Freezing inflation or fighting it?

Press, 30 June 1982, Page 20

Freezing inflation or fighting it?

By

Professor J. D. Gould,

Professor of Economic History, Victoria University-

Announcing the wage-price freeze last week, the Prime Minister. Mr Muldoon, said that inflation had become enemy number one both for the public and for himself. Whether the freeze will prove a useful starting point in the fight against it. depends in part, on what causes inflation. Here one must have some sympathy for Mr Muldoon, for there is no universally-agreed view amongst economists as to what does cause inflation.

Milton Friedman, a leading exponent of the monetarist view, was in New Zealand last year trving to persuade us that “inflation is always and everywhere a monetary phenomenon." Only a minority of New Zealand economists unreservedly share his view. Even some of those who do. might not wish to see the fight against inflation carried on by policies of monetary restraint alone, for under that treatment the cure may be worse-than the disease.

On the other hand, in spite of the low public esteem in which trade unions are held, there are not many who would argue that trade union intransigence is solely to blame for inflation. Monetarists here side with the majority, for they put the blame for inflation squarely on governments and not on trade unions.

Probably most New Zealand economists hold an eclectic view, seeing inflation as the outcome of an "interactive” process in which both trade

unions and the money supply (and the government deficits which fuel it) play a part, but which also depends on other elements of New Zealand’s distinctive economic structure. These elements include the wide-spread indexation of wages and social security benefits to the Consumer Price Index, and the linking of public to private sector pay rates; a sheltered manufacturing sector in which cost increases can be passed on with, relative ease; and a “creeping devaluation” exchange rate system that prevents us benefiting from the slowing down of inflation rates overseas and helps to keep inflation going once it is under wav.

In this system, many employers don’t very strongly resist the wage demands their workers put forward, because they know they can pass on cost increases in increased prices for next year’s production. They know that their competitors, where there are any, will do the same, and they have felt reasonably sure that the Government will not step in to stop the process. Indeed, the linking of public service to private sector pay rates means that the wage increases they concede flow over to the state sector, fuelling government expenditure and the Budget deficit and thus increasing the monetary base which in turn enables the money supply to expand to “accommodate” the higher levels of money income. As Mr Muldoon says, the fact

that inflation is slowing down overseas makes the time ripe for a new initiative against it here. Moreover, the Budget deficit ■ before borrowing in 1981-82 turned out to be much lower than expected, more bygood luck than good management, and the huge success of the second issue of inflation bonds means that more of this Budget deficit is being financed in a non-inflationary way by borrowing direct from the public. This should cause the money supply growth rate to slow down. It hardly need be added that if any tough measures are going to be taken, the year immediately after an election is the time to take them.

Mr Muldoon is also quite right in thinking that government leadership is needed, for inflation is now built so firmly into the system that only a strong and many-sided campaign, led from the centre, has any hope of eradicating it. To see why this is so, imagine (if you can) some socially-responsible trade union that realises the futility of negotiating annual wage increases to ‘catch up’ with last year's inflation and merely guarantee that it will continue. Say that the leaders of this union try to break the vicious circle by standing aside and asking for no wage increase for their members. Are they rewarded for this admirable restraint? Of course not. The members of no union, even of the largest, produce

more than a small fraction of what consumers buy and inflation will therefore roll merrily on as a result of the selfish actions of everyone else. Members of the responsible union will merely suffer a fall of real income from the inflation which flow's from other people’s actions, and they will very rightly throw their leaders out the next chance they have and go back to more militant and more successful tactics.

It is because the practice of social responsibility is hopelessly penalised in this way that we must look to the Government to orchestrate the fight against inflation. Howlikely is it that the freeze will be helpful in this? An historian shies away from predictions, and indeed it won’t be possible to see the full picture until the Budget, which alone will supply the missing pieces of the jigsaw.

Certainly the evidence of history is’not very encouraging, for the many attempts made during the 1970 s both in New Zealand and overseas to arrest inflation by price and income restraints have enjoyed, at best, only a partial arid temporary success. Most experts see such measures as offering, at best, a breathing space to get the rest of the policy together to tackle the fundamental causes of inflation. (Not that the “experts” agree what those causes are).

'This is by no means entirely correct. One of the essential needs is merely to hold the

rate of inflation down for long enough to rid people’s minds ol the belief that inflation is inevitable. This belief is the glue that binds the "interactive system" together, encouraging trade unions, employers, investors. the Government and everyone else to plan their activities on the expectation that inflation will continue at a rate not very different from that of the recent past. As long as they do so. their belief becomes what the jargon of the dav calls a "self-fulfilling prophecy.” To eradicate or at least' weaken that expection is a vital part of the fight against inflation, and a successful, even if temporary, “freeze" may in itself, prove of some benefit here.

History notwithstanding, there are some grounds for hoping for a rather more effective “freeze" this time. First, the present freeze is far more comprehensive than most of its Eredecessors and this will give Ir Muldoon some scope for relaxing it as anomalies develop. as they certainly will, and yet keep enough in place to continue to have some effect.

Second, prices and incomes policies have often failed in the past because they have been at odds with other aspects of government policy or with the economic circumstances of the day. On this occasion these other elements are more favourable. Moreover. Mr Muldoon shows some signs of recognising that price and income controls on their own will not succeed and need to be

supplemented by supporting measures of other sorts,.He has been well advised, for example, to abandon the "creeping devaluation" svstem that has prevented New Zealand from benefiting from the decline of inflation overseas.

Third, public concern about inflation and awareness that it is receding overseas has reached a level at which there is some chance of getting people to accept difficult measures and co-operate in implementing them, though the immediate reactions to Mr Muldoon’s announcement are not encouraging.

Success is obviously far from guaranteed, if only because the freeze may provoke trade union disruption and industrial chaos. If the freeze fails. New Zealand's hope for a return to stable prices is unlikely to be the onlv casualty. The Prime Minister has / nailed his colours firmly to the mast of government interventionism, rejecting in doing so. everything National is supposed to stand for as well as contradicting his own previous utterances.

Because of this, the freeze is the most perilous decision for his own political future he has ever made: if it fails he has delivered himself beyond any possibility of salvation into the hands of his critics. If the policy fails, and if Mur Muldoon departs as a result, at least he will go not with a whimper, but with a bang. This, doubtless, is as he would wish it.