Recent Inflation: Its Causes and Implications for Public Policy

Canadian Public Policy

Recent Inflation: Its Causes and Implications for Public PolicyAuthor(s): Christopher GreenSource: Canadian Public Policy / Analyse de Politiques, Vol. 2, No. 1 (Winter, 1976), pp. 42-53Published by: University of Toronto Press on behalf of Canadian Public PolicyStable URL: http://www.jstor.org/stable/3550041 .

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Recent Inflation: Its Causes and

Implications for Public Policy

CHRISTOPHER GREEN* / Department of Economics, McGill University

The paper investigates the causes of the recent inflation. It argues that money growth is not the 'cause' and that the factors which force the monetary authorities to 'accommodate' make the money supply an essentially endogenous variable. The 'underlying causes' of the recent inflation are divided into 'immediate' and 'secular' categories, the latter reflecting changes over time in economic structure which have an inflationary bias. The paper argues that the chief effect of 'tight' monetary policy is upon output and employment rather than upon wage demands and price level change. While there is no short run 'solution' to the inflation problem, some longer run policies that may be helpful are suggested.

Cet article 6tudie les causes de la recente inflation. L'auteur affirme que la croissance de la masse monitaire n'en est pas la cause et que les facteurs qui obligent les autorit s monetaires a s'en 'accommoder' transforment la masse monetaire en une variable essentiellement endogene. Les 'causes profondes' de la recente inflation se divisent en deux categories: les causes 'immediates' et les causes 'structurelles,' cette derniere categorie reflttant les changements intervenus avec le temps dans la structure economique et qui ont une tendance inflationniste. L'auteur affirme que l'effet majeur d'une politique monetaire 'restrictive' s'exerce sur la production et I'emploi au lieu de s'exercer sur les demandes salariales et le changement des niveaux des prix. S'il n'existe pas de 'solution' a court terme au probleme de l'inflation, I'auteur suggere certaines politiques a long terme qui peuvent &tre utiles.

In 1974, the rate of inflation in Canada reached 'double-digit' levels. An orthodox economic explanation for inflation is the truism that there is 'too much money' - or more meaningfully, that the money supply has been expanded at too fast a rate. A new twist in the explanation (Velk, 1974) is that extra-legal international banking consortia, operating in the Eurodollar mar-

* The author would like to thank J.C. Weldon, two referees, and the editor of the journal for many helpful comments. The author is responsible for any errors.

CANADIAN PUBLIC POLICY-ANALYSE DE POLITIQUES, II: I winter/hiver 1976 Printed in Canada/Imprime au Canada



Inflation and public policy / 43

ket, are the cause of 'too much money.' I dissent from the view that the underlying cause of the current inflation is too much money or that in the absence of Eurodollars and the international banking consortia the world money supply would be significantly different from its present magnitude. I believe that, even in the absence of Eurodollars and international consortia, monetary authorities would have yielded to economic and political pressures to meet increased demands for money by increasing the money supply of their respective nations at what the 'monetarist' would say is 'too rapid a rate' to maintain price stability. In short, I argue that we can consider the money supply an endogenous variable and we should seek the relatively exogenous causes of the recent inflation.

The money supply is 'endogenous' in the sense that over time its rate of growth is dictated by economic conditions and the political requirement that monetary authorities 'accommodate' government policies and institutional realities, some of which I believe are the 'underlying causes' of inflation. In considering the money supply an 'endogenous' variable, I do not deny that the monetary authorities are able temporarily to alter and control the money supply through, say, open market operations. For example, I make reference below to 'tight' monetary policies. The reader is apt to misunderstand the basic argument of the paper if this argument that the money supply is 'endogenous' is not kept in mind. The causes of the inflation, to my mind, reside in the factors which have pulled or pushed up money incomes at a rapid rate. Because the demand for money is a function of income, the inflation of money incomes has sparked a tremendous increase in money demand. The monetary authorities have responded to the increase in money demand by rapidly increasing the money stock. Just why the monetary authorities are so 'accommodating' may become clearer in the discussion of the underlying causes of inflation. Many of these causes have a 'social' basis which suggests to me that despite the concern about inflation, society has a stake in its underlying causes.

