Various Types of Inflation
The usual pattern of inflationary movements is one of gradualness; inflation is insidious and persistent. There has been a continuous depreciation in the value of money since time immemorial. Three trends of rising prices are continually at work:
- The very long-term upward price movement In the UK, the average general price level in almost every century (with the possible exception of the nineteenth century) has been higher than in the preceding century. Recalling the equation of ex-change MV PT, nineteenth-century experience may be regarded as not being in accord with the general, age-old inflation largely because of the large growth in 7: i.e., there was unprecedented economic growth, especially in the Golden Years of the Victorian Era. Even in the Great Depression of 1873-96, there was a tremendous rate of growth in T (exceeding the growth in M and V) so there was a fall in the value of money. The nineteenth century is selected because it provides a warning to the embryonic economist that generalizations and sweeping statements are dangerous. Victorian experience does not invalidate the almost universal experience of 'creeping' inflation throughout the ages.
- The 25-year cycle of price movements This is also well illustrated by nineteenth-century experience. Given the long-term upward movement of prices, it would be expected that in most cases each upward cycle would be at a higher level than the previous upward cycle. 'Twenty-five years is only an arbitrary period. The four usually accepted periods of nineteenth-century approximately 25-year 'price' changes were:
- 1821-49-falling prices: after Britain's return to the Gold Standard and a decrease in the issue of banknotes following the collapse of hundreds of private banks that went bankrupt during the Napoleonic and French wars, e.g., in the crisis of 1797.
- 1850-73-rising prices: following large gold discoveries in the USA and Australia plus the extension of the cheque system, especially after joint stock banks were granted limited liability in 1858.
- 1874-95-falling prices: dependent mainly upon a greatly increased rate of industrial production and increased demand for gold concerning its supply; Germany and France adopted the Gold Standard in 1873 and 1878, respectively.
- 1896-1914-rising prices: consequent upon the discovery of gold in the Witwatersrand area of South Africa; Britain was especially affected until she abandoned the Gold Standard in 1914.
- The short-term sharp price cycle The typical or classical trade cycle lasted about nine years, e.g., prices rose steeply in 1929 and then fell sharply to the 'trough' of the Depression in 1931-33. Recovery was slow (see Fig. 5.8); another price cycle was probably obviated by economic recovery associated with rearmament programmes in the late 1930s.
The 25-year cycles' are general trends. Although over two or three decades, prices may show an increase, there will be short periods, within the quarter of a century, when prices are falling. This brings us to the third trend, commonly known as the trade cycle.
Hyperinflation or 'galloping' inflation takes place when price increases get out of hand. In the UK, we have not yet had this type of inflation where prices of commodities and the price of labour have to be adjusted upwards on a twice-daily basis as in Germany in 1923. Inflation is rarely a government policy; there is no need for such a policy because prices tend to rise in any event in normal circumstances. The control of inflation may be claimed to be a policy, but the type of headlong inflation under discussion is uncontrollable until the current unit of currency is abandoned and a new unit is adopted. The classic case of hyperinflation took place in Germany after the First World War. In November 1923, Dr Schacht, the Currency Controller, introduced the new 'rentenmark', the value of which was stabilized at the round figure of 1 rentenmark = 1 billion old marks. Theoretically, the new rentenmark represented a mortgage on the whole land of Germany, but in practice, there was no way of claiming a portion of German land, any more than one can claim gold based on the 'Promise to pay printed upon a current Bank of England note. The system worked because the people realized that they just had to make it work and, therefore, accepted the new currency; acceptability is seen to be the most vital attribute of any form of currency.
