THE AMERICAN ENTERPRISE INSTI­ EXECUTIVE TUTE FOR PUBLIC POLICY RESEARCH, COMMITTEE established in 1943, is a publicly sup­ Herman J. Schmidt ported, nonpartisan research and edu­ Chairman of the Board cational organization. Its purpose is William J. Baroody to assist policy makers, scholars, busi­ President nessmen, the press and the public by providing objective analysis of nation­ William G. McClintock Treasurer al and international issues. Views ex­ pressed in the institute's publications Richard J. Farrell are those of the authors and do not Dean Fite necessarily reflect the views of the staff, advisory panels, officers or trustees of AEI. SENIOR STAFF Thomas F. Johnson ADVISORY BOARD Director of Research Paul W. McCracken, Chairman, Ed­ Joseph G. Butts mund Ezra Day University Professor Director of Legislative of Business Administration, Univer­ Analysis sity of Michigan Anne Brunsdale R. H. Coase, Professor of Economics, Director of Publications University of Chicago Robert J. Pranger Director of Foreign and Milton Friedman, Paul S. Russell Dis­ Defense Policy Studies tinguished Service Professor of Eco­ nomics, University of Chicago Robert B. Helms Director of Health Policy Gottfried Haberler, Resident Scholar, Studies American Enterprise Institute for Earl H. Voss Public Policy Research Assistant to the President for Special Programs C. Lowell Harriss, Professor of Eco­ nomics, Columbia University Gary L. Jones Assistant to the President for Administration George Lenczowski, Professor of Po­ litical Science, University of Califor­ nia, Berkeley Robert A. Nisbet, Professor of Sociol­ ogy and History, University of Ari­ zona James A. Robinson, President, Mac­ alester College INDEXING AND INFlATION • Eileen Shanahan,• Moderator Milton Friedman Charis Walker Robert J. Gordon William Fellner An AEI Round Table held on 17 July 1974 at the American EnterpriseInstitute forPublic Policy Research Washington, D.C. THIS PAMPHLET CONTAINS THE PROCEEDINGS OF ONE OF A SERiES OF AEI ROUND TABLE DISCUSSIONS. THE ROUND TABLE OFFERS A MEDIUM FOR INFORMAL EXCHANGES OF IDEAS ON CURRENT POLICY PROBLEMS OF NATIONAL AND INTERNATIONAL IMPORT. AS PART OF AEI'S PROGRAM OF PROVIDING OPPORTUNITIES FOR THE PRESENTATION OF COMPETING VIEWS, IT SERVES TO ENHANCE THE PROSPECT THAT DECISIONS WITHIN OUR DEMOCRACY WILL BE BASED ON A MORE INFORMED PUBLIC OPINION. AEI ROUND TABLES ARE ALSO AVAILABLE ON AUDIO AND COLOR-VIDEO CASSETTES. © 1974 BY AMERICAN ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH, WASHINGTON, D.C. PERMISSION TO QUOTE FROM OR REPRODUCE MATERIALS IN THIS PUBLICATION IS GRANTED WHEN DUE ACKNOWLEDGMENT IS MADE. SECOND PRINTING, JUNE 1975 ISBN 0-8447-2049-6 LIBRARY OF CONGRESS CATALOG CARD NO. L.C. 74-19771 PRINTED IN UNITED STATES OF AMERICA ILEEN SHANAHAN, The New York Times: Good E evening. Tonight we're going to discuss a subject that is so new that there isn't even any complete agreement on its name. It's sometimes called indexing or indexation, sometimes called monetary correction, and many people may be familiar with it by an earlier name, escalation. We all remember, I think, when the first escalation clause, in modern times at least, was written into a labor contract right after World War II-the contract of the United Auto Workers. It was based on the idea that, if prices were going up, wages ought to go up in some direct relation. Now a proposal has been made-or rather revived, I am told-that indexing be made more general than that. We have here to talk about it four distinguished economists, one of whom is currently the most promi­ nent advocate of the adoption of escalation, or indexa­ tion, in a certain form. I think you will find there is dis­ agreement not only about the overall wisdom of the pro­ posed policy, but also over how widely it should be ap­ plied, what should be left in, what should be left out. Because the subject is so new, we're going to ask each of the panelists for a three-minute opening state­ ment to define what it is we're talking about, where we agree and disagree. Our first speaker is Professor Milton Friedman of the University of Chicago, who is perhaps at the moment the most noted advocate of indexation. 