I divide the underlying causes of inflation into two groups: 'immediate' causes and 'secular' causes. The immediate causes pushed inflation from single digit levels of about 5 to 6 per cent rates of price increase per year to double digit levels. In the absence of the 'immediate causes,' the secular causes would have assured us the 'headache' of 5 to 6 per cent inflation, a modest level by current standards, but a rate considered serious two or three years ago.

THE 'IMMEDIATE' CAUSES

The immediate causes that pushed us to double digit inflation levels are, in my view: I) The tremendous increase in oil prices brought about when OPEC took

I Velk holds that consortias of large banks dealing in the Eurodollar market are beyond the banking controls of sovereign countries and therefore have the ability to create money without limit because of the absence of reserve requirements. The deposits on which this loan expansion is based have been greatly expanded by the 'petrodollars' placed by oil producing nations.



44 / Christopher Green

control of Middle Eastern oil prices thereby substituting a seller cartel with strong monopoly power for the old international oil company cartel with more limited monopsonistic power.2 2) Rapidly rising food prices produced by bad weather, sharply rising demand for feed grains, and government policies which in the I96os and early 197Os greatly reduced wheat and feed grain stocks.3 Incidentally, high oil prices have raised fertilizer costs substantially and thus have helped to push up food prices. 3) A minor 'immediate cause' of the spurt in North American - as opposed to European - inflation was the implementation and subsequent abandonment of wage and price controls in the us. While they were in effect, the controls appear to have constrained prices more than wages. Writing in 1973, Gordon (1973:777-78) concluded: 'Controls worked not by moderating the behavior of wages relative to prices, but rather by squeezing profit margins sufficiently to hold prices below their free market levels. This is not a situation that can be expected to last indefinitely, and hence the very fact of short-run 'success' for the control program guarantees its long-run failure.' Moreover he accurately predicted that '... there will be a catch-up period after the controls are lifted during which the rate of inflation will be substantially faster than it would have been had the controls not been imposed.' Apparently, many firms took the opportunity to restore or raise profit margins after being released from controls. It seems likely that the pricing policies of us firms 'spilled-over' into Canada either via subsidiaries of us parent firms or otherwise. 4) Another 'immediate cause' of us and thereby North American inflation was a large budget deficit in the us in 1972, as the us economy was beginning to show signs that it was close to capacity in a number of sectors.4 Pressure on Canadian productive capacity appeared in 1973 (Department of Finance, 1975:29). Contributing to demand pull inflation in 1972 was the spur to us exports produced by the depreciation of the us dollar. Moreover, dollar depreciation contributed to inflation by raising the price of imported goods with consequences for most tradeable items. Whitman (1974:554) cites evi- dence that as much as two percentage points of the us wholesale inflation between November 1972 and August 1973 was due to depreciation of the us dollar. She also notes that 'the improvement in the net balance on goods and

2 Using simulation analysis, Jump and Wilson (1975:35) have estimated that, in 1974, the 'direct' (higher oil prices) and 'indirect' (higher prices of competing energy products) impacts of the energy crisis together made the price index for GNP 3.24 percentage points higher than it would otherwise have been.

3 Hathaway (1974) believes a'flash point' was reached in 1972 when world stocks of wheat and feed grain reached low levels compared to world consumption. He also claims that the us-Russian wheat deal, in 1972, was a relatively unimportant cause of food price inflation.

4 Modigliani (1974: 546-47) says that the estimatedfull employment deficit in 1972, was between 7 and io billion dollars. He notes that 'in 1972, as unemployment was moving rapidly down, the rate of growth accelerated to 7 per cent; in the last (and election) quarter, with unemployment down to just over 5 per cent the rate of growth exceeded 8 per cent.' Modigliani calculates that standardiz- ing the 4.9 per cent unemployment rate reached in 1973 for the labour force composition that prevailed in 1956 yields a 4.1 per cent adjusted unemployment rate. Thus, he believes the rapid growth of the economy in late 1972, spurred on by very expansive fiscal and monetary policies came at a time when the unemployment rate was closing in on the full employment level.




