Can We Hold Down Prices?

SUMNER H. SLICHTER, Lamont University Professor at Harvard, has been rated by Fortune as “the best-known economist in the United States. He is the public’s economist, labor’s economist, and the businessman’s economist.”His forthcoming book. What’s Ahead for American Business, is predicated on the belief that our contest with Soviet Russia is primarily a contest of production. Events may plunge us into total mobilization, but short of that emergency Mr. Slichter believes that, if we are vigilant, we can build up our defenses and at the same time maintain a dynamic economy. One of our most immediate responsibilities, he argues. is to stop a runaway increase in prices.

by SUMNER H. SLICHTER

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DURING the next twelve months the volume oi personal income after taxes (at present tax rates) will rise by 15 billion dollars a year or more, but output of consumer goods will remain about the same or perhaps drop a little. That sentence states the crux of the problem oi inflation. Four principal influences will bring about the increase in personal incomes: the number of people at work will increase by 1.5 million to 2 million: the weekly hours of work will increase; many employees will shift from lower-pax ingoccupations into higherpaying ones; and wage rates will rise.

The country will raise its rate of output during the next twelve months — perhaps by 15 billion dollars or more in terms of present dollars. But this gain in output will all be needed tor defense and foreign military aid. The outlays of industry on plant and equipment will be about as high in 1951 as in 1950 because defense orders will require large outlays on equipment, Hence, consumers will be fortunate if there is no drop in the total supplies available for consumption. As a matter of fact, there probably will be a small drop perhaps 5 billion dollars a year, or about 4.5 per cent.

Any cut in the demand for goods or any increase in supplies helps to control inflation, but the problem in the main is one of preventing rising personal incomes from being used to bid up the prices of the very limited supplies of consumer goods. It is wise to remember this because many proposals for checking inflation do not reach ihe heart of the problem they do not reduce the gap between personal incomes and the supply of consumer goods.

Opinions on how to check inflation are sharply divided. There are two principal schools of thought. One school would rely mainly or solely upon the socalled “indirect" controls strict control of credit, higher taxes, reduct ion in government spending, and the encouragement of saving. The other school would rely upon “direct" controls -that is, ceilings on prices and wages, allocations of materials, and rationing. Much can undoubtedly be done to keep the rise in prices moderate, but the more closely one looks at the various anti-inflation programs the more one is forced to the conclusion that some rise in prices is inevitable and that the advocates of the various proposals are making excessive claims for t heir wares.

Some of the anti-inflationary measures would be effective within narrow limits, but only within these limits. Hence they would be helpful, but not adequate. A few of the so-called “controls” are not controls at all they would aggravate, not check, inflation. Finally, some of the most ellective controls have little political appeal and will be used only sparingly and perhaps not at all. Let us examine briefly the merits of some of the specific controls — first indirect ones and then direct ones.

Strict controls on credit. Rapid expansion of credit during the second half of 1950 aggravated inflation, and it is plain that strict control of credit is badly needed. But credit restrictions are of limited usefulness because they cannot close the gap between personal incomes and the supply of consumer goods. They simply prevent the gap between the supply of consumer goods and the demand tor them Irorn being made still wider by borrowing.

Higher taxes on corporations. Taxes on corporate profits have been greatly increased and President Truman is proposing additional increases. But higher taxes on corporate profits would have little or no effect upon the size of personal incomes, they might have a small effect through limiting the dividend disbursements ot corporations. One should remember, however, that dividends provide less than 5 per cent of all personal incomes.

Some people argue that higher taxes on corporations would help increase the supply of consumer goods because they would force corporations to cut expenditures on plant and equipment and thus would release raw materials, labor, and productive capacity for making consumer goods. Under other circumstances, higher taxes on corporations probably would limit expenditures on plant and equipment. During the next year, however, most of the buying of plant and equipment will be for reasons that are little a affected by higher corporation taxes —to acquire equipment needed in defense production or to hold down labor costs. Consequently, corporations will finance purchases of plant and equipment, if necessary, by selling some of their large holdings of government securities or by borrowing from banks. Each of these methods is inflationary. Hence, higher corporate income taxes may accentuate rather than retard inflation.

Sales taxes. The effect of a sales tax in a strong sellers’ market is quite mixed. It is a tax on spending, and thus tends to encourage some people to save. But in times of strong demand the main effect of a sales tax would be to raise prices. Furthermore, the rise in prices produced by sales taxes may increase the pressure for higher wages—another inflationary effect. In defense of the sales tax one may argue that the revenue from the higher prices caused by the sales tax would not increase private incomes but would go to the government.