1 MILTON FRIEDMAN: Indexation may appear new in the United States because we have been so fortunate as to have relatively stable prices over the past century and a half, except during wartime. But it is a very old idea that goes back centuries and that has arisen intb promi­ nence whenever a country has gone through periods of rapid inflation or rapid deflation. Indexation is a plan whereby contracts which have a time duration are expressed in dollars adjusted for the rate of inflation, instead of being expressed simply in dollars. The escalator clauses in wage contracts are of this form. In these cases, a wage agreement is made for, say, three years with the proviso that if prices rise dur­ ing that period wages will be adjusted accordingly. In the same way, an adjustment for inflation can be made in contracts for mortgages on houses and for loans. Indexing is badly needed in the United States to ad­ just the income tax because, under current circumstances, rises in prices push people up into higher income brackets, so that their tax load is heavier than was intended by Congress. In fact, because of such automatic effects of price inflation, the United States government last year realized something over $25 billion in the form of tax revenues which were never legislated by Congress on anybody. I am strongly in favor of indexation for two rea­ sons: First, I would like to see legislated indexing of governmental contracts in order to make the government honest, in order to eliminate taxation without representa­ tion, in order to make it possible to sell government bonds without conductiing a bucket-shop operation. Second, I am in favor of voluntary indexing on the part of business enterprises and people engaging in contracts over a pe­ riod of time in order to ease the withdrawal pains from our present high level of inflation. Indexing per se will not, in my opinion, do anything to reduce inflation. But what it will do will be to make it easier to terminate our inflation. It will make it easier by reducing the incentive for government to inflate and by making the withdrawal pains from inflation less severe. 2 MS. SHANAHAN: Now, an opponent of the whole idea, Dr. Charls Walker, former deputy secretary of the Treas­ ury and now an economic consultant in Washington. CHARLS WALKER: Thank you very much, Miss Shana­ han. I disagree very much with my friend, Dr. Friedman. I do not think that he has the right answer for the big problem confronting us at this particular time. I'm very grateful to him for his article on indexing in the current [July] issue of Fortune magazine. It re­ minded me of that old statement, "Oh, that my enemy would write a book"-because his arguments for index­ ing gave me some thoughts as to how I might respond. Professor Friedman's first sentence in that article reads as follows: "The real obstacles to ending inflation are political, not economic." I strongly agree, and I think that many of the things he says in that article and has said in, the last few minutes and will say tonight make a great deal of economic sense. But since he has said that this is basically a political problem, it seems to me it has to be approached in po­ litical terms. I think that indexing is not only politically unnecessary but can be politically damaging through the economic process for a variety of reasons. The question that Professor Friedman raised about the government being honest or dishonest in its offering of fixed term securities to the public-I'm tempted to say, rubs me the wrong way-does raise questions in my mind. We have a representative government-a demo­ cratic system of government-and when we talk about whether the government is straightforward or not, we're really talking about whether the people of this country are exercising their role as citizens and voters in the proper ways. So my fundamental points tonight will be on the political side, although I will make a point or two on the economic side as the argument goes along. MS. SHANAHAN: Our next speaker is a supporter of the 3 idea of indexing, Dr. Robert Gordon of Northwestern University. ROBERT J. GORDON: I think it's wise to set the dis­ cussion in context by going back to the very beginning and asking why it is at the present time that most mem­ bers of the press and most everyday people, in reacting to their own life, find inflation so difficult to live with. One may wonder why inflation is considered to be so bad, because, if you think about it, what is the dif­ ference between one state of the world with constant wages and constant prices and another state of the world with all wages going up 5 percent a year and all prices going up 5 percent a year? Now, if we contrast this ideal situation with what's actually happened in the United States in the last two years, we get an idea what the argument is all about. The problem is, of course, that in the United States we have not been experiencing this ideal escalation of prices and wages moving together. Representatives of various groups in society could step up right now and tell us they have not gained under the inflation. Although the rise in prices has been ac­ celerating particularly due to the increase in food costs and oil prices, we have not had any acceleration in the average wage increase until very recently.