services from a deficit of $0.8 billion in 1972:4 to a surplus of $ I .6 billion in 1973:4 (both in 1958 dollars) represented 38 per cent of the total increase in real GNP over the period.' Although Canada's floating exchange rate permits us, in principle, to insulate ourselves from the inflation experience of our trading partners, in practice there has been little or no insulation since official Canadian policy appears to be to maintain the Canadian dollar at proximate 'par' with the us dollar. In an interesting paper Harry Johnson (i975) outlines how Canada can use the floating exchange rate 'to bring inflation under control and also produce a more satisfactory domestic employment situation ...' A pure float and government actions realized and intended are, in any case, contradictory. Professor Johnson is not talking about a pure float because he proposes exogenous monetary actions to stem inflation. My point is that monetary actions should be considered endogenous. It is one of the contentions of my paper that the underlying causes of inflation severely limit the ability of the monetary authorities to choose the desired level or rate of growth of the money supply. Ironically, Professor Johnson's paper appeared when the Canadian government was worried about a rapidly growing trade deficit accompanied by a depreciating Canadian dollar, as Canada inflated relative to the us.

THE 'SECULAR' CAUSES

The secular causes of inflation in the 1970s are: I) The rapid relative as well as absolute growth of the public sector in the last two decades, particularly in the last ten years or so. Government activity as a per cent of GNP is now close to 40 per cent.5 To finance this growth in public sector activity, governments have both increased taxes and have relied on an increasing percentage of earners moving up into higher income tax rate brackets. The taxpayers' reaction to the rapidly increasing tax rates is to attempt to shift the taxes forward. Businesses attempt to shift higher sales and property taxes to consumers. Wage and salary earners react to higher marginal income tax rates by increasing their wage and salary demands in order to maintain a desired net (i.e., after tax) increase in wages and salaries.6 Each of these reactions tends to increase prices and contribute to inflation.7 Inciden- tally, the reaction of taxpayers to increased taxes is likely to be more strenu- ous the less beneficial (the more 'unproductive') the government expenditure

5 In 1972, spending by all levels of government, excluding intergovernmental transfers, was 38.5 per cent of GNP. This compares to a figure of 31 per cent in 1966 and 22 per cent in the early 195o's. The relative growth of government has become a matter of concern to the Economic Council of Canada which voiced concern over the rapid growth in transfer payments which has led the relative growth of government spending. (Economic Council, 1973: 68-71)

6 The idea that the personal income tax is shifted is certainly an unorthodox one. What is claimed here is that workers respond to rising tax rates by demanding higher wage rates. The effect, however, may not be to change the distribution of income in real terms, although it raises the nominal level of income and prices. For an investigation of the impact of income taxes on wage demands, see Wilson (1973).

7 For an important recent recognition that at the 'macro' level increasing taxes may. ceteris paribus, raise prices rather than reduce them, see Blinder and Solow (1974). For earlier recogni- tions. see Auld and Brennan (1968) and Hotson (1971a).




is perceived to be." Finally, government expenditures tend to generate higher prices because of the 'cost-plus' rather than competitive basis on which these goods and services are so often purchased.

The present argument treats taxes as 'costs.' The rise in 'costs,' as taxes (per unit of output or income) increase, is translated into increased prices. Increased taxes, of course, can also exercise a 'deflationary' effect if accompanied by a smaller increase or decrease in government expenditures. How- ever. I ignore this effect because I am concerned with tax increases required to finance an increase in government expenditures. If the growth of government expenditures is limited to the rate of growth of the economy as a whole, it will not normally be necessary to raise tax rates, nor to rely upon taxpayers moving into higher tax rate brackets, in order to secure an increase in tax revenues of about the same magnitude as the growth in government expenditures. In fact. government expenditures have risen faster than GNP in the past decade or two. While deficit financing has been used to some extent, most of the increase in the relative size of the public sector has been 'paid for' by allowing income taxpayers to move into increasingly higher income tax brackets in response to the secular rise in taxpayer incomes. The movement into higher marginal tax rate brackets stimulates increased wage demands because higher marginal income tax rates require an increase in gross earnings to maintain a given rate of growth of disposable income. For example, suppose a group of workers want a 4 per cent increase in disposable income. The rate of growth of gross (of tax) earnings necessary to achieve this objective depends on the marginal and average tax rates faced by the workers. If these are 'low,' say 20 per cent and Io per cent respectively, a 4.5 per cent increase in gross earnings is required to provide a 4 per cent increase in 'net' (of tax) earnings. If these rates are 'high,' say 40 per cent and 20 per cent (or alternatively to per cent) respectively, it will take a 5.3 per cent (or alternatively 6 per cent) increase in gross earnings to produce a 4 per cent increase in disposable income.9 2) The increasing 'syndicalization' of modern economies.10 It sometimes seems that faith in the operation of market forces has almost totally vanished except among a subset of the economics profession. Competition which is supposed to benefit consumers is replaced by government-authored or sanctioned restrictions to the benefit of producers (sellers) and at the expense of consumers. These interferences with market forces, generally designed to prevent supply adjustment, have increasingly limited the degree of competition in the economy. Presumably, government regulation and other legal restrictions are rationalized on the grounds that market power is already great

