Inflation and Deflation Lyle M

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5-1952 Inflation and Deflation Lyle M. Bender

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Recommended Citation Bender, Lyle M., "Inflation and Deflation" (1952). SDSU Extension Circulars. 560. http://openprairie.sdstate.edu/extension_circ/560

This Circular is brought to you for free and open access by the SDSU Extension at Open PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. It has been accepted for inclusion in SDSU Extension Circulars by an authorized administrator of Open PRAIRIE: Open Public Research Access Institutional Repository and Information Exchange. For more information, please contact [email protected]. 'XTENSION CIRCULAR 482 MAY 1952

el M F L A T I 0 ,4,J, . DEFLATION

STABILITY

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AGRICULTURAL EXTENSION SERVICE SOUTH DAKOTA STATE CO LL EGE, BROOKINGS U. S. D E P A R T M E N T O F A G R I C U LT U · R E •i I • What Is It? Inflation and deflation are words of many different mean- ings. They refer to the changes in general price levels. Inflation refers generally to a situation where most prices are rising. On the other hand, deflation refers to a situation in which most prices are falling. In between these two extremes is an "ideal" situation called "stability." In our form of economy fluctuations in general price levels are normal. Inflation may be more carefully defined as a situation where the number of dollars spent increases faster than the goods and services produced. In this case, prices will rise. The opposite situation, deflation, is·defined as a situation where the amount of goods and services produced increases faster than the number of dollars spent for them. In this case, prices will fall. The in-between situation, called stability may .be defined as a situation where the dollars spent equal the goods and services produced. This is a condition of more or less stable prices.

