life. Each economic expansion has ultimately brought greater inflation, War II period, spending increases have persistently exceeded output

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1 INFLATION AUSE, URES AND PLAEBOS Beryl M. Sprinkel INTRODUTION Inflation is a rise in the average price level, inevitably brought on by too much money chasing too few goods. Since most of us prefer stable prices, either for equity or confidenceenhancing reasons, the solution should be obvious. onduct our nation s financial affairs in a manner designed to increase total spending in line with the increase in total production. Yet, throughout the post World War II period, spending increases have persistently exceeded output increases, but by varying degrees, and inflation has become a way of life. Each economic expansion has ultimately brought greater inflation, followed by recession and lower inflation rates. But there has been a persistent tendency for each inflation peak to exceed the prior peak, and each inflation trough to exceed its predecessor. There is no shortage of views concerning why spending increases have exceeded real growth, thereby bringing inflation. They include too much money, too large deficits, slow productivity, excessive wage increases, monopoly in labor and business, too high taxes, currency depreciation, rapacious oil sheiks, high farm supports, higher minimum wages, higher interest rates, higher social security taxes, etc. It is Dr. Sprinkel is Executive Vice President and Economist at Harris Trust and Savings Bank in hicago, Illinois. 43

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5 ignoring or disbelieving the inevitable inflationary consequence. True, higher monetary growth in the short run brings many goodies. Perhaps interest rates will briefly decline. ertainly spending will go up, incomes will rise, employment will increase, unemployment will decline) profits will spurt, and financial markets may be buoyed. In the inevitable longer run, i.e., one to two years later, inflation will pick up. We are now in the long run, and we are not dead as Keynes once suggested. Until at least recently arter Administration economists argued that widespread excess capacity would assure positive economic benefits from stimulative policies with only minimal inflationary consequence. learly they were wrong. Excess capacity measures are notoriously in exact, and even if they weren t, Keith arlson demonstrated in the September 1978 Review of the Federal Reserve Bank of St. Louis that a policy of rapid stimulus is likely to bring higher inflation with only very short run benefits to production and employment. Third, the Federal Reserve System has chosen a technique for implementing aggregate policy objectives that nearly assures a procyclical, not a stabilizing money growth pattern. The attempt to choose a target for the Federal funds rate believed to be consistent with money growth targets nearly assures excessive money growth during expansions, and weak money growth during recessions. The facts are that the Federal Reserve money desk in New York has done an excellent job of achieving Fed funds targets while almost consistently overshooting money targets since 1975, The Fed funds target chosen was too low to be sustained without intervention. Hence, purchase of Treasury securities by the money market desk increased bank reserves and the 47

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7 inflation. Only excessive money creation can do that. Factors limiting productivity growth such as government controls and low levels of capital formation reduce real output growth and add to the inflation resulting from any given level of monetary growth, but the contribution is moderateperhaps one per cent per year. Slow productivity improvement is the major factor limiting improvement in our real living standard, while monetary growth has little effect on long term growth, but is the major force bringing out near doubledigit inflation. It requires no great insight to predict present voluntary controls will fail because the selfpolicing incentives are all wrong. Unless fundamental correctives are applied, mandatory controls will follow. ontrols are an attempt to shift blame for inflation from Washington, the source of our difficulties, to blameless labor and business The recent massive moves to support the dollar will also fail unless reduced monetaryfiscal stimulus develops. Germany, Switzerland, and Japan expended billions of dollars of resources buying dollars during recent times, to no lasting benefit. Perhaps policies are tightening. Vetoes of spending bills have been sparce, but apparently stringent efforts to slow spending increases are now underv~ay. Let us hope so. The recent one per cent boost in the discount rate and the $3 billion rise in required reserves may do the trick, but only if Open Market purchases of securities don t continue to spur growth in the monetary base. The motto of my native state, Missouri, should serve us all well on that score: Show me! areful monitoring of Federal Reserve purchases of securities and 49

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9 lexicon, we will have come full circle. Finally, when political promises are followed by performance, I will then conclude that policies of financial prudence have become good politics. 51

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