DISINFLATION AN EXPLANATION OFD A NEW TERM IN ECONOMICS

Press, Volume LXXXVIII, Issue 26855, 7 October 1952, Page 6

DISINFLATION AN EXPLANATION OFD A NEW TERM IN ECONOMICS

[Reprinted from the Reserve Bank Bulletin] . “dieinflation” is a recent addition to the language of tJL;-,, it tends to be confused in the minds of some people w?th and is often thought to involve a This article is an attempt to explain, m non. and de P re ?s • ee what the policy of disinflation—so widely throughout the present Um —

The various “flations” which are so often referred to nowadays < in- . “de-" “re-”, and "disin-”) can be defined’in various ways. It is nreferable here to base the definitions rtn the relationship between demand aSd supply On t£ one hand there is the desire to spend money—the desire of individuals, companies, Z oney bodies, and governments. The thpv want to spend comes out or cur rent income, past ing (including borrowing from a hank, if available). On the other hand there is supply—the supply of labour, materials, land. coods If aggregate demand ana sup ply are approximately in teatance and the needs of those who are willing and able to spend can be satisneo without any usable resour , c ff. in s left idle or goods accumulating in Stocks th”e will be no genera tendency for prices to rise or fall, though individual prices may of . c °drse vary considerably. This situation can best be described as “full employment . though there may be a few workers temporarily in transit, between, jobs and there may be a few vacancies. Inflation is the condition in which aggregate demand exceeds supply at current prices. Deflation is the condition in which supply exceeds demand at current prices. Both supply an? demand are variable, but demand is much more subject to quick changes. Hence short-term economic fluctuations tend to be caused more by changes in demand than by changes in supply. Supply changes too, but not so quickly, and usually only in response to actual or anticipated changes in demand or as a result of climatic conditions affecting crops. Therefore, in the short-run, economic stability and full employment are best promoted by measures which stabilise demand, e.g., changes in the availability and cost of bank credit, changes in the amount of savings and of taxes and of government expenditure. In the longer run, measures to stabilise supply are needed also. Disinflation is .the policy adopted m a period of inflation to reduce the excess of demand over supply so that supply demand may be brought into balance at a level of full employment. Reflation is the policy adopted in a period of deflation to increase demand in order to bring it back into balance yrith supply at a level of full employment. (It should be noted that inflation and deflation have been defined here as conditions of the .economic system, while disinflation and reflation are defined as policies. It is sometimes held that inflation is the process of change by which excess demand arises, deflation the process of change by which demand falls below supply. This version is possible, but the other has been adopted here.) Dealing with Inflation The problem of inflation can be dealt with in three different ways: (a) The supply of goods can be increased. If the increase is to come from local production, it will take a long time, because during inflation all available resources of labour are fully employed and there are likely to be bottlenecks in materials and equipment. On? difficulty is that the production of extra goods results in the creation of additional incomes and generates further demand. This method, therefore, though not to be ruled out, is not an immediate solution. Alternatively the supply of goods coming on to the market can be increased by using up stocks or by additional imports. In the short-run these can help to relieve the pressure of inflation, but they can only be temporary, since stocks will be used up or an external balance of payments problem will arise. (b) The second method is to control the distribution of scarce goods in accordance with a system of rations or priorities based pn need. This involves much administrative difficulty but seeks to ensure a fair distribution.

(c) Prices could be allowed to rise sufficiently to deter soipe of the would-be buyers, sp that demand and supply are equal again at the higher price level. This method, known as “rationing by the purse,” has several advantages. It leaves tfie market free, does not require administrative organisation and permits price increases to act a? a stimulant to sup, P’F-teuune prices, in moderation, might be tolerated for a period, but il the rise is persistent or large the consequences are harmful. This rise in price is often regarded as identical with inflation itself. This is wrong. Inflation is the condition or situation in which demand exceeds supply at current prices. Rising prices are a consequence of inflation, and then , c ' ontrols i or subsidies do not £I e t'h ent them. They could also be part of the remedy for inflation, for at the higher price demand and supply are towards equilibrium again duced Foi°t n h <Proper J y defined ) is reuuced. For this remedy to be effective however, demand must not be furthS stimulated, otherwise the inflation will continue and prices rise further, xu; - e *• st . sh <>rt-run method of jS.? nfl ation is to reduce deT hls can be done by several & o S r a hVi" e ? nS CUting the uesne or ability to spend, whether nf persons or businesses or government of expenditure are hwd to cut down or for social reasons should not be cut down, eg, the baste Benefits of Moderate Inflation lerel dols I bring d ce S Jtai’i y '“S pri « not only to a in ..advantages, also to of W lnd ividuals but most of the community. The