Agricultural Extension Service Published under Acts of Congress May 8 and June 30, 1914 by the Agricultural Extension Service of South Dakota State College, George I. Gilbertson, director, and the United States Department of Agriculture, cooperating. •• f) INFLATION and DEFLATION LYLE M. BENDER* Causes of Inflation and Deflation There are many causes of inflation and bor are fully employed. It increases incomes deflation. Six different causes are described. without creating immediate consumer Changes in Money or Credit Supply: On gqods to offset higher incomes. It is infla- the money and credit side of our economy tiona,ry in the short run and deflationary in changes in its supply in relation to demand the long run. for goods and services may bring about in- Inventory Building: An inflationary pres- flationary or deflationary conditions. On sure may come from the attempts of manu- the inflationary side whenever there is an facturers, wholesalers, retailers and con- expected shortage of goods there is usually sumers to increase inventories. This in- a scramble for them. This requires financ- crease means that manufacturers bid against ing, usually through an increase in the each other for raw materials; wholesalers money or credit supply. An increase in the against each other for manufactured goods; money or credit supply may come from retailers against each other for retail goods; many sources such as, government deficit and you and I against each other for that spending, increase in bank loans and an in- sugar, those tires, etc. crease in consumer credit. The other side of the picture, deflationary When bank credit is allowed to expand, pressures, come when we stay at home, eat either through borrowing by individuals, off the pantry shelves, and work hard to pay business or by government the money avail- off our short term debts or replenish our able to be spent is increased. It means more savings. dollars available in relation to the supply of Spending from Savings: People's atti- goods. tudes about savings may also be an impor- Supply of Goods and Services: One of the tant factor contributing to inflation or defla- greatest inflationary pressures in a defense tion. Early in the Korean war people fig- economy comes from the decline in the pro- ured that goods might be scarce and high in duction of consumer's goods, such as refrig- price in the future. Those with savings used erators, cars, clothing and the like. The them to buy goods. Such action increased amount of inflationary pressure varies with the money supply relative to available goods the amount of goods going into military in the market. Early in 1951 the opposite production. situation took place. Savings were in- A deflationary condition arises when creased, thus the effective money supply total consumer's goods production increases was smaller than the increasing supply of as a result of new plant expansion and or a goods for sale and this action is contribut- reduction in the amount of goods going to ing to deflation. the military. Cost-Price Spiral: The cost-price spiral is Investment Expansion: A strong destab- an important cause of inflation. It is most ilizing factor in our economy is capital in- important when the economy is near or at vestment such as new plants and equip- full employment or under the strain of war ment. It puts pressure on raw materials and or defense production. Under such condi- labor at time~ when existing plants and la- tions a shortage of goods causes prices to rise. Labor is fully employed or there may •Extension Farm Management Specialist be shortages. With this set up, organized , 4 South Dakota Extension Circular 482 labor can use their power to push wages up labor and plants are fully employed, indus- A and prices usually rise with them. Often, try may tend to push up prices faster than under these conditions, wage rates tend to costs and plant productivity. This new in- increase faster than labor productivity. come or purchasing power makes further Also, when goods are in short supply and price increases possible. · Effects of Inflation and Deflation Not all price rises are bad. Neither are all Effects on Debtors and Creditors: Infla- price declines bad. Gently rising prices en- tion tends to favor people who owe debts. courage increasing productivity. Gently Deflation, on the other hand, tends to favor lowering of prices tend to encourage more those who receive payments for debts. consumption of goods produced by industry · Farmers' and others who are in debt ga~n and agriculture. Probably what concerns us from inflation as the price rises making the most is the rapid rise in prices when our debt easier to pay. economy is operating at a full plant capacity Effect on Profit Receivers and Fixed In- and full employment level. Three effects are come Groups: In periods of inflation people described. on fixed incomes stand to lose a great deal. Effects on Output of Goods and Employ- This group includes all those on salaries, ment: The effects of inflation on production and people who receive money incomes in of goods are mixed depending on the the form of pensions, interest on bonds and amount of inflation and its rapidity. A mild saving deposits, annuities, and rents that are inflation increases employment and produc- fixed by long term contracts. These folks tion. Rapid inflation distorts employment suffer because any type of money payment and production. received such as life insurance benefits, loan repayments or bond redemption means Inflation may offset workers' productiv- much less in terms of goods and services it ity and willingness to work if consumption will buy. In periods of deflation these goods are very scarce and if inflation de- groups tend to gain relative to other groups. stroys the value of savings. During periods of inflation people who In deflation the growing unemployment receive profit such as businesses and farmers of labor and capital causes the total of the gain from rising prices. During the infla- community's well-being to be less. Almost tion prices rise faster than costs. However everyone loses in a bad deflation or de- when deflation takes place the gains by pression. these groups are narrowed and may be lost. M~thods of Controlling Inflation We can now deal with some of the major system to work "freely" at all times. T he proposals for controlling inflation. Since price system is the basic mechanism which deflation is the other side of inflation, the allocates resources and guides production proposals for controlling deflation would and consumption. usually be the oppo~ites that _are proposed By following this procedure we would for controlling inflation. eliminate all administrative costs and the The major suggested proposals for con- inconvenience of other schemes, and would trolling inflation can be classed into three insure the continued operation of a "free" groups as follows: market. It would tend to encourage people "Do Nothing" Policy on fixed income to shift quicker to defense This policy is one of allowing the price jobs to maintain their standard of living. Inflation and Deflation 5 On the other hand, if prices were permit- rate may slow down investment when ma- ted to move freely through the inflationary terials and labor are short. It would also cycle there would be many inequities creat- tend to encourage some people to save ed between different income groups. When more. we reach the condition of full plant use and 4. Margin Controls: The ability to con- employment, rapid inflation would take trol margins in stock and commodity mar- place as a result of wage-price battles. In kets can help control inflation by prevent- order to p.rovide adequate military produc- ing speculation in the markets on money tion it would mean greatly increased taxes borrowed from banks. and or a higher national debt. 5. Consumer Credit Controls: These con- Monetary and Fiscal Controls trols" generally apply to short term install- Monetary and fiscal control is an attempt ment credit for