8 At the 1973 meetings of the Canadian Economics Association, two papers addressed themselves to the impact on taxpayers of government expenditures which at the margin do not give as much utility as private goods. See Auld and Southey (1973) and Velk (I973).

9 The rate of increase in gross earnings, Y,, required to yield a target rate of increase in net (of tax) earnings. Yn*, is given by the formula.Y, = Yn* -a, where a = the average rate of income tax and m = the marginal income tax rate faced by the earner.

io The use of the word 'syndicalism' to describe the plethora of seller groups with inherent or government sanctioned market power is the result of reading Henry Simons (1948). Simons' use of syndicalism referred to labour unions although his analysis of the impact of monopoly powers granted unions is similar to his analysis of seller monopoly in general.




and competition is already limited in the important manufacturing and mining sectors of the economy. Additionally, as modern society's tasks have become more specialized with fewer close substitutes for any particular task, the bargaining power of workers has increased. What appears to be emerging is an economy in which economic agents are organized into seller groups ('syndicates' in the broad sense of that term), each with substantial muscle where its own output or labour services are concerned, and each prepared to go to great length to win its demands for higher prices or wages. The effect is obviously inflationary.

Increasing 'syndicalization' is not necessarily the same thing as an increase in concentration. In fact, it would be very difficult to find any significant change in market concentration, at least in the manufacturing, mining, or trade sectors. Rather, increasing syndicalization is perhaps best described in terms of one or another form of barrier to entry. The barriers take the form of quotas, more numerous non-competing groups, minimum rates of pay, and more widespread job 'tenure.' These diverse barriers reflect, in part, the effect of increased education and training, technology, and the desire for increased job security. But they also reflect the creation of 'artificial' monopoly - artificial because the barriers can only last so long as they are maintained by government-sanctioned restrictions of one or another sort. 3) The post-war 'baby boom' has 'come of age' and is now marrying, settling down, and having children. In other words, we are experiencing a 'demo- graphic bulge' in that age group which the 'life cycle' saving hypothesis (Modigliani and Ando, 1963) suggests will have relatively high consumption demands. Since the spending of the young marrieds will be particularly great for homes and durable goods, a relatively high propensity to spend may be reflected in large increases in consumer credit outstanding (representing a transfer from future to present consumption) rather than in any important change in the propensity to save out of current income.'• 4) Changes in the composition of the unemployed, which in conjunction with relative improvements in social welfare and social security programs (particularly unemployment insurance), have tended to increase 'frictional' unemployment and to raise the full employment level of unemployment. Most of the unemployed are now youths and other 'secondary' workers such as wives. In 1973, only 33 per cent of the unemployed were heads of households and only an estimated 16 per cent were heads of families in units with no other earners.12 The data indicate that a steadily increasing proportion of the unemployed are persons who usually have good non-market work alterna-

Ii See also Evans (1969: 46). Consumer credit outstanding grew from $5.3 billion in 1963 to $11.7 billion in 197o to an estimated $17.6 billion in 1973. See Statistics Canada, Consumer Credit, Monthly, Cat. 61-004.

12 In 196I, 46 per cent of the unemployed were heads of households. The percentage in 1966 was 41 per cent. (Department of Finance, Economic Review 1974, Tables 35 & 36, pp. 130-3I.) The estimate that in 1973 only I6 per cent of the unemployed were heads of families in units with no other earners was arrived at as follows: in 1971 when Labour Force Survey data indicated 37 per cent of the unemployed were heads of households, Survey of Consumer Finance data indicated that 47 per cent of the heads who experienced some unemployment in 1971 were the only earner in the family. Assuming that the 47 per cent figure applies to 1973 as well as to 1971. the 16 per cent estimate is arrived at by multiplying .47 times 33 per cent. (Statistics Canada, Incomes of Unemployed Individuals and their Families, Cat. 13-552, Table 9, p. 52).)




