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A-New-Look-At-Inflation.Pdf Job Name:2105159 Date:14-12-30 PDF Page:2105159pbc.p1.pdf Color: Magenta Yellow Black THE AMERICAN ENTERPRISE INSTITUTE FOR .PUBLIC POLICY RESEARCH, established in 1943, is a publicly supported, nonpartisan research and educational organization. Its purpose is to assist policy makers, scholars, businessmen, the press and the public by providing objective analysis of national and international issues. Views expressed in the institute's publications are those of the authors and do not necessarily reflect the views of the staff, officers or trustees of AEI. Institute publications take three major forms: 1. Legislative and Special Analyses-balanced analyses of current legislative pro­ posals and special policy issues prepared with the help of specialists from the academic world and the fields of law and government. 2. Studies-in-depth studies and monographs about government programs and major national and international problems, written by independent scholars. 3. Rational Debates and Symposia-proceedings of debates, seminars, and confer­ ences where eminent authorities with contrasting views discuss controversial issues. ADVISORY BOARD Paul W. McCracken, Chairman, Edmund Ezra Day University Professor of Business Administration, University of Michigan R. H. Coase, Professor of Economics, University of Chicago Milton Friedman, Paul S. Russell Distinguished Service Professor of Economics .. University of Chicago Gottfried Haberler, Resident Scholar, American Enterprise Institute for Public Policy Research c. Lowell Harriss, Professor of Economics, Columbia University Paul G. Kauper, Henry M. Butzel Professor of Laro, University of Michigan George Lenczowski, Professor of Political Science, University of California, Berkeley Robert A. Nisbet, Professor of Sociology and History, University of Arizona lanles A. Robinson, President, Macalester College Joseph T. Sneed,* Dean, School of Law, Duke University EXECUTIVE COMMITTEE Herman J. Schmidt, Chairman of the Board Richard J. Farrell William J. Baroody, President Dean Fite William G. McClintock, Treasurer SENIOR STAFF Thomas F. Johnson, Director of Research Earl H. Voss, Assistant to the Presi­ Joseph G. Butts, Director of Legislative dent for Special Programs Analysis Gary Jones, Assistant to the President Anne Brunsdale, Director of Publications for Administration Robert J. Pranger, Director of Foreign and Gordon S. Hodgson, Assistant to the Defense Policy Studies President for Development Dave M. O'Neill, Director of Human Resources Studies * On leave for government service A NEW LOOK AT INFLATION A NEW LOOK AT INFLATION Economic Policy in the Early 1970s Phillip Cagan • Marten Estey • William Fellner Gottfried Haberler • Charles E. McLure, Jr. American Enterprise Institute for Public Policy Research Washington, D. C. Distributed to the Trade by National Book Network, 15200 NBN Way, Blue Ridge Summit, PA 17214. To order call toll free 1-800-462-6420 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 20036 or call 1-800-862-5801. This volume is presented within the framework of the American Enterprise Institute's research project on economic policy and infla­ tion, William J. Fellner, project director. Participants in that project who contributed the studies in this volume are: PHILLIP CAGAN, professor of economics at Columbia University and adjunct scholar of the American Enterprise Institute. CHARLES E. McLURE, JR., Allyn and Gladys Cline professor of economics and finance at Rice University and adjunct scholar of the American Enterprise Institute. GOTTFRIED HABERLER, Galen L. Stone professor of economics (emeritus), Harvard University, and resident scholar of the American Enterprise Institute. MARTEN ESTEY, professor of management and industrial relations} The Wharton School, University of Pennsylvania, and adjunct scholar of the American Enterprise Institute. WILLIAM J. FELLNER, Sterling professor of economics (emeritus), Yale University, and resident scholar of the American Enterprise Institute. Domestic Affairs Study 17~ September 1973 ISBN 0-8447-3113-7 Library of Congress Catalog Card Number L.C. 73-87768 © 1973 by American Enterprise Institute for Public Policy Research, 1150 Seven­ teenth Street, N.W., Washington, D. C. Permission to quote from or to reproduce materials in this publication is granted when due acknowledgment is made. Printed in Unitea States of America CONTENTS PREFACE William Fellner 1 CONTROLS AND MONETARY POLICY, 1969-1973 Phillip Cagan 1 Introduction 1 Progress in Curbing the Inflation before Controls 3 The Economy under Controls 13 Summary and Evaluation 30 2 ~]lADUALISM AND THE NEW ECONOMIC POLICY: iSCAL ECONOMICS IN TRANSITION Charles E. McLure,]r. 35 Introduction and Conclusions 35 Kennedy-Johnson Economics 40 The Game Plan of Gradualism 46 Nixon"s New Economic Policy 52 Nixon's Fiscal Policy Appraised 65 3 INTERNATIONAL ASPECTS OF U.S. INFLATION Gottfried Haberler 79 Introduction 79 Historical Perspectives 80 Recent Developments: August 15, 1971 to June 1973 84 The Nature of the Recent Crisis 88 The Weakness of the Dollar and the American Inflation 90 Some Implications for the Future of the International Monetary System 96 Postscript: Developments since Completion of This Paper 99 4 WAGE STABILIZATION POLICY AND THE NIXON ADMINISTRATION Marten Estey 107 Introduction 107 Phase I: The Wage-Price Freeze 110 Phase II 111 Phase III 125 The 1973 Price Freeze and Phase IV 126 What Happened to Wages during Controls? 