Higher taxes on personal incomes. Increases in the personal income tax are undoubtedly the most antiinflationary kind of taxes, but even the effect of higher income tax rates may be quite limited. If the higher tax falls mainly on people who are in the habit of doing some saving (for example, people of moderate or high incomes), the tax may limit saving as well as the demand for consumer goods. To the extent that the higher tax limits saving, it is not anti-inflationary. The kind of change in the income tax that would be most anti-inflationary is a reduction in exemptions. Lower exemptions would not cut the volume of saving appreciably; their principal effect would be to reduce the demand for consumer goods. But this excellent weapon against inflation has little political appeal.

Reductions in nonessential government expenditures. Cuts in government spending are just as anti-inflationary as cuts in personal consumption. Hence, economies in government operation and postponement of unnecessary government outlays are useful ways of checking inflation. Unfortunately, these methods are quite limited in their possibilities. The very fact that employment is high and the country is trying to raise production compels the government to make many expenditures that would not otherwise be necessary. The need for larger outlays on new highways and on the maintenance of existing highways is an example. Nevertheless, cuts of several billion dollars a year in nondefense expenditures are possible and would be an effective way of limiting the demand for goods.

Personal saving. An increase in personal saving may be an even more effective check upon inflation than increases in the income tax. The anti-inflationary effect of higher income taxes, as I have just pointed out, may be limited by a decrease in savings. An increase in savings, on the other hand, does not produce smaller income tax payments. But an increase in saving is not necessarily antiinflationary, because the savings may be invested in land, old houses, or existing supplies of stocks or bonds and thus help bring about a rise in the prices of real estate or securities. Savings are anti-inflationary when they are held as cash or bank deposits or are invested in new issues of government bonds. During the Second World War, individuals accumulated cash and bank deposits on a large scale and also purchased huge quantities of government bonds. Personal holdings of cash and demand bank deposits increased from 16.7 billion dollars at the end of 1941 to 45.7 billion at the end of 1945, and personal holdings of government securities from 8.2 billion dollars to 41.6 billion during the same period.

People who accumulated cash or bank deposits or bought government bonds during the recent war have lost much of the purchasing power of these savings because prices have risen well above wartime levels. Consequently, people may not be as willing today as they were ten years ago to hold cash or to buy government bonds. Price ceilings and material controls, as I shall point out presently, will encourage saving because they will make it impossible for people to get the kind and quality of goods that they wish. It would be desirable, however, for the government to have a carefully planned program to encourage saving and the buying of government securities. But the individual who buys a government bond runs Considerable risk that the purchasing power of his principal will drop. If he is to be persuaded to invest in government bonds rather than real estate, stocks, or some other “inflation hedge,” he must be offered a generous rate of interest to compensate him for this risk or he should be offered a bond that is redeemable (if held a minimum period) in the same amount of purchasing power that he paid for it.

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WHAT about the efficacy of direct controls — price ceilings, wage ceilings, allocations of materials, and rationing?

Price ceilings. Price ceilings only prevent inflation in part. Inflation takes the form of reduction in quality, of shifts of transactions to black markets, of the failure of industry to make the kind and quality of goods that the market demands. If one has to buy a gaily colored sport shirt when one really wishes a plain utility shirt, the purchasing power of one’s dollar has dropped. Unfortunately, ceilings on prices are least effective with respect to the very kinds of goods that are most important in the cost of living — namely, food and apparel. For example, between 1942 and 1945, when the consumer price index increased 10.2 per cent, foods went up 12.3 per cent and apparel 17.5 per cent.

The enforcement of price ceilings is difficult in the case of food because the food products may move from the farm into local black markets before they even reach the cities, where most of the consumers live. Ceilings on apparel have limited effectiveness partly because quality cannot be controlled and partly because producers stop making the items on which price ceilings most severely limit profits. Perhaps these effects can be mitigated by allocating a certain proportion of raw materials for the making of low-priced items, but this would involve additional controls to assure that low-priced items really are made.

Since price ceilings prevent consumers from getting the kind and quality of goods that they desire, ceilings do discourage spending as was plain lx shown by the rapid rise in personal holdings of cash and demand deposits during the Second World War. Perhaps the remedy was almost as bad as the disease, but many people did wait until they could Imx the kind of goods they wished.

Wage ceilings. Wage ceilings are an essential pari of a scheme of price control in a strong sellers market. Otherwise the wage demands of strong unions will accelerate the rise in prices, as recent experience in the steel and coal industries shows. But wage controls must be flexible. Since no one knows hoxv much prices will rise, wage controls are not likely to command public support unless they permit wages to rise as much as the cost of living. Furthermore, a lew larger increases will be needed in order to give workers an inducement to go into rapidly expanding war industries — particularly to go to places where housing is source or living conditions are unattractive.

