Journal Issue
Finance & Development, March 1977

Toward a consensus on inflation?: There may be wider agreement on the causes and the remedies than is apparent

International Monetary Fund. External Relations Dept.
Published Date:
March 1977
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John H. Young

There is a wider area of agreement on the causes and consequences of inflation than appears on the surface, and differences in the measures suggested to deal with this problem do not generally reflect a basic disagreement on the remedies required.

Given the sharpness of the controversy among professional economists, as well as among interest groups and political parties, this view calls for some explanation. If this position is to be convincing, moreover, evidence is required to show that people in many countries are not as far from a rough consensus as the heat generated by current discussions would suggest.

First of all, when reference is made to a wide area of agreement among economists, it is in terms of the kind of economic analysis used in reaching decisions on public policy. As is evident from what is published, a good deal of exploratory work goes on in academic economics that is not directly related to current problems. While there has been more criticism than usual of the irrelevance of academic economics in recent years, it has always been the case that those not directly involved in public affairs have been able to spend more time examining the logical foundations of the subject, pursuing refinements in theory, or engaging in the search for empirical regularities that are not a matter of immediate concern.

This article was originally an address to a conference sponsored by the University of Toronto in November 1976.

In the academic environment, moreover, it is possible to regard many questions as unsettled, while in the arena of public policy one often has to come down on one side or the other or play no part in the decision making. Thus, the economics generally used in discussions of public policy tends to be both more elementary and more dogmatic than that to be found in the learned journals. It is at this level that I think views are tending to coalesce, or, to put it less emphatically, old distinctions do not seem quite as important now as they did some years ago.

Origins of inflation

For example, over the years much has been made, particularly in Europe and the United Kingdom, of institutional factors as the basic cause of inflation, as opposed to demand pressure. To a lesser extent some North American economists have laid stress on similar factors. Some years ago, I can remember attending a conference which included Professor Milton Friedman on a panel dealing with inflation. The speaker before him referred to the multifaceted nature of the origins of inflation. Over the course of what seemed to be an hour, we were reminded of the student revolution, the decline of religion, women’s liberation, environmental concerns, North-South tensions, the rising tide of expectations, the militancy of interest groups, and so on. When Friedman gave his usual thirty-second statement of the invariable relationship between significant rises in prices and the growth of the money supply, there was an almost audible sigh of relief from the audience. Perhaps, after all, the problem had a solution which did not require a root and branch change in every aspect of society.

That kind of sharp distinction is often very welcome as a means of enlivening a conference, but those who are responsible for implementing the kind of policies advocated by Friedman often encounter great difficulty in finding a solid public constituency that will give them reliable support. Some months ago, Mr. W. Simon, the U. S. Secretary of the Treasury, was quoted as saying that preaching moderation in the pace of economic recovery was about as popular as advocating the virtues of leprosy; the frequency of similar complaints by those responsible for financial policy in many countries indicates that this is a general problem. No doubt the attractions of financial prudence have always been difficult to appreciate, but it is not beyond the bounds of possibility that -some of the characteristics of modern society have weakened the influence of what are called, with some significance, nineteenth century virtues.

Some would argue, of course, that the inflationary monster has grown on what it has been fed, and that the past actions of the authorities themselves have weakened the position of those urging caution in wage and price decisions. That, of course, simply raises again the question of why this happened in the past. Unless we can ascribe all, and not simply most, of our current difficulties to mistakes in economic analysis or to errors in applying that analysis, we are back to looking at the role that might have been played by broad social and political forces. There is a sense, therefore, in which some of the disagreements on the causes of inflation are more a matter of emphasis than of principle.

Everyone agrees that you cannot continue to have inflation unless the level of money expenditure is allowed to rise fast enough to accommodate it. Everyone also agrees that if the financial accommodation has been provided for a number of years, people and institutions begin to act very much in the way predicted by those who have an institutional explanation of inflation. This is not to say that differences in emphasis on the causes of inflation are without effect on suggestions for policies to deal with it, but as we shall see later even here it is not hard to find a good deal of common ground.


While discussions of the causes of inflation have covered a good deal of pages and led to some sharp interchanges, an equally important issue is the consequences of inflation. When one lives in a society in which there is widespread belief that the value of money will be preserved, it is easy to see some net advantages from inflation. If one errs a bit on the high side in pressing demand on the system, the result will be higher employment and higher output. It is difficult to think of this as an attempt to produce beyond the potential output of the economy, since in fact such a level of output is attainable. It may be clear, of course, that the tightness existing in some markets leads to a rise in wages and prices but, after all, what are the costs of a bit of unanticipated inflation?

