Life with Inflation

To the Editors:

That the costs of living with inflation are far less than the costs of avoiding it is certainly true, and, as Tobin and Ross (“Living With Inflation,” NYR, May 6) say, jobs and output, not prices, are what counts in assessing economic performance. But more is not always better. Quite apart from the issue of quality in jobs and output, there is the question of distribution. To which classes, races, and sexes do the better jobs go? To whom does the lion’s share of output go? Might not a smaller or more slowly growing output, more equitably distributed, be “better”? Of course this depends on the sense of better, no small issue, but one not resolved by evasion.

Inflation is precisely the system’s way of evading the issue. Labor and capital do make inconsistent demands, but they are not alone in this. Different sectors of the economy, agriculture, services, and defense, also make mutually inconsistent demands. Inflation is, therefore, itself something of a “money illusion.” For while we concentrate on the rise in the general (wholesale or consumer) price index, we neglect relative changes in the components in this index. Consider the relation between wages and prices: as Keynes long ago pointed out, when prices rise faster than wages, profits increase; when wages rise faster than prices, income is redistributed to wage earners. Two consequences follow. Firstly, wage earners have a higher propensity to spend. So, when income is redistributed to wage earners, spending rises and savings fall, and vice versa when prices rise at the expense of wages. Secondly, wage earners spend on different goods from dividend receivers or business investing their retained earnings. Spending out of wages and spending out of profits will therefore be directed to different sectors.

Now consider changes in relative prices: when prices in one sector rise relatively to those in another, other things being equal, its profits increase. Such a shifting in profits can have important consequences. Different sectors reinvest out of profits at different rates, and pay out a different proportion in dividends. Further, the composition of their investment demands varies widely. For example, expansion in some sectors may involve a relatively large increase in the demand for labor; in others, a relatively slight one relative to the capital goods required. Further, and perhaps more importantly, the demand for labor may be largely for skilled or largely for unskilled workers.

So there are both—class distribution of income and sectoral composition of output—effects which result from the nonuniformity of price and wage increases. Moreover, the causes of inflation may well lie largely in attempts to change either or both the distribution of income and the composition of output. To say that we “can live with inflation” is therefore unhelpful; it is to miss the trees for the forest. We can live with a rising consumer price index, perhaps; but how much redistribution from wages to profits—or from profits to wages—can we live with? We can live with an erosion of the value of the dollar, but with how much erosion of city services, with how many more real estate agents and used car salesmen? We can live with rising wages, but how much unemployment among teenagers and the unskilled are we to tolerate? Finally, to whom does “we” refer?

Aggregate economics was meant to assist in the analysis of, not in the escape from, the conflicts inherent in a capitalist economic system. Inflation cannot be discussed in purely aggregate terms.

Edward J. Nell

Professor of Economics

New School for Social Research

New York City

James Tobin and Leonard Ross replies:

We have no disagreement with Professor Nell’s suggestion that it is important to attend to sectoral as well as aggregate behavior, of both prices and output. This is true whether inflation is going on or not. Professor Nell seems to forget that sectoral shifts and relative price changes can and do occur around any general price trend, deflationary, stable, or inflationary.

We see no basis for his implicit assumption that taking account of the sectoral shifts which coincide with inflation weakens the case for a full employment policy.

Professor Nell asks “how much redistribution from wages to profits—or from profits to wages—can we live with?” As our article pointed out, there is no evidence that inflation results in any systematic redistribution, one way or the other. He asks “how much unemployment among teenagers and the unskilled are we to tolerate?” A good deal less than at present, we suggested, which is precisely why full employment is desirable; it is teenagers and the unskilled who gain most from tight labor markets.

Professor Nell suggests that “a smaller or more slowly growing output, more equitably distributed” might be better than a rapidly growing GNP. Conceivably, but when that smaller output is obtained by running the economy at half-steam the redistribution that takes place is away from the disadvantaged. If “more real estate agents and used car salesmen” are a misallocation of resources, there are fairer and more direct remedies than slowing down the whole economy.