CAN WE HAVE HIGH EMPLOYMENT
WITHOUT INFLATION?

At the end of World War II, Congress passed the Employment Act of 1946. This announced that it is the policy of the federal government to help achieve the “maximum production, employment and purchasing power” consistent with maintaining a free, private-enterprise economy. Although the language is general, it has been generally interpreted to establish twin goals of high-level employment and reasonably stable prices. More recently, many have added two other goals—more rapid long-run growth and a strong international position for the dollar.

Is There a Conflict Between High Employment and Price Stability?

Either unemployment or inflation alone can be attacked readily by monetary and fiscal policy. The former calls for easy money and an expansionary budget, the latter for the reverse action. But when unemployment and inflation occur together, there is trouble.

Until the 1950’s, economists generally assumed that prices would not rise much until reasonably full employment prevailed. But now there are many doubts. A pioneering study ~by A. W. Phillips of the London School of Economics showed that in England over the past century, whenever unemployment fell below about 5 per cent, wage rates tended to rise faster than was consistent with stable prices. Some American economists believe they see the same general relationship in our economy; others doubt that any such simple relationship holds or that 5 per cent is a critical level. But everyone agrees that as we approach full employment and labor markets become tighter, it is increasingly likely that wage rates will be bid up by employers or pushed up by unions. And everyone agrees that higher wage costs and prices will surely appear in many sectors before the economy as a whole reaches “full” employment (even if full employment is defined to allow for 2 or 3 per cent frictional unemployment)

The B.L.S. consumer price index did creep upward at 11/2 per cent annually from 1957 to the mid-1960’s while unemployment averaged about 5 per cent. These facts suggest that the high-employment-or-inflation dilemma may be a real one. If we had expanded aggregate demand faster in order to get unemployment down to 3 or 4 per cent, surely the rate of consumer price inflation would have been higher. Alternatively, restricting aggregate demand enough to hold the consumer price index stable would have generated more unemployment than in fact occurred. There was no obviously “right” amount of aggregate demand to solve this problem. Looking back at Fig. 5-2, we seem to be in the area of the dashed line. \Vhether or not there is a predictable tradeoff between rising prices and falling unemployment is a complex and unsettled issue. Clearly, in the short run, rapid increases in demand when the economy is near full employment will generate rising prices before full employment is reached, and we can have lower unemployment only by accepting some inflation. But it is far less clear that in the long run the equilibrium level of unemployment can be reduced by inflation. Much evidence suggests that the unemployrnent-reducing results of inflation are transient.

The Wage-Price Guideposts

In 1962 President Kennedy’s Council of Economic Advisers suggested a set of wage-price “guideposts” for unions and businessmen. The Council suggested that if unions and businesses would adhere to these guideposts, aggregatedemand policy by the government could bring full employment and prosperity without inflation. The Council didn’t suggest government action to force unions and businesses to adhere to the guideposts, but it did urge them as useful guides to private behavior.

In essence, the guideposts suggest that annual wage increases in all industries should roughly equal the average increase in output per man hour in the economy. With such wage increases, prices of final products should be kept stable. Bigger wage increases would be inflationary, while smaller ones would give an undue share of the benefits of increasing productivity to profits. The guideposts were based on the general position that wage rates should behave about as they would in a highly competitive market where supply and demand would tend to produce wage increases equal to increases in “productivity.”

Consider a simple example. Assume a stable population and an economy where all income goes to wages and profits. Total output is $300, of which wages are 2/3 and profits ฝ. Now suppose the total output increases by 3 per cent (that is, $9), and that wages are increased by 3 per cent, as suggested by the productivity guidepost. Wages will now rise by $6 (that is, 3 per cent of $200), leaving $3 for increased profits (that is, 3 per cent of $100). Thus, the average-productivityincrease guide would increase both wages and profits by the same -percentage, maintaining whatever distribution of income prevailed before. It is important to see that increasing wage rates in proportion to productivity increase does not mean that all of the increase goes to labor, although this is a commonly held misconception.

Since 1962 the guideposts have been the source of violent disagreement. The critics make three main points.

First, if you don’t think the present income distribution between wages and profits is fair, preserving it won’t be very attractive. Many union members believe that profits are already ex orbitant. Many businessmen believe profits are already too low. And at any time individual wage rates in particular firms or industries may be unfairly out of line, too high or too low.

Second, fixed-income people—the pensioners and old people—would like to see prices decline with advancing productivity, since unless prices fall they don’t share in the fruits of progress.

Third, and most important, both unions and businessmen told the government to keep its nose out. They wanted no government control, and rebelled at the idea that they shouldn’t take full advantage of their competitive positions, though some were reluctant to’say so publicly. If productivity rises 5 per cent annually in the auto industry, the auto workers are understandably reluctant to settle for only a 3 per cent wage increase, just because productivity elsewhere has increased less than theirs. If you were head of the auto union, would you agree to take a 3 per cent increase when by hard bargaining you could get 5? If you were president of General Motors, would you reduce prices just because the guideposts say that this is desirable when you believe you’ll make bigger profits by keeping them up? Would you take a costly strike to hold wages down to help the nation fight inflation, when there’s plenty of demand to support higher prices for autos?

Guideposts that ask unions and businesses to forego private gain for the national good, without any government enforcement mechanism, obviously face serious problems. And few Americans want the government to have power to set individual wages and prices. Some guidepost advocates urge government intervention in patternsetting wage bargains, and pitiless government publicity on inflationary wage and price behavior. But often such informal pressure hasn’t been very effective, and the step from it to actual governmental dictation of key wage and price settlements is a short one. Nearly everyone agrees that the guidepost results are sensible, but how to achieve them is another story.