PKT message, Re: Inflation,Stagflation and Unemployment

"Stagflation" was a term that was coined to describe the situation that
emerged in the early 1970s. It combined the words "stagnation" and
"inflation" to describe a phenomenon in which economic growth stagnated
while the rate of inflation increased.
This followed the decade of the 1960s, a decade of phenomenal economic
growth and social advances in which almost everything seemed possible. In
the United States, it seemed to give sturdy embodiment to President
Kennedy's concept of "Why not?" - in other words, we should not doubt our
capacity to reach "imposssible" goals or to satisfy "impossible" aspirations but, when
an "impossible" project is suggested to us, our response should be, "Why
not?"
Not only in the United States but, for example, in my homeland of Australia,
we had, in the 1960s, one of the highest rates of sustained economic growth
in our history.
We had full employment, high public and private fixed-capital investment,
and low inflation. In the last few years of the decade, expenditure on such
things as education, health and welfare doubled - in real terms - and then
began to double again.
In the United States, both welfare and civil rights were embraced as never
before. As part of the Cold-War struggle but going beyond it, the United
States realised the goal set by Kennedy of putting a man on the Moon by the
end of the decade. More aid was given to the developing countries than ever
before and, through such arrangements as UNCTAD, the prospect was for
ever-increasing advancement of the world's poorer people.
All of this was at a time when the Cold War and the Vietnam War as a
particular manifestation of it, were absorbing so much of United States
resources.
Despite all this, when Richard Nixon became President in January 1969,
inflation was modest - certainly manageable by the standards that were to
come in the next fifteen years or so.
In retrospect, it probably would have been better if the Nixon
Administration had simply let things be.
As it is, we might recall the Shakespearean warning, "In trying to
better, oft we mar what's good."
By the summer of 1969, Nixon had already applied or was in process of
applying fiscal restraints and in July of that year, the Chairman of the Fed
announced a hike in interest rates.
At that point, stagflation, though not yet christened, was born.
In my book, The Multiple Abyss, I wrote -

"In July 1969, six months into the first Nixon Administration and just
twelve days before man took his first steps on the Moon, the Federal Reserve
Board raised interest rates. In the midst of all the drama of the times, the
raising of interest rates seemed a dull, stodgy, inconsequential event. So,
not surprisingly, it was received with calm and, initially at least,
understanding. The United States had spent enormous amounts of money on the
Cold War, on the Vietnam War, on aid to less developed countries and, above
all, on President Johnson's welfare society. The resources of even the
mighty United States economy were stretched and prices were rising. So the
Fed acted "to slow the economy down." Its action was, in the conventional
wisdom of the time, "correct." But what happened then?
"One account [in The Indigent Rich, pp.41-2] said that -
"...towards the end of 1969, that is, less than six months after the Fed had
acted, policies instituted by the Nixon Administration began to push
unemployment up. The intention of these policies was to stop inflation by
reducing demand. Demand was to be reduced by reducing personal income, which
was assumed to be a function of increasing unemployment. But President Nixon
had already arranged in his message to Congress that 'if unemployment were
to rise' the programme of unemployment insurance 'automatically would act to
sustain personal income.' He had therefore undermined in advance his
capacity to attack inflation through increasing unemployment and reducing
personal incomes.
"But he was more shackled in his capacity to attack inflation by these means
than even this contradiction in his policies demonstrates. For his policies,
if they did not reduce incomes as much as the increase in unemployment would
have done in an earlier period, they did reduce production. The number of
unemployed shot up by more than one million in less than a year. The rate of
increase in the gross national product dropped sharply. The President's
Council of Economic Advisers estimated that the United States economy, in
the second quarter of 1970, was operating at about 4 per cent below its
potential capacity and that the real rate of growth of GNP in the third
quarter was down to 1.4 per cent - or to 2.5 per cent, if the effect of the
General Motors strike were excluded. Growth in the fourth quarter was
probably nil. The difference between these estimates and the real rate of
growth of 5 per cent or more before the advent of recessive policies was
substantial; and was borne out by data showing movements in industrial
production. From a peak in July 1969, the index of industrial production
dropped steadily to a point 7 per cent lower in October 1970. The decline
was sharper as unemployment grew (and as the General Motors strike caused
further production losses). The index which stood at 173.1 in October 1969,
had fallen to 166.1 in September 1970, and 162.3 in October 1970".