It is true that until the system has adjusted to a continuing rate of inflation, some transfers will occur between debtors and creditors, and more generally between those whose incomes are responsive to changes in nominal wages and prices, and those whose incomes are not. These are, however, only transfers, and even those who are acutely concerned about the inequities resulting from unanticipated inflation are in a weak position to argue that the real costs of such transfers are likely to exceed the real benefits arising from higher output. When inflation is correctly anticipated, even the transfers are eliminated, and one is left with the real costs arising from economizing on the use of noninterest-bearing money. With moderate rates of anticipated inflation, this is a very minor cost and it is easy enough to conceive of relatively small institutional changes that will eliminate it.

Clarification of the costs and benefits of inflation has been going forward over the years, but the argument between those who are prepared to take risks on the side of overexpansion, as opposed to those who favor a more cautious approach, is a long-standing one. Indeed, from the point of view of economic policy, some of the most important pages in J.M. Keynes’ General Theory are those in which he brands D.H. Robertson’s position that nations should not set their employment objectives too high as “dangerously and unnecessarily defeatist,” and argues that “the right remedy for the trade cycle is not to be found in abolishing booms and thus keeping us permanently in a semi-slump, but in abolishing slumps and thus keeping us permanently in a quasi-boom.”

The same argument continued through the 1940s and 1950s. Much has been made recently of the oral tradition in particular universities, where greater wisdom was shown in what was said and taught than can be demonstrated by what was written. In discussions at Yale in the 1950s, Professors William Fellner and Henry Wallich in effect argued that the short-run Phillips curve would prove to be unstable before that curve had ever been invented. If they had had more success in persuading the next generation of economists, we would have avoided some of the difficulties of the intervening period.

Why did Fellner and Wallich see more clearly than others? Partly, no doubt, because they were sympathetic to neoclassical reasoning that, in effect, pointed out that you cannot deceive people for very long. Their second advantage was that they had both come from parts of Europe which had experienced very serious inflations, and they were aware of how people would respond to price changes if their belief in the future value of money was undermined. It was the absence of this kind of experience among their audience that was the principal obstacle.

Twenty years later the world has come almost full circle. What was then a view held by a handful of relatively conservative neoclassical economists with an appreciation of the consequences of hyperinflation has captured an important place in mainstream economics. There are still differences of view on how to balance the risks of unemployment and inflation over the short run, but views similar to those expressed in the U.K. Prime Minister Callaghan’s recent address to the Labor Party Conference in Blackpool are being heard more frequently in many countries:

  • “We used to think that you could just spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists and that insofar as it ever did exist, it worked by injecting inflation into the economy. And each time that happened the average level of unemployment has risen. Higher inflation, followed by higher unemployment. That is the history of the last 20 years.”

Not only has there been a rapid growth of skepticism about whether there is any continuing benefit from inflation, but the world’s experience with double-digit price increases has led to greater attention being paid to the difficulties arising from unanticipated inflation on the orderly planning and execution of the decisions of businesses, households, and governments. While much has been written in a general way about this problem, it is now attracting greater attention, and we can expect to hear more about the domestic and international costs of rates of inflation which vary over time and differ from country to country.

In summary, over the years there has been growing agreement that any benefits of inflation are short-lived. Similarly, there has been growing recognition that the costs of allowing inflation to occur are significant, and that attempts to stop it are fraught with difficulty. In brief, for those who can take a view which is independent of short-run political considerations, implicit cost-benefit analyses of inflationary economic policy seem to have yielded the conclusion in country after country that it is a losing proposition.

If one could abstract from short-term political considerations, there might also turn out to be a fair measure of consensus on the objectives of anti-inflationary policy, and only a limited amount of disagreement on the means to achieve them. For example, there seem to be very few people in the world who are highly religious on the subject of the necessity of achieving absolute price stability. Everyone is aware that our measures of price and wage increases are imperfect. Moreover, recognizing that there are some serious downward rigidities in most economic systems, most people see some merit in not setting too high a standard. Relatively flat prices for internationally traded goods imply low positive increases in most countries in the price of a typical basket of consumer goods and services, and nominal wage increases somewhat higher than the national rate of productivity growth, and this is regarded by most people as a sufficiently demanding definition of reasonable price stability.

