Cost-push?  Or too much money? Old questions about rising prices remain far from settled

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From the beginning, the thing that puzzled me was the way the experts talked past each other, or, more frequently, didn’t talk at all.

I explained last autumn how a magazine assignment in 1975 immersed me in the Seventies debate about inflation and led me to 700-year index of wages and prices in England. An unreversed “price revolution” in the sixteenth century was its central feature.  Immediately I had turned to rival experts on the period, both emeritus professors at the University of Chicago. As I wrote in November,

It turned out that the facts of the price revolution were well-established, and had been understood in a certain way since Jean Bodin, in 1556, first pointed to the influx of New World gold and silver.

In 1934, Earl J. Hamilton has published American Treasure and the Price Revolution in Spain, 1501-1650; in 1940, John Nef had produced The Rise of the British Coal industry, in 1929; Industry and Government in France and England 1540-1640, in 1940; and War and Human Progress: an essay on the rise of industrial civilization, in 1954.

Here were champions on opposing sides of the long-running argument about the price revolution.  Some years late I learned that Joseph Schumpeter in his monumental History of Economic Analysis had characterized the difference of approach as between monetary and real analysis. I was dimly aware the gulf existed because I had began learning economics by reading two little books published in the 1920s, before John Maynard Keynes entered the debate:  Money, by Sir Dennis Robertson;  ’and Supply and Demand, by Hubert Henderson.

Schumpeter’s dichotomy was comforting because it periodized the controversy.  Monetary analysis had thrived in the seventeenth an early eighteenth centuries, he had written; then, starting with Adam Smith, real analysis of supply and demand had eclipsed money for well over a century.

By 1975, the argument had again become front-page news.  Inflation was surging.  Why?  Was the Federal Reserve Board imprudent in its conduct of monetary policy? Or were “cost-push” factors, OPEC price hikes and costs of its America’s Great Society and its Vietnam War forcing the hand of the Fed?

Alas, neither Hamilton nor Nef were of much use in writing about the issue in the present day. Both men had been born in 1899. Hamilton was a member the university’s famous department of economics; Nef, a cultural historian, a member on its Committee. Only later did I come to understand what was implied by the distinction.

Hamilton had definitely won whatever debate existed between the two.  As his department colleague Donald McCloskey wrote a few years later, “Various attempts to revise his history of prices (attaching it to population, for instance) have had difficulties with the sheer mass of evidence that Hamilton had accumulated, Kepler-like.”

Nef, orphaned son of a beloved Chicago professor, ward of another, married a pineapple heiress, and had gone on to write The Conquest of the Material World, in 1964, and, in 1973, a very beguiling The Search for Meaning: autobiography of a non-conformist.

More to the point, though, professional economics had moved on, dramatically.  A new Nobel Prize in Economics had been established, first awarded in 1969. Paul Samuelson, a Keynesian (that being the new name that real analysis had acquired), had won the prize its second year, for “raising the general analytical and methodological level in economic science.”

And in 1976, Milton Freidman was recognized “for his achievements in the fields of consumption analysis, monetary history, and theory; and for his demonstration of the complexity of stabilization policy” – that is, for monetary analysis.

I wrote a cover story, in March 1975, taking note of the unreversed nature of sixteenth century price explosion, venturing that it seemed unlikely that deflation, if it occurred, would return price levels to those that prevailed at the beginning of the twentieth century.

Like most journalists untrained in economics, I was partial to the cost-push explanation. Those OPEC price increases weighed heavy in the balance, it seemed to me.  Moreover, the mid-Seventies saw the beginning to the tax revolt:  maybe the unmistakable growth of government since the Thirties had something to do with it: there were new social programs, nuclear weapons, and rockets to the moon.

Reflecting on the similarities between the sixteenth century and the twentieth, I was more intrigued by the emphasis the historian Nef had placed on developments in industry, government, and warfare, than by the changes in the quantity of money that had inarguably taken place, new world treasure then, and central banking now.

Mainly I was struck by the extent to which monetary analysis simply ignored the developments in the real sector that so interested Nef. Instead, monetarists (we were beginning to call them that) pursued their interests in money with apparently no thought for developments “on the ground” and banking.   As for Hamilton, I thought of Albert Einstein rather than Johannes Kepler: Einstein had famously asserted, “It is the theory which decides what we can observe.” I had only just begun to read Milton Friedman’s work.

What was needed, I thought, was a theory real events of generality equal to that of the quantity theory, one which that might somehow cover all the ad hoc explanations usually advanced to explain rising prices. Together with a colleague, Lawrence Minard, I persuaded Forbes editor, James Michaels, to let us prepare a longer piece to say as much. “Growing crops don’t make the sun shine” was a phrase we bandied about freely in those days.