Here was the essential cause of stagflation, identified (even before its
baptism) in The Indigent Rich as early as 1971. By 1974, the term itself had been
coined and in "Inflation: A Study in Stability", published in that year, I wrote -

"If it is socially unacceptable to move demand down far enough to balance
supply, then the only way of achieving balance in an inflationary situation
is to move supply up or, at least, keep it up to meet demand. Our failure to
try to do this explains why we have so often had 'stagflation'. When
insufficiency of supply started to cause inflation, we have applied - and,
indeed, we still do apply - monetary and fiscal policies that curtail
certain areas of demand, including investment demand, and that curtail
production. This reduction of supply while demand necessarily stays up under
the pressure of government as well as of private outlays, achieved those
twin evils of more unemployment and higher prices.
"When we have reached that point of ultimate frustration, we have then -
just as we did in the 1930s - flailed around desperately for remedies
roughly within the confines of our existing economic orthodoxies. Wage
levels are said to be too high (that was a favourite in the 1930s too);
therefore wages should be frozen or cut. Others say we need an incomes
policy and price control. Or we should revalue the currency or cut tariffs.
Most governments have tried some of these; some have tried them all. None
really works....."

Thirty years later, we still haven't moved far beyond where we were in 1974.
We now depend almost entirely on hiking or cutting interest rates to solve
our problems of inflation - and just about everything else, domestic and
external.
We have learned to live with high rates of unemployment, low rates of real
investment, inadequate economic and social welfare, education and health, widespread
poverty, inequality, homelessness and all the rest.
I have noted above that the policies that thrust us into the stagflationary
1970s were applied just days before Man took his first steps on the Moon.
The Moon program was curtailed in the early 1970s and we've never embarked
on any manned space program to any heavenly bodies since. The first
President Bush talked about it but nothing was even begun. The current
President Bush talks of going back to the Moon - thirty years on - and
perhaps from there to Mars; but we know that neither he nor his successors
will ever do it.
They will never do it unless economic policies are fundamentally changed and
we turn from the wrong road that Nixon took in July 1969 and follow another,
more positive, more dynamic, more enlightened road whose elements have been
adumbrated above.
I might just say a final word on unemployment. It is a misery for the
individual and a curse for the economy and the society. It is, above all
things, avoidable
and its definition political. More than thirty years ago, in The Indigent
Rich, I wrote -

"Full employment, especially of labour, achieves a political definition, as
distinct from a technical definition, over time. At the end of the Second
World War, it was widely considered that a level of 4 per cent of
unemployment would constitute a reasonable definition of full employment of
labour. Against a background of unemployment during the thirties rising to
20 per cent and even 30 per cent and remaining, for long periods, at or
above 10 per cent, it was understandable that 4 per cent should look pretty
good. But, as time passed, unemployment began to settle, for long periods
and in an increasing number of countries, below 4 per cent and to move
towards an almost irreducible level of 1 to 2 per cent. Once people become
accustomed to an unemployment level of 1 per cent, then a movement back to a
rate of 2 per cent causes what is regarded as widespread distress and 3 per
cent or 4 per cent comes to be regarded, in many countries, as a national
disaster."

What is certain, whether thirty years ago or now, is that unemployment
causes, to put it at its lowest, a dreadful waste of valuable human
resources. In recent years, in the developed world, we have become used to
unemployment rates of over 5% and often over 10%. In many of the poorer countries, the chronic
rate is 20, 30, 50% or even more. Underemployment is as much a curse as unemployment.
Wage rates, even for the fully employed, often do not constitute an adequate
living income.
Unemployment and underemployment of those who want to work reduce the
potential of the society in which they occur, limit human aspirations and
frustrate the "impossible" dreams of both individuals and societies.
Starting with the Nixon policies of 1969 - which were adopted by other
governments and were approved and continue to be approved by mainstreamer
economists right up to the present day - we moved away from full employment.
We became so entangled in policies that strangled employment that few now
seem to believe that we can ever return to the employment situation that
we knew in the 1960s.
That is a attitude of inexcusable despair. There is no good reason that we
should not return to policies of full employment. Such a return would not only enable us to
solve - positively - our problems of inflation, stagflation or whatever, but
also put us once more on the path to achieve a multitude of our
aspirations including, if we so choose - and not at the expense of
neglecting our needs here on earth - a voyage to the planets and even onwards - if we
believe it not to be "impossible" - to the stars.

James Cumes
http://www.authorsden.com/visit/author.asp?AuthorID=3473
http://members.chello.at/jamescumes/default.htm
http://www.kokodatrail.com.au/forums/?showtopic=54
http://members.chello.at/jamescumes/VOW/default.htm

----- Original Message -----
From: "Gary Santos" <garysantos@xxxxxxxxxxxx>
To: "James Cumes" <cresscourt@xxxxxxxxx>
Sent: Saturday, January 17, 2004 5:09 AM
Subject: Interest Rise Causes Stagflation

> James,
>
> Could I trouble you for an explanation? I would think it would depend on
the
> specific circumstances, would it not?