tives (education, housework, etc.) if the only market work available is at low wages or is otherwise unattractive. This implies that today the typical unemployed person is likely to be choosier when deciding whether or not to accept a job than was the case a decade or two ago. In addition, a substantially more generous unemployment insurance program further reduces the costs of being choosy. The result is that a given degree of labour market tightness and inflationary pressure is now reached at a higher level of unemployment than it was a decade ago. 5) Environmental programs have required increasing 'internalization' of waste disposal, thereby increasing the amount of inputs required to produce a given amount of output. In other words, as man-made waste disposal facilities replace air, water, and land as receptacles for waste generated in production, capital, and, to a much lesser extent labour, costs per unit of output have increased and these are passed along to consumers in the form of higher prices."

The nine causes of our current inflationary experience that I have outlined above suggest that the inflation problem is a complicated one with no easy or quick solutions. The dilemma is exacerbated by the fact that attempts to 'catch-up' for real wages lost due to past inflation and wage demands designed to anticipate future inflation will be factors in a continuing inflationary experience. In addition, inflation and attempts to combat it with a 'tight' monetary policy, raise interest rates. Higher interest rates translate into higher housing prices and enter as an increased cost in the production of many other goods.14

Let me attempt to summarize the argument so far. I reject the notion that the cause of the current inflation is too much money. Instead, I believe a number of 'immediate' and 'secular' causes have combined to raise inflation to double digit levels. Some of these causes reflect attempts by the community to maintain or raise real disposable incomes in the face of increasing taxes, much higher fuel and food prices, and increased real costs necessitated by policies to 'internalize' waste disposal. Others of the causes reflect the increased bargaining power of earners as the result of the rapid growth and development of income maintenance programs and heightened barriers to entry reflecting the increasing 'syndicalization' of the economy. Together, these causes have generated an 'income' or 'cost' inflation which has been 'monetized' by the monetary authorities. In the next section, I will argue that if the monetary authorities are not accommodating, the chief impact of a 'tight' monetary policy will be upon output and employment rather than upon wages and prices. An important general policy implication is that although inflation is inevitably a monetary phenomenon (in the sense that a general rise in prices will be associated with an increase in the money supply) policies to

13 Ayres and Kneese (1969) have reminded economists that Newton's second law (conservation of mass) implies that almost all production and consumption result in physical waste which must be

put somewhere. The problem can usefully be analyzed within an input-output framework. See Leontief (1970).

14 I owe the last point to a referee. I have not included the rise in interest rates during the past decade

among the 'secular' causes of inflation because I view the rise as the result of inflation and of

attempts to fight inflation with 'tight' monetary policies. Nevertheless, I am sympathetic to the view (Hotson. 1971a, 1971b) that high interest rates raise costs and prices.




deal with the current inflation require focusing on the non-monetary underlying causes of our present inflationary experience. In other words, while rising prices and an increasing money supply are associated, both are the result of - i.e. caused by - some thing or things more fundamental.

SOME IMPLICATIONS

Some analytical coherence can be given to the preceding discussion. The thrust of the 'secular' causes of inflation is to place a 'floor' under the rate of change of wages. The important economic implication of this floor is that thinkable reductions in economic activity cannot reduce wage change to a level consistent with price stability. Thus, price stability cannot be bought by increasing unemployment. This was the situation that was developing prior to the intervention of the 'immediate' causes of inflation in 1973. The immediate causes produced a quantum jump in the rate of inflation and were especially instrumental in raising the price of items (food and fuel) which are an important and regular part of consumers' budgetary expenditure. The effect was to substantially heighten consciousness of inflation with a resultant feedback into increased wage demands. The once for all nature of the inflationary impact of the immediate causes was thus translated into a continuous price increase as wage and salary earners demanded, and received, compensation for inflation-induced reductions in real income. Increased wages mean increased unit labour costs and thus higher prices, thereby fuelling a further increase in wage demands.