individuals who benefit most usually those \uith things to sell S inflation means a "sellers’ markfl” one In which sellers have no o>, in disposing of all the goods they ai buy at good profit margins wiui , minimum of effort, in which •», enterprising businessman can eul devise new ways of persuaE customers to part with their moiwi in which new businesses flouriah new fortunes are made. There ,'r. . many people gaining materially ~ Inflation that disinflation meets strong resistance. The benefits of moderate inflate add up to a quite impressive list. wi.. about the other side of the pictwr The harm done to a community by i] flation includes the following: “ 1. The steadily rising cost of livk, with the incomes of a large section t the community lagging behind, a flation is in •effect an unfair form e taxation—it tends to injure most a those people who are least able to if crease their incomes, and they mostly people with small or modem incomes. 2. The misuse of resources. M,.. essential industries go short of lab® and materials while less valusble otw are able to expand. The harm*? effects are not always apparent, br they are there just the same. . 3. A ''sellers’ market” for lab®, means rapid turnover of staff lower productivity. 4. There is a tendency, for compsm. to make insufficient provision for k preciation reserves, especially if rates are at a high level at the aaf. time. 5. Black markets, spivs, M racketeers flourish in inflation. esp«f ally if attempts are made to deal shortages by means of direct controk such as rationing and price eontrote 6. The real value of savings 1, incentive to save are reduced si flation progresses. 7. The power of local industrial meet overseas competition is weakened, with a consequent tendency >» raise trade barriers, such ns tariffs nd import controls. 8. There is a tendency towards sa adverse balance of external payrnttj and a loss of monetary reserves 9. There is a danger—which is iu». entirely absent and which all tao often materialises—that a moderate infiata may gradually deteriorate into a niaaway inflation, with disastrous nsulta Disinflatiefl Policy New Zealand attained approxtautt full employment about the end ot UK or the beginning of 1938. Sines the we have had inflation—a little man « less but never of a “runaway” nsturi Policies designed to keep inflation u check have been in force since ew in the war, with some success. Bui some degree of inflation remaiw. The evidences are still with us—th«t is over-full employment, vacancies an numerous, the. demand for oversea funds greatly exceeds current rsceieu and prices have been rising steaiik (This situation is by no means conSni to New Zealand.) By the Use of direct controls ovc prices, materials, and imports and to the payment of subsidies, it was mv sible for a time to counter the effeco of inflation to some extent. With & partial abandonment of these messure the existence of inflation becraa more obvious, the need for a posiuj policy of disinflation, using monetef and fiscal weapons to reduce demand becomes more insistent. Though the demand for exchange li pay for imports is still heavy, the overall excess of demand over suppt’ in New Zealand is not great, and s the moment it is probably less than a any time since the early days oi Hi war. The last few months have sea a substantial improvement in the sup ply position‘(to the point of over supply of many goods), a changed atmosphere in the business communtr. much caution and spme uncertain!’ Too severe restrictions at this Stan could easily cause a loss of confidence too sharp a drop in spending, and the beginning Of unemployment. Hov ever, the basic condition of inflation remains throughout most of th economy. There are several Indicatais to which we can look to determine has far disinflation ought to go. Emplt’ment is the quickest indicator, nd in many respects the best. At th end of July, 1952, there were onlvlt persons registered as “disengaged” st the district offices of the Departmat of Labour and Employment, but tot notified vacancies numbered 16.379. Disinflation, if successful, would substantially reduce the number of registered vacancies. It would also increase the number of temporarily disengaged persons, but it must not sc so far as to bring about a deficiency tn aggregate demand resulting in unemployment. The disengaged persons should be merely in transit between jobs When the number of vacancies has been reduced to a figure closer to the number of disengaged persons available to fIR the vacancies, it could be said that full employment has been rf ac l)ed. The disinflation policy should then be revised accordingly. It is necessary to form an estimate of the extent of inflation and to attempt to measure the reduction in spending which is needed to bring de rnand and supply back into balance it a level of full employment. Too smill a reduction would mean continuing tonation; too large a reduction would cr ™" e ' an .unemployment problem. The methods that a central bank can use to reduce inflation are varied Use is already being mad# Of selective advance controls and higher reserve ratios for the trading ba"b Their great advantage is that they cn be quickly adapted to meet changiM circumstances, being relaxed or intensified as required. Jf there i« signs that inflation is increastol n T? ary contr ols can be applied mon or new or >es introduced. H H}ui, econoi ') y is becoming more stable sup piy and demand broadly d . balance, they can be relaxed or «■ moved. If a or depression should begin to develop, the bankinl system can stimulate demand msteai of restraining it.