127 Conclusion 132 5 EMPLOYMENT GOALS AND MONETARY-FISCAL OVEREXPANSION William Fellner 135 Note on the Price Freeze Announced after Completion of the Study 135 Overview 136 Manpower Problems: 1956-57,1965,1972 143 Inflation: Its Acceleration, Deceleration and Revived Acceleration 149 The Danger of Trusting the Hypothesis of "Inflationary Equilibrium" in Very Tight Labor Markets 156 Money Supply Targets 159 Differential Hardship Cases in a 5 Percent versus a 4 Percent Unemployment Economy 165 Conclusion 168 Appendix: The Controversy about "Neo-Keynesianism" and "Monetarism" 169 PREFACE This volume is a sequel to Economic Policy and Inflation in the Sixties, a collection of studies begun in ·1970 and published by the American Enterprise Institute in April 1972. In addition to concerning itself with the antecedents of the problems faced in 1970-71, the first volume attempted to evaluate the policies that were adopted during the period in which our studies were being written. The present volume continues our survey and evaluation through the spring of 1973, again taking account of the antecedents that are relevant to the analysis of the more recent period. Somewhere between the time when our first volume was pub­ lished and the present, chances appeared to be good that the rate of inflation would be reduced to a very moderate level at adequate rates of resource utilization. In my appraisal, explained in the last of the five studies in this volume, this had to do with the fact that until some time in 1972 it could be hoped that expansionary policies resulting with a lag in significant overshooting would be avoided. However, perhaps mainly under the influence of strong criticism voiced by their opponents, policy makers grew impatient and adopted a course that became, after a while, one of substantial overexpansion. By the early part of 1973 inflation flared anew, and only partly because of adverse factors-hopefully temporary ones-affect­ ing the supply side of raw-material markets. In good part we are now confronted with the consequences of overambitious expan­ sionary policies against which a fair number of economists, including members of our group, have been warning policy makers for several years. The dangerous tendency to overexpand demand and then to try to suppress the symptoms by methods of direct control-methods that weaken the incentive to adjust supplies to demand-seems exceedingly difficult to fight. WILLIAM FELLNER To me this belongs among the most disturbing experiences of recent times. However,' on no matter should I speak here for the group as a whole, not even on matters regarding which I would expect similarity of views. On some of the problems discussed in the present volume the reader will be offered a fair degree of diversity of opinion, and I hope he will find this as refreshing as we did in our meetings. I am happy to be able to note that this time Professor Gottfried Haberler has participated in our joint effort with a paper on the international aspects of the inflation problem. Professor Thomas Gale Moore, who wrote a study for our earlier volume, has been engaged in other research, partly also undertaken for the American Enterprise Institute, and he is not among the contributors to the present volume. Professors Cagan, Estey, McLure and I have con­ tributed to both volumes. William Fellner Project director 1 CONTROLS AND MONETARY POLICY, 1969-1973 Phillip Cagan Price controls were originally imposed in mid-1971. The rationale was to contain the inflation while stronger monetary and fiscal policies were to speed the recovery and restore full employment. The experience of 1971-72 convinced the general public of the effectiveness of con­ trols, and the nation returned to them, after the brief respite of Phase Ill, 1vhen prices exploded in 1973. Con­ trols are likely to remain a serious option of policy in the future. The interpretation of recent events presented here is that the public's faith in controls is misdirected. They appeared to work earlier only because markets were slack; and they failed to stop the price explosion in early 1973, not because Phase III controls were too weak, but because the monetary authorities, lulled by confidence in the effec­ tiveness of controls, followed an overexpansive monetary policy that pushed the econon1Y to capacity levels of opera­ tion at top speed. The new round of straitjacket controls will not work against the resulting outbreak of demand­ pull inflation, which can only be subdued by monetary restraint. Introduction During the first half of 1973 prices erupted in one of the strongest bursts of peacetime inflation in U.S. history. The skyrocketing prices of foods brought housewives out in angry protest.
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