It took some time. Not until other November 1976,  a month after Friedman’s recognition was announced, did our lengthy article appear, under the headline “Inflation Is Now Too Important to Leave to the Economists.” A line from a Clark Gable film served as the article’s MacGuffin: “What do you mean they can’t pay more taxes?  Tell them to put up the price of beans!”  I wince now to see the headline in print, but the story won a Loeb award the next year, and Minard’s career and mine were launched.

There were parts of the argument that first piece made that Minard and I didn’t like. The tax angle was too acute; other angles we had come up with were missing. I persisted; Michaels remained receptive: ten months later Part Two appeared: “The Great Hamburger Paradox: An investigation into how economics went astray” (Wince again)!

This time I was “the author.” The MacGuffin was the contrast between a heavily-staffed an extensively-decorated restaurant with a fancy menu and a hamburger stand. That distinction conveyed well enough the difference between the sixteenth century, when an ordinary householder was fortunate to possess a bowl and a spoon, and the twentieth.  The paradox was the way the labor cost of a hamburger had plummeted over centuries during which its money price continued to rise. This was a proposition about the importance of real factors: I ignored economists’ highly-developed framework of supply and demand and conjured a nascent theory of “economic complexity,” employing an intuitively appealing but analytically empty word to connote the difference between degrees of development.

In terms of a restaurant menu, I wrote, the problem might be better understood as the bundling together of various costs, conflation of many costs, rather than the inflation of single price.  Wordplay! This was very far from economics, and it wasn’t history, either. It was economic journalism, pure and very simple.

Then came the supply-siders, the “Mundell-Laffer hypothesis” and all that, with their emphasis on tax cuts and their preoccupation with economic growth, which they called an increase of “aggregate supply.” The influence of Steve Forbes, a future presidential candidate, grew at the magazine his grandfather had founded and his father ran. After I was unable to get a story about James Buchanan, a future Nobel laureate, onto the magazine’s story list, I left for the library and the newspaper business. I had begun to specialize, and for the next forty years, I grew more interested in the economics profession and closer to it with every passing year.

All this came back recently as I browed through A Financial History of Western Europe, by Charles Kindleberger, in connection with another matter.  I came across a section on the price revolution.  It turns out that prices may have been rising in Europe for decades before the voyages of discovery got underway. The mines of central Europe yielded relatively little gold; silver was draining off to pay for spices imported on camels from the East; Henry the Navigator’s Portuguese sailors were able to sail south to the gold coast of Africa thanks to the invention of fore-and-aft rigging of sails, the stern rudderpost, and the compass; and that Columbus had been sent into the unknown in search of gold. (His diary mentions it 65 times in a voyage of less than a hundred days.) Kindleberger wrote,

Since [Earl] Hamilton’s book came out in 1934, something of a question has arisen whether the discovery of South America produced a price revolution de novo or whether it merely supported one already underway. The argument is a familiar one that we still encounter a number of times – in the debate between the banking and currency schools in nineteenth century England; between those who blame the first Great Depression represented by the fall in prices between 1873 and 1896 on the slowdown of the rate of increase in gold stocks and demonetization of silver, and those who ascribe it to real factors;  and again in the explanation of the German inflation after World War I, held by monetarists to be  due to simple over-production of money, and by their opponents to a complex set  of real factors, including reparations, restocking, speculation, and the like….

The main a priori attack on the price revolution rests on the belief that, apart from the short run when money may be inelastic and halt a boom, money adjusts to trade rather than trade to money as the quantity theory would have it. .. If a clear-cut choice must be made between real factors and the quantity theory of money, this goes to the heart of the issue. But both explanations can be right and leapfrog one another.  the bullion famine of the fifteenth century  led to a frantic search for money’ the discovery of copious quantities of silver, plus debasement, and perhaps dishoarding and the coinage of plate, supported and extended the price rise which would otherwise had to reverse itself or lead to the development of money substitutes, as happened later. Clearly silver and war leapfrogged, and war is one of the greatest strains of resources and contributors to inflation.

I read the passage twice. Kindleberger’s compression of real and monetary explanations forcefully reminded me of the single most important lesson I had learned from covering professional economics in the fifty years since I wrote those adolescent articles for Forbes.

That clear-cut choice doesn’t have to be made, at least not when considered in the context of the sweet fullness of science and time.  It is enough to expect that young economists will continue to do their work. “Inflation,” if that is what it is, is too important not to leave to economists. More on how I learned that lesson next week..

.                                                       xxx

Meanwhile, the best article I read last week on Russia’s war in Ukraine is How to Make Peace with Putin: The West must move quickly to end the war in Ukraine, by Thomas Graham and Rajan Menon.  First time Foreign Affairs readers may see it for free, I believe.