Although the German hyperinflation was a monetary phenomenon, its starting point was a shortage of supply. Under the over-severe conditions imposed upon Germany after the First World War, the defeated nation was faced with such severe reparations that it was forced into a series of defaults that culminated in a failure to supply France with 100 000 telegraph poles. The French occupied the Ruhr and the Germans simply stopped working in their vital industries. There was thus a great slowing down of production. The German Government was forced to increase the quantity of money because it could not otherwise finance itself. Government indebtedness caused deficit-induced inflation and the Reichsbank Director, Rudolf Havenstein, employed scores of printing presses turning out 'money' with Teutonic thoroughness. Thousand-mark notes lost any purchasing power and were used as scrap paper or overprinted with much higher values; e.g., a thousand-mark note was transformed into a million-mark note. The people who gained the most were borrowers, as the value of money depreciated so quickly that their debts were cancelled almost as soon as the ink was dry on the loan agreements. The German Government was the main debtor and by November 1923 the National Debt, including the cost of the First World War, had fallen to £50.
Many amusing, if not frightening, anecdotes came out of Germany during this period. People trundled pianos around the streets to pay the grocer's bill, kites were made from marks or were used for wallpaper, workers wheeled home their wages in barrows and people turned monetary assets into old iron-anything was better than retaining a mark which was like trying to grasp a snowflake. The exchange value of the mark was officially changed at 11 a.m. and 5 p.m., but speculators hurried from one shop to another trying to find a seller who had missed some huge new depreciation in the value of the mark. People rushed to spend their wages immediately after they received them, knowing that prices would shoot up again in a matter of hours. Hotel and café managers stipulated that the price of the meal depended on the rate of exchange at the time the customer finished eating; a cup of coffee would cost millions of marks. People began to think in millions. A father, when questioned about the number of his children, might carelessly reply: 'Five million. In 1918, the mark was worth about 1½p but by 1923 one English £ exchanged for about 20 000 000 000 000 (20 billion) marks as Die Grosse Inflation went into its lunatic spasm. The money supply increased over a million times in those last cataclysmic weeks of 1923.
Causes of Inflation
There is far from complete agreement about the causes of inflation. For monetarists, the cause of inflation is identified simply as a direct consequence of previous expansions of the money supply. Suggested alternative causes, such as increasing costs of production or cost-push inflation, are denied by monetarists. However, students should adopt a broad perspective and not align themselves with one particular school of economic thought. Governments who have adopted monetarist policies, for example, in the USA and the UK in the 1980s, have nonetheless attempted to keep wage settlements low-although from the monetarist's viewpoint wages are a cost of production and not related to inflation.
Monetarist Explanation of Inflation
'Inflation over any substantial period is always and everywhere a monetary phenomenon arising from a more rapid growth in the quantity of money than output.' So asserted Professor Milton Friedman in a memorandum submitted to the UK Treasury and Civil Service Committee in the summer of 1980. Indeed, so convinced is Professor Friedman of this axiomatic truth that he feels able to continue 'few economic propositions are more firmly grounded in experience... experience extending over thousands of years. The monetarist theory is a 'demand-pull theory, i.e., inflation is seen as stemming from excess demand concerning productive capacity.
Monetarism has had a particularly long gestation period. Indeed, one first encounters a wholly mone tsarist account of inflation in the seventeenth century when Bodin and Locke related the rising prices in Western Europe to the increase in money resulting from the importation of large amounts of gold and silver from South America. It is as well to note at this stage that although a type of inflation was not formally articulated, this early quantity theory was a theory of demand-pull inflation; i.e., the increase in money would, naturally, generate increased expenditures and if this increased demand was not matched by increased supply then prices would be pulled upwards. This simple idea became universally accepted in fact, not only by political economists but also by successive policymakers. Thus, in the UK the adherence to the gold standard from 1821-1914 can largely be explained in terms of the acceptance of a quantity theory of money by those in power.
Monetarists see the emergence of an apparently/ irreversible inflationary trend in Western economies as a result of excessive increases in the money supply. Policymakers, it is said, developed a general acceptance of Keynesian economics, and relegated money to a very minor role. Ironically, by failing to take into account the monetary implication of expansionary fiscal policies, the authorities were fuelling the very inflation that was to lead to the re-emergence of monetary policies.
Monetarism is an important integral strand of classical (market) economics. Hence it is not surprising that the efficiency of 'the market is held aloft by those in the monetarist school. Monetarists contend that if only the authorities would trust in the self-regulating nature of the market economy and remove those imperfections that prevent its smooth operation, then the principal economic problems would be solved. Price stability would be combined. after a short period of adjustment, with really high employment and sustained economic growth.