It is one of the contentions of this paper that wage demands are unlikely to be much influenced by changes in the rate of economic activity and employment.15 The resistance of wage demands to changes in economic activity is one reflection of the reduction in competition that has accompanied a more 'syndicalized' economy.16 Thus, attempts to fight inflation with monetary and fiscal policies which slow down the rate of economic activity are almost certainly doomed to, at best, limited success - and that at the expense of a substantial increase in unemployment. Reductions in the rate of inflation due to declines in the rate of economic activity are chiefly the result of falling (or more slowly rising) prices of raw materials rather than to substantial reductions in higher money wage demands. Moreover, 'tight'

15 In a recent paper, Vanderkamp (1975) reaches a somewhat similar conclusion within the framework of a modified Phillips curve analysis. Among other things Vanderkamp argues that once inflation is anticipated the Phillips curve shifts so that modest increases in unemployment will not reduce the rate of inflation very much. In his paper the exogenous forces are the rate of monetary expansion and the rate of 'autonomous' inflation. I have not included inflationary expectations among the secular causes of inflation, as it is clearly an endogenous factor.

16 Solow (1975:59-6o) provides an alternative explanation 'of the inflationary bias of modern economics near full employment.' Solow suggests that 'prices hardly ever fall because workers and employers nowadays fear prolonged recession and mass unemployment less than they used to, and they are right. Those things are very unlikely to happen.' The price level rises because of changing relative prices due to shifts in demand and supplies in a world in which 'most prices have got out of the habit of falling...' While my concept of'syndicalization' is not inconsistent with the factors creating Solow's 'ratchet' inflation, I believe the 'inflationary bias' is not limited to positions of 'near full employment.'




monetary and fiscal policies will reduce growth, thereby adding to the economic hardship produced by inflation. It does not seem too far from the mark to argue that the rate of economic activity is only one of several important determinants of wage and price behavior, other important factors including secular changes in economic structure, unexpected economic shocks. and feedbacks between wages and prices as earners attempt to protect their real wages or salaries from inflation. Contractionary monetary and fiscal policies may influence the feedbacks between wages and prices if recession (falling real income and rising unemployment) change expectations about future price increases.

If this view of wage and price behavior is correct, there may be some long run economic implications. In particular, there is likely to be a concerted move to denominate all contracts in real terms - especially so for wage and salary contracts. In a sense, we may be leaving the 'Keynesian' world of money wage bargains and returning to the 'neo-classical' world of real wage bargains (at least where wage increases are concerned), while retaining the Keynesian dependence of production and employment on real aggregate demand. But in a world in which rising supply price (as a result of develop- ments in the primary sector of the world economy) is replacing the constant cost conditions so long characteristic of manufacturing, an inevitable conflict arises between attempts to re-employ the unemployed and the desire of the employed to maintain their real wage. For if a rise in employment depends on an expansion of demand, and demand expansion puts an upward pressure on prices in the primary sector. and thus indirectly on prices in manufacturing, a policy of tying wages to a price index will tend to siphon off most of the demand change in the form of increased prices rather than increased output and employment. Thus, if in the present circumstances unemployment is allowed to rise. it may be very difficult to reduce it later on.

What, then, are the policy implications of the picture that I have painted? First it is important to remember that the inflation experience will not be as bleak as it may otherwise seem so long as real output per capita (appropriately measured) is increasing. The recent 'stagflation' in the us with output actually falling makes the inflation experience there much less tolerable. Thus, a short-run goal of policy in Canada should be to assure that the economy continues to grow. The preceding discussion suggests that an important threat to real growth is an attempt by government to curb inflation via a 'tight' monetary policy. But inflation is also a threat to real growth if it is accompanied by proliferating strikes and slow downs as frustrated workers force employers to agree to compensate, or more than compensate, for real wages lost due to past price level increases. At this point public policy may have an important role to play. A federal government policy urging employers (private and public) to temporarily 'index' wages rather than resist employee demands and risk long, output-reducing strikes may be desirable.

But indexing does not solve the basic problem of inflation. Raising wages to catch up with price increases will push up labour costs, thereby pushing up prices further. Indexing, as an instrument of public policy can be, then, of only temporary usefulness. If. as is argued in this paper, workers will demand maintenance of their real income in the face of inflation, governments might




consider using grants to individuals or families to compensate for inflation-induced reductions in earnings. A policy of lump-sum transfer payments to maintain real income might take some pressure off the price level by providing workers with an alternative to increased wage demands. Financing the grants could pose problems. Tax financing would make no sense since for the most part that route would essentially involve, for most persons, receiving with one hand and giving with the other. There are two possibilities: (I) the creation of 'new money' or (2) the sale of bonds to households (businesses will have enough difficulty finding funds to replace 'worn out' capital without being induced to buy more government debt). The former alternative is viable if there is substantial excess capacity in the economy. The second suggests the possibility that the government grants to individuals could take the form of claims on future goods and services whose purchasing power is guaranteed in real terms. The difficulty with the bond proposal is that, if inflation continues, ever-larger bond issues are required raising the possibility that the bonds will feed future inflation when they are converted into a demand for goods and services. Thus, the government grant approach is probably only viable in conditions of substantial excess capacity when the grants can be financed with 'new money.

