The Macroeconomic Mix to Stop Stagflation PDF
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THE MACROECONOMIC MIX TO STOP STAGFLATION By the same author STERLING AND REGIONAL PAYMENTS SYSTEMS BRITAIN AND AUSTRALIA: ECONOMIC RELATIONSHIPS IN THE 1950S INTERNATIONAL POLICY FOR THE WORLD ECONOMY MACROECONOMIC POLICY: A COMPARATIVE STUDY (editor and co-author) AUSTRALIA AND THE WORLD ECONOMY BILLION DOLLAR QUESTIONS: ECONOMIC ISSUES FOR AUSTRALIA IN THE 1970S MACROECONOMIC POLICY IN AUSTRALIA THE BANKS AND THE CAPITAL MARKET (co-author) THE AUSTRALIAN ECONOMY (co-author) THE PATTERN OF AUSTRALIA'S TRADE AND PAYMENTS THE STERLING AREA, THE COMMONWEALTH AND WORLD ECONOMIC GROWTH CONTEMPORARY MACROECONOMICS (co-author) CRISIS POINT IN AUSTRALIAN ECONOMIC POLICY? UNEMPLOYMENT, INFLATION AND NEW MACROECONOMIC POLICY THE MACROECONOMIC MIX TO STOP STAGFLATION J. O. N. Perkins Professor of Economics University of Melbourne M © J. O. N. Perkins 1979 Softcover reprint of the hardcover 1st edition 1979978-0-333-25396-0 All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission First published 1979 Reprinted 1982 Published by THE MACMILLAN PRESS LTD London and Basingstoke Companies and representatives throughout the world British Library Cataloguing in Publication Data Perkins, James Oliver Newton The macroeconomic mix to stop stagflation I. Inflation (Finance) 2. Monetary policy 3. Wage-price policy 1. Title 332.4'1 HG229 ISBN 978-1-349-16041-9 ISBN 978-1-349-16039-6 (eBook) DOI 10.1007/978-1-349-16039-6 To the PM, whoever he or she may be Contents PREFACE IX I INTRODUCTION 2 MACROECONOMIC POLICY: THE 'ORTHODOX' APPROACH 4- 3 THE POLICY MIX IN A CLOSED ECONOMY 19 4- STOPPING STAGFLATION 52 5 PROBLEMS, OBJECTIONS AND COMPLICATIONS 80 6 THE POLICY MIX IN THE OPEN ECONOMY 108 7 INTERNATIONAL IMPLICATIONS AND CONCLUSIONS 153 Appendix I: THE POLICY MIX AND THE AGGREGATE SUPPLY SCHEDULE 178 Appendix 2: THE FUNCTIONAL RELATIONSHIPS UNDERL YING THE POLICY PRESCRIPTIONS 181 NOTES AND REFERENCES 186 Index IBg Preface My main debt in the writing of this book has been to the many academic and official economists-nearly two hundred of them in sixteen countries and several international organisations who were tolerant enough to allow me to try out my ideas on them in the course of visits to Western Europe, North America, Japan, India and Singapore in 1976-7-in addition to many in Australia. Without their comments-both critical and helpful-I would not have had the confidence to put my ideas into print. Among my colleagues at the University of Melbourne lowe a special debt to Ian McDonald, who refused to let me get away with shifting the aggregate supply curve by means of monetary policy without adequate logical foundation, and who, together with David Vines, finally helped me to find a sustainable argument for doing so. In addition to these two, who have commented on parts of various drafts, I have benefited also from comments made by Richard D. Freeman, Dennis Mahoney and Sam Soper; and also from comments by Kwang Ng, whose work on the theoretical aspects of changing the mix I discovered at a late stage in my work. His rigorous exposition (so far unpublished) of the implications of what I would call the cost-push aspects of high tax rates takes the matter much further than I would have been capable of doing. I am naturally solely responsible for remaining deficiencies. Mrs Rosemary Thompson typed from an often difficult manu script with admirable speed and efficiency. Don Frearson gave me valuable assistance with proof-reading. l·O.N-P. London, March 1978 IX Introduction I During recent years the world economy has been plagued by the dual problem of inflation and unemployment. To a considerable extent the problem has been manmade; for governments in many major countries have been reluctant-rather than unable-to take the measures necessary to raise the level of activity to nearer the economic potential of their economies, because they believe that only by holding down the level of activity (that is, generally by holding up the level of unemployment and of spare capacity) can they restrain the rate of inflation. The main contention of this book is, by contrast, that there is available a combination of measures that would enable govern ments to hold down the rate of inflation, and even to return to price stability if the process were taken far enough, without continuing to make the large sacrifices of output, and so of economic welfare, that have been made in the past few years-and yet without relying solely or mainly (and perhaps not even at all) on some form of voluntary or compulsory prices and incomes policy. It will be argued that success in restraining inflation at any given level of activity will depend upon the particular combination of monetary and budgetary measures employed by a government. It will not be contended that policies directed at holding down the rate of inflation by holding up the level of unemployment will necessarily fail to check inflation: they may, or may not, succeed, depending partly on the 'mix' or blend of macroeconomic measures -monetary and budgetary policy, and measures such as exchange rate policy-with which they are applied. But this is also true of measures directed at raising the level of operation of the economy of a country up closer to 'full employment'. Taken by itself, and holding 'everything else equal' one might expect that a policy that raised the level of activity would tend to raise prices and the rate of inflation. But the kernel of the argument of this book is that the other things need not remain equal; that it is perfectly possible in principle so to change the combination of monetary and The Macroeconomic Mix to Stop Stagflation budgetary measures employed, whilst taking steps to raise the level of activity, that this change of mix can have as much downward pressure on the price level as any upward effect on prices that results from operating the economy at nearer to full employ ment. It is not a contention of this book that prices and incomes policies are either necessary, inevitable, useless or harmful, though they may in fact be any of these things in particular countries at particular times, depending largely on the form they take. But it will be argued that any prices and incomes policies that are adopted will have a greater chance of success, and the best hope of doing more good than harm, if the mix of monetary and budgetary measures chosen to accompany them is such as to hold down the price level. In contrast to the mix of measures to be proposed here, the setting of the main macroeconomic instruments chosen in most major countries in recent years has been such as to generate a high rate of inflation whilst also making it harder to reduce unemploy ment without causing a faster rise in the price level. Governments generally have kept tax rates too high and have been unwilling to provide people with adequate supplies of attractive financial assets in which to hold their savings. The process of changing the mix in the opposite direction that will be proposed in the ensuing chapters should be acceptable to people with a wide range of views on most matters of macroeconomic policy. The proposals are not distinc tively 'monetarist' or 'anti-monetarist'. They share the 'monetarist' view that it is dangerous to ignore the growth of the money supply. But the view to be put forward strongly contests the aspect of 'monetarist' views that seems to have been most widely accepted by governments-namely, that the curtailment of the level of activity is a necessary price to pay in order to lower people's ex pectations of the future rate of inflation. Such a policy mayor may not succeed: but, even if it can succeed, it is not necessary to pay this price in lost output and other social costs if, as this book contends, there is a way of doing the same thing that does not involve permitting a high level of unemployment. The proposals are preceded by a very briefo utline (Chapter 2) of the nature and operation of the various measures available to governments to deal with macroeconomic problems. Those with any systematic knowledge of macroeconomics will probably not find it necessary, or even useful, to read this chapter, but those who
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