autos, etc. and longer term to control the causes of inflation. This policy housing credit. Such controls require cer- would still allow prjces to allocate resources tain down payments and specifies the length throughout the economy. It would allow payments can run. It is designed to limit the and encourage increased production, but amount of money people spend on scarce would attempt to drain off the increased goods. demand it creates. It attempts to get at the B. Fiscal Controls problem by indirect methods that interfere Fiscal controls or policy is in general an less with the freedom of individuals. The attempt by the government, through the essential features of this plan are: treasury, to slow down inflation by removing the excess demand through taxation. It A. Monetary Controls: can also operate on the expenditure side by 1. Change in Reserve Requirements of removing excess demand by cutting govern- Banks: In our banking system each bank's ment spending. loaning ability is limited by the amount of its reserves. A rise in the reserve require- 1. Balance the Federal Budget: Under a ments of member banks means that the war time or extended period of defense member banks can make less loans on a building we face the possibility of deficit given amount of reserves. It limits expan- financing. Such financing is inflationary if sion of credit beyond that needed for gen- financed by borrowing from banks. If bor- eral business at any particular level. rowing is done out of savings by individuals etc., it will not be as inflationary. we wish 2. Open Market Operations: The open If market operations of the Federal Reserve to avoid inflation a part of the over-all prob- System is another method of influencing lem is to bring the budget more neatly into the money supply. This is accomplished by balance. This may be done by reducing the expenditures or raising the receipts or by the buyi 1g and selling of government securities in the open markets of the country. adjusting both. Since these securities must be either bought Public improvements and other expendi- from someone or sold to someone, some- tures should be judged on the basis of ef- one's bank account must be increased or de- ficiency of operation and the general effect creased in the process. on the nation as a whole. 3. Interest Rates: Changes in the interest 2. Income Tax: A properly levied income rates may help in controlling inflation. In- tax is a strong weapon to fight inflation. To terest rates can be influenced through be made effective the tax must exclude the changes in the supply of money brought minimum living costs. It must be progres- about by open market operations, changes sive to a degree. in reserve requirements, and changes in dis- 3. Reduce the Volume of Government counts for member banks. A higher interest Loans and Guarantee of Loans: The object 6 South Dakota Extension Circular 482 of this program, in times of inflationary Monetary and Fiscal Policy pressures, is to hold down the demand for With Some Direct Controls materials and services thus reducing the This alternative for the control of infla- pressure on prices. tion would use all or a part of the monetary 4. Coroporation Excess Profit Tax: One -fiscal, and voluntary controls just dis- of the most popular taxes is an excess profits cussed along ·with a system of direct con- tax. The excess profit tax does little to pre- trols. By direct controls we mean those acts vent inflation because, corporations are of government that reach down and restrict usually savers in good times. individuals and business firms directly. 5. Consumer Sales Tax: A tax of this sort The monetary-fiscal and voluntary con- would do little to control inflation. It has an trols get at the real causes of inflation. advantage over excise tax because it would Direct controls are used to get at the rapid · not be figured in prices to aid the cost-price rise in prices when plants and labor are fully push. It would adversely affect people with employed as in a war or defense economy. low incomes. They can help check price inflation tem- porarily, slow down its rate of progress, but C. Voluntary Controls they cannot prevent inflation. People and business themselves can help A full system of direct controls may in- to reduce inflation. One of the ways is to clude control of rents, wages, basic material expand production quickly wherever possi- prices, retail prices, allocation or rationing ble. As a means of controlling·inflation in of basic materials and rationing of retail the very short-run, this method is not very goods. The range of control may be limited effective under full employment conditions. or all inclusive depending mainly on the Another way-buy only what is needed. degree of mobilization. Current spending power can be reduced by more saving and paying off of debts. Volun- Characteristics of Direct Controls tary credit' restriction on speculative loans Rent control, sets forth ceilings on differ- sponsored by the banks and other lending ent types of dwelling units. Since housing is groups is another way of reducing spending short, in periods of rapid development, such power. as in war or mobilization, such ceilings D. Appraisal serve to equalize the sacrifices necessitated There are many advantages claimed for by the defense program in that prices of the monetary fiscal control system. It is de- scarce commodities are held within the signed to get at the cause of inflation. This reaches of low income groups. For the long- proposal would not interfere too drastically er run, rent controls, may reduce home con- with the normal automatic operations of the struction and improvement. Should con- market. Such a plan is inexpensive from the struction and improvements be slowed standpoint of administrative costs. down due to long, continued controls, such action may create an excuse for further gov- On the other hand this plan may not ernment action, such as subsidies or public move fast enough and far enough to control housing projects. inflation in its early phases. There is a possibility that controls would be too hard. It is Wage Controls involve the setting of lim- not possible to prevent inflation due to cost- its on wage and salary increases based on price spiral or spending from savings. It some current historic base. Its purpose is an would be difficult to prevent sharp price attempt to slow the cost-price upward rises on industrial commodities. Some of movement in price at times when labor and the monetary controls do not touch all plant capacity are nearly or fully employed. banks. Some flexibility is needed in order to help I Inflation and Deflation 7 attract labor to more needed jobs by way of allocation or rationing must be used to pro- wage increases in high priority work. vide an orderly distribution of short supply. Price Controls and Rationing: One set of The degree of allocation or rationing that ~ontrols apply to industry namely-basic may be necessary depends on how strong materials price control (non-farm) and al- we use the monetary-fiscal and voluntary • location or rationing of basic materials. The controls. If these are fully adequate there other set of_controls are retail price controls and rationing of retail goods. will not likely be a serious amount of excess Because·the law 't>f supply and demand demand to bring on wide spread allocation ( operates whether prices are determined in or rationing. free markets or administered m arkets, basic The ·object 0£ a general price freeze is an materials price control and allocation along attempt t~ check speculation on the part of with retail price control and rationing must everybody. A general freeze is not expected go together. If prices are arbitrarily held to be absolute for all time nor on all com- below what they would be a free market, modities. Some flexibility is essential. Such then that means that there will not be a freeze order is an attempt to slow down or enough to go around at the lower price and suppress a rapid rise in prices.