A policy of giving inflation-compensating grants to workers also has the advantage of allowing the government to give added aid to low income workers and their families who may find it particularly difficult to cope with inflation. But where the inflation is accompanied by, or is the result of, a reduction in the growth rate of output, government grants to workers have the (not necessarily desirable) consequence of redistributing income toward labour and away from other factors of production whose real incomes are not maintained. Moreover, unless the grant payments are continued indefinitely, the fall in worker disposable income when payments stop will likely generate a further (once and for all) increase in wage demands.

The causes of our current inflation make it difficult to think of any effective near-term policies to curb inflation. Some persons may be drawn to the conclusion that an obvious method for dealing with our income or cost inflation is an 'incomes policy.' This paper is not the place for a discussion of incomes policy. However, it is my impression that an 'incomes policy' would be fruitless - or worse - given (a) the openness of the Canadian economy; (b) the importance of primary production, where increasing cost conditions are often found; and most important of all, (c) the lack of a national consensus on an acceptable distribution of income, plus the power of organized groups to overturn any 'incomes policy' imposed from above. In our increasingly syndicalized society of many fragmented, but powerful, seller groups such a national consensus or 'social contract' is increasingly difficult to reach. An incomes policy would appear more feasible in an 'atomistic' world where the state would not have great difficulty enforcing such a policy or in a world with a few, very broadly based 'syndicates,' making it easier for the state and the syndicates to discern areas of common interest and mutual advantage. One is thus led to examine some of the secular causes of inflation where emphasis is on longer term structural changes, which, although not panaceas, may nevertheless be helpful on the inflation front.




To reduce, via public policy, the importance of any of the secular causes of inflation is complicated, problematic, and time consuming. My assessment of the secular causes leads me to think that the following policies, whatever else their merit or demerit, might have some salutary effects where inflation is concerned: (I) reduce the rate of growth of the public sector and reduce tax rates. The object would not be to attempt to attack inflation by reducing the absolute size of government or by altering the level of budget deficit or surplus, but rather to combat the cost increasing tendencies associated with higher taxes and government expenditures per dollar of national income; (2) reverse the trend toward syndicalization in the economy by amending and invigorating anticombines policy, eliminating supply restricting and price increasing government regulation, and more sharply limiting the power of unions and professional associations to restrict entry into specific trades and employment."7 These policies while not attacking the immediate causes of inflation should, nevertheless, tend, over time, to combat two of the causes of income inflation: tax shifting and increasing market power. The policies are preferable to a policy of monetary stringency since they are not as likely as the latter to dampen economic growth.

These two policies, however, cannot solve the inflation problem by themselves. Moreover, the policies are only meaningful in a long run context so their contribution, if any, cannot be gauged by immediate results. Unfortu- nately, their long run character is probably a political liability. So is the fact that they are not panaceas. But I believe a more important political problem is that both policies may be perceived as inconsistent with some other social goals. For example, reducing the relative size of the public sector may not be consistent with further improvement of income security, health, and other individual and social welfare programs. And what about increased government involvement in the energy field? Likewise, reversing the trend toward syndicalization of the economy will almost surely be perceived by most persons as a threat to increased personal security in their role as producers, whether of final goods or of labour services. Essentially, then, what may make this inflation particularly difficult to combat is society's stake in the underlying causes of inflation.

REFERENCES

Auld, D.A.L. and G. Brennan (1968) 'The Tax Cut as an Anti-Inflationary Measure,' Economic Record, December, 520-525.

Auld, D.A.L. and C. Southey (1973) 'A Theory of Public Sector Inflation,' University of Guelph (mimeo)

Ayres, R.U. and A.V. Kneese (1969) 'Production, Consumption and Externalities,' American Economic Review, June, 282-297.

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Recent Inflation: Its Causes and Implications for Public Policy

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