At the time of writing (March 1982), however, and following nearly three years of monetarist-type policies in the UK, inflation remains at 12 per cent; unemployment is over 3 million, and output has fallen by about 20 per cent. It is not surprising that critics of monetarism not only doubt the wisdom of the theory but also the viability of the practice. Monetarists would argue that the principles of monetarism are still valid; the monetarist policy has not been successful because the all-important money supply has not been adequately controlled. When the UK Government effectively controls the money supply it may be possible to reduce the rate of inflation substantially.
Other Explanations for Inflation
- Cost-push inflation This results from an increase in the costs of production and especially in labour costs because wages are the most volatile of production costs. Increases in the price of raw materials and power are just as much part of cost-push inflation. Those who believe in cost-push theories of inflation contend that trade unions are important instigators of inflation. If trade unions force employers to concede to wage claims which can only be met by raising the prices of consumer goods, then further wage demands will follow leading to an inflationary spiral.
- Imported inflation This results from an increase in the cost of imports and is consequently a type of cost-push inflation. If the cost of imported raw materials increases, then inflation will result. The best modern example is that of increased oil prices brought about largely by the policies of the oil gopoly of OPEC.
- Supply-shortage inflation In the past, this has resulted from bottlenecks in production and from worldwide shortages during periods of war or the aftermath of war. When economic goods are in short supply concerning their demand, then the activity of hopeful but frustrated potential buyers will force up prices. This type of inflation operates when goods are in perfect (or almost perfect) inelastic supply. The prices of old masters, rare coins, and stamps provide examples of supply shortage inflation. 'Rent of ability' where an entertainer can demand an 'excessive' price for his labour, because he has talents that others do not possess, may also be classified under this heading. Inflation in the aftermath of war is often extreme; prices rise with such staggering rapidity that inflation is destructive of an orderly civilized or rational society. Forms of assets to which a monetary value was attached lose all value overnight.
- Profit-induced inflation This takes place when there is an excess of profits above the level required to service investments. The inflation of 1929 which resulted in the Wall Street crash may be held to have been profit-induced as share prices soared and investors attempted to cash in. Surplus investment potential led to excess industrial capacity and production which in its turn led to under-consumption.
Falling, Rising, Or Stable Prices?
Depending on the circumstances, a case can be made out for a little deflation (with a slowly falling price level), a little inflation (with a slowly rising price level), or a stable price level.
- The case for a slowly falling price level As the volume of production is continually increasing, one way to ensure that the mass of people shares in the greater affluence of the economy as a whole is to stabilize the quantity of money and adopt fiscal and other money methods to ensure decreasing prices. However, falling prices might tend to have a depressing effect if profits also fell. If entrepreneurs plan for a certain level of variable costs and then find that the price secured for their product is less than expected, profits may fall and there may be a temptation to contract business, with consequent unemployment.
- The case for a slowly rising price level A little inflation goes a long way. Creeping inflation is usually associated with gradually rising wages, increased profits, and full employment. An entrepreneur plans his production in an attempt to maximize his profits with a certain price range in mind; if prices rise and his profits are greater than expected, he will be tempted to expand his business and take on more plant and labour. Thus inflation has been associated with boom conditions. Mild inflation may give a continuous incentive to businessmen in the shape of both actual and prospective profit margins. A state of creeping inflation can be justified on the grounds of high levels of employment, national income, and investment.
- A stable price level Stable prices would seem to ensure more justice between creditors and debtors. A managed currency facilitating stable prices over a long period would reduce the risk of entrepreneurs, while workers would know that their 'real' wages would be maintained and that their wage increases would not be eroded by price increases. Economic waste and friction would be mitigated. On these grounds, stable prices would seem to make for good industrial relations resulting in fewer strikes for higher pay. In theory, people would know exactly where they stood, but the impracticalities of sustaining stable prices over a long period are immense.