Many people do not regard the type of wage control that I suggest as worth having — they think it would be too inflationary. Nevertheless, the practical choice is between flexible controls that command public support and can be strictly enforced and more rigid ones that can be made workable only by permitting many exceptions, as was done in the case oft he Little Steel Formula during the Second World War. As a matter of fact, had wages been adjusted closely to the cost of living during the Second World War, the rise would have been a little bit slower than it aclually was.

Material controls and allocations. An eflectix e way of discouraging the demand for consumer goods and there by limiting inflation is to prex enl indusl rv I rom making the kind and quality of goods that consumers desire to bux. Price ceilings, as I have pointed out, do this to a certain extent though that is not their purpose. A more effective restraint mi consumer demand, however, comes from rest rict ions on the use of scarce materials. This, of course, is not one of the intended effects of material controls: the restrictions are necessary in order that scarce materials be available for defense goods. Nevertheless, when automobiles, refrigerators, stoves, radios, and main other goods contain greater or less quantities of substitute materials, many would-be buyers decide not to purchase now but to wail until goods of standard quality become available. Postponement of boxing for ihis reason will undoubtedly be an important check on inflation during the next year or two.

Rationing without price ceilings. For some types of goods fhe most eflective way to protect the purchasing power of the consumer’s dollar would be rationing, without price controls. Ibis is likely to be true in the case of goods that would otherwise go into black markets or that cannot be controlled in quality. Meat is an example. The rise in prices would be substantial, but rationing would limit the ability of the well-to-do (and the ability of hotels, dining car services, clubs, and restaurants) to bid up the price. Even though prices would rise somewhat, the consumer would get more for his money. Unfortunately, the case for rat ioning without price controls is not easily understood by the public, and government officials may not be willing either to attempt to explain the case or to assume the responsibility of imposing rationing on consumers while not subjecting sellers to price ceilings.

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FROM this list of indirect and direct controls on inflation, a fairly effective anti-inflation program could be constructed. Sales taxes and increases in taxes on corporations should be avoided, because they are likely to contribute to inflation. Strict control of credit is, of course, a must, even though it is not capable of closing the gap between personal incomes and the supply of consumer goods. Reduction in nonessentiaI government expenditures is another “must,”although it probably cannot be expected to limit demand by more than 3 or 4 billion dollars a year. Higher income taxes are essential, but Congress will probably not be willing to go very far in taxing away part ol the gap between personal incomes and the supply of consumer goods. Mage controls, like credit controls, will not close the gap between incomes and the supply of goods, but they will help prevent it from growing larger.

If the demand for goods can be reduced by about 3 or 4 billion dollars a year ihrough reductions in nonessential government spending and another 4 billion dollars a year by higher income taxes, a third to a half of the inflationary gap will have been closed. Perhaps the rest of the gap will not be closed. If it is closed, this will have to be accomplished by an increase in personal savings. Price controls and material controls may be so effective in preventing consumers from being able to buy the kind of goods that they desire, that the rate of saving will rise by 7 to 10 billion dollars a year.

This increase in saving may or may not bring about an unhealthy inflation in the prices of securities and real estate. Hence the government should endeavor both to encourage saving and to absorb savings by offering securities that millions of thrifty people would find attractive. The combined effect of strict control of credit, a moderate reduction in government expenditures, an increase in income tax rates producing several billions of revenue a year, the limitation of wage increases to the rise in consumer prices, and a well-designed program of selling government bonds to individuals would be to limit the rise in prices to around 5 per cent a year. If this sounds discouraging, let the reader remember that from 1945 to 1940 the consumer price index rose 8.5 per cent; from 1946 to 1947, 14.2 per cent; and from 1947 to 1948, 7.5 per cent.

Let me conclude with a few words on a neglected but important subject. In several ways inflation is being suppressed or postponed. For example, the increase in the length of the work week tends to bring about postponed inflation because, when the work week eventually drops, workers will demand compensating wage increases and these, in turn, will bring about price increases. Furthermore, if prices are held down more effectively than wages during the next year or two, inflation will be postponed because prices must ultimately adjust themselves to labor costs. Finally, inflation is postponed when the inability of consumers to buy the kind and quality of goods they desire causes them to defer purchasing.

It is better to postpone inflation than to have it now, because two or three years hence supplies will be more abundant and the danger of a runaway increase in prices will be less. And the longer inflation is postponed, the better is the chance that technological progress will so cut costs and increase supplies that the postponed inflation never occurs. It is plain, however, that the problem of checking inflation will be with us for several years.