve to help combat inflation. In theory, the rate of inflation is a function of the money supply. By restricting the money supply, inflation should also contract. The Fed cooperated. The result…the economy slowed down. Unemployment mounted. But inflation was barely affected. It was so entrenched that people expected it to continue, and it did. Critical economists and politicians called for the government to directly freeze prices and wages. Nixon ordered a freeze on all prices and wages throughout the United States for a period of ninety days." And prices did zoom up again when controls were lifted. Comment and Analysis b y Richard Gill The basic reason that wage and price controls were adopted was that the traditional Keynesian remedy for inflation - cutting back aggregate demand - suddenly seemed inadequate to the new situation. In a general way, however, by the early 1970’s, prices had a tendency to rise well before full employment in the economy was reached. Inflationary pressures were being felt even when there was substantial unemployment in the economy.
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