An Appraisal Proponents of this alternative-a combi- other hand many would advocate price nation of monetary fiscal and direct controls controls if we were in an all out war and our --claim that direct controls achieve imme- war efforts were taking 40-50 percent of diate results while waiting for the slower our national production. Opinions differ indirect program to become effective. Price greatly on the in-between zone, where 15- tend to equalize the sacrifices, ceilings 20 percent of the national income goes to brought about by the defense program. In our defense effort. the defense program is the case of flexible agricultural prices, ceil- If ings may prevent wide variation in prices to become a lorig, drawn out one there is a between commodities and lessen wide and danger that controls may become perma- sometimes undesirable shifts in production. nent. To guard against this danger the pur- Under conditions of mobilization, full em- pose and extent of such controls must be ployment and a sellers market, it is difficult clearly stated, and must be definitely limit- without such controls to prevent strong ed as to duration. · groups from shifting their burdens of the Furthermore, the function of our price defense effort to others through wage in- system-to guide production and ration creases, price increases and higher profits. goods, would be largely ineffective through Finally, direct controls along with mone- the establishment of arbitrary price and tary-fiscal measures, makes it possible for wage ceilings. This is especially true for the defense establishment to procure neces- most agricultural products whose prices are sary goods at reasonable prices. generally flexible-that is price moves up Opposition to any system of direct con- and down readily with changes in supply trols has been vigorous. Much _of the dissen- and demand. Price controls on flexible price tion in regard price controls center around goods generally do more harm than good. the intensity of the war or defense effort. Direct controls do not attack the true source Few people would advocate price controls if of trouble, but direct attention toward the the defense program were taking only 5 to symptoms of price inflation. Any direct IO percent of the national income. On the control also requires large quantities of •• manpower, both within government and hamper production efforts by failing to industry to administer and keep the neces- allow the necessary price incentives or by sary records. distorting the price structure petween the Controls if absolutely rigid may also . raw material and its manufactured product. • Summary In a democracy such as ours the mass of people must be in- formed. It is essential that they understand the broad principles involved in problems of national affairs such as inflation and deflation. Citizens must not only know what they want and which of their wants are most important; they must also ha:ve the information and insight to know whether and to what extent a given program will lead to satisfaction of those wants. Decision as to which route we will follow in this extended period of defense preparation with its inflationary and deflationary tendencies, must be made by an enlightened public. What-. ever action is taken must reflect the will of the people. Such action depends upon a better understanding of the main issues involved.

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