Some would argue that it is too hard to work back to anything close to this, and that countries should be content to stabilize their economies at rates of price increase much closer to those currently existing. The difficulty here is twofold. First, it is hard to make price objectives of 6, 8, or 10 per cent credible. If 6 per cent is all right, why not 7 per cent or more? In the past in North America a movement from a consumer price index increase of 1-2 per cent to 4 per cent was regarded as something of a catastrophe. It is hard to believe that a movement from 10 per cent to 13 per cent would lead to the same kind of response.

Moreover, there is a good deal of unnecessary international inconvenience in settling at whatever rates happen to be prevailing in individual countries. If, for example, some of the major countries—the United States, the Federal Republic of Germany, and Japan—were able to settle their economies down to the point where their traded goods prices stayed roughly stable, then any other country which was not doing as well would be faced with continuing devaluations relative to the U. S. dollar, deutsche mark, and yen. Without suggesting that this would be a fate worse than death, continuing devaluation is sufficiently unattractive that there is little doubt that the price objectives of many of the smaller countries would be heavily influenced by the degree of stability achieved by those at the center of the international monetary system.


When we turn to the question of when and how countries should move toward the objective of reasonable price stability, it is not surprising that short-run considerations begin to weigh heavily. The short-run results of restraint are bad for business, bad for those seeking good nominal wage increases, and bad for the governments who are blamed for what is happening. It is not surprising, therefore, that there is a strong tendency to put off the evil day as long as possible, and that when action is taken there will always be those who suggest that further postponement is desirable, or that the process of restraint should be terminated now or in the near future.

The fact is, of course, that for those countries that are going to deal successfully with inflation, the restraint in one form or another is going to have to go on permanently. If the average annual rate of productivity increase in an economy is going to be of the order of 2-3 per cent, then the average nominal wage and salary increase cannot be higher than 4-5 per cent, if reasonable price stability is to be preserved. That in turn implies very modest increases in the supply of money or close substitutes for money, and low nominal increases in consumption, investment, and government expenditure.

The argument about whether this is the time to act goes on whether governments are using incomes policies as a supplement to demand management or not. Many, if not most, of the countries following anti-inflation policies today are using some form of incomes policy to supplement the monetary and fiscal steps they are taking to slow down the rate of wage and price increases. As has occurred in almost every case in the past, these income policy efforts will fail where-ever the demand for money is allowed to grow at a rate which is too high for the guidelines provided to those making wage and price decisions. Thus a device which, through providing some direct guidance, can speed up the process of adjustment to a new lower rate of demand growth will again be shown to be unhelpful and costly if the growth of demand is inconsistent with the announced targets of the control system.

Here again, however, it is not hard to find common ground. Except for the pessimists who think that, in the absence of a permanent system of controls we will be faced with intolerable unemployment or continually escalating inflation, those of us who think that incomes policy can play a useful role and those who do not can both look forward to the day when incomes policy will become obsolete. The best way to ensure that this will happen is to get inflation under control and avoid creating the conditions under which it will be rekindled. It is not going to be easy to get out of inflation, and the longer it is left unrestrained, the harder it gets. Perhaps the present experience many countries are having with withdrawal symptoms may stiffen their resolve to avoid inflation in the future.

While it is becoming more widely agreed that higher inflation will not lead to lower unemployment over the long run (and in the opinion of some may raise it on average), it remains true that in some countries there may well be a tradeoff between unemployment this year and unemployment next year, or, indeed, between unemployment during the next two or three years and unemployment in a period four or five years ahead. Under these conditions, there is always a strong temptation to lose resolve at a time when an anti-inflationary policy may be well on the way to yielding some results. Many members of the public often express contempt for the lack of resoluteness sometimes shown by governments. When viewed from within a government, however, it appears that the public itself bears a heavy responsibility for any weakening of resolve by the public authorities. When the anti-inflationary army is first assembled, it marches through the sunny streets to the enthusiastic cheers of the crowds. When the battle has gone on for some time, however, the cheering turns to booing, the allies begin to drift off, and a handful of people are left with the dirty job of holding the trenches against an ancient and powerful enemy.

It is easy, therefore, to have doubts about the success the world will have in dealing with the problem of inflation. There is some possibility, however, that over the course of the next few years a number of major countries will come a good deal closer to achieving the “orderly economic growth with reasonable price stability” that finds a place in the new Article IV of the Proposed Second Amendment to the Fund’s Articles of Agreement. The more successful they are in this effort, the more likely is the restoration of a stable international monetary system.

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