Abstract
Demand Inflation: “Too much money chasing too few goods”. An increase in effective demand beyond the point of full employment (excess demand) causes prices to be bid up; the resulting profit opportunities cause wages also to be bid up by the competition of employers; this means (in money terms) still more demand; and so a cumulative inflation.
“It is a difficult thing (I confess) to discern these causes whence they come, and amidst such variety to say what the beginning was. He is happy that can perform it aright”.
—Burton (“The Anatomy of Melancholy”).
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Notes
- 1.
If composition is perfect, supply price equals marginal prime cost, and contains (at a margin) no clement of profit. Otherwise, supply price exceeds marginal prime cost of a percentage of marginal profit which depends on the “degree of monopoly”, as determined by the competitive structure of industry, and is likely to be fairly stable (See Kalechi and Lerner. Keynes takes as given “the degree of competition”, but does not say what is meant by this).
- 2.
This is because in a closed economy inter-firm transactions in raw and semi-processed materials cancel out, and all production can be regarded as the output of labour working in an environment of natural resources and equipment. Keynes' “marginal user cost” and other minor elements in marginal prime cost are neglected, and these are assumed to be no indirect taxes.
- 3.
Cost inflation may or may not be associated with a growth of unemployment, depending upon whether the money total of effective demand is increased in proportion with the price-level.
- 4.
This applies at least for an increase in effective demand. If (as Keynes usually supposes) money wages are rigid against downward pressure, then a decrease in effective demand would reduce the volume of output and employment rather than the money wage-level and the price-level. On this view, the “critical” level of effective demand shifts continually upwards in the course of a demand inflation, which is therefore never reversible without unemployment. This is Keynes' famous “asymmetry” (p. 303).
- 5.
In a “composite” inflation, such as the Australian post-war inflation was supposed to be, the influences of the two contrary time-lags would tend to offset each other.
- 6.
Measured in terms of the (general) price-level.
- 7.
There is no need at this stage to define the “general price-level” more precisely—for example, to specify whether it relates only to goods and services sold on the home market, or includes exports as well. Provided that it includes both home wage cost and external elements, and provided that real wages are measured in terms of the “general price-level”, however defined, the argument in this and the next few paragraphs will always hold good.
- 8.
It is not suggested that this is an ultimate statement of the determinants of real wages. Depending on what assumptions are made about the economic system as a whole, there may be various restrictions imposed on the manner in which the money wage-level can vary in relation to the external price-level—restrictions connected notably with the balance of payments and the terms of trade. The point relevant at present is merely that this ratio, as well as productivity is inevitably involved in any movement of real wages in an open economy.
- 9.
Let P be the general price-level, W the money wage-level and M the marginal productivity of labour (as before), and let E be the external price-level, all on the base unity. Let a and b be fractions of unity representing the appropriate weights of home wage cost and external prices in the general price-level. Then—
$$P = a\frac{W}{M} + bE$$(1) - 10.
Of course we have known these truisms (in less elaborate and laborious terms) all along.
- 11.
In any event, it would be necessary to ensure that the influence on the price-level of (a) and (b) was not offset by a rise (or too great a rise) in real wages. See Eq. (3) of the footnote to paragraph 8.
- 12.
See paragraph 2 above. The catalogue was: “curtail demand, increase supply, and instill (or knock) a sense of responsibility into the Trade Unions”.
- 13.
The quarterly figures for U, V, W and P are from the official indices (except for December Quarter, 1949, which is in some cases an estimate), but those for T and M are rough interpolations.
- 14.
The index of Z is (in effect) calculated on the base 1938–1939 = unity, and then converted to the base 1945–1946 = unity. The 1938–1939 weights are derived from Table I (above), and are the ratios of items (1), (2), (3) and (4), respectively, (in the Outlay column) to total Prime Costs. The 1945–1946 weights are these ratios, varied in accordance with the movement of the relevant index numbers between 1938–1939 and 1945–1946, and again expressed as fractions of unity. The results would not be significantly different if 1948–1949 were chosen for weighting.
- 15.
Very roughly, it may be estimated that in the Australian economy, instead of a proportional relationship between money wages and the price-level, as in a closed economy, there is a proportional relationship between real wages and the price-level (import prices, rural prices, indirect taxes and productivity being taken as constant). Wage cost has a weight of about 50%, so a change of 10% in money wages means a change of about 5% in the price-level and therefore a change of about 5% in real wages also. This assumes, of course, that real wages are measured in terms of the price-level as we have defined it. In a true Consumer Price-Level, wage cost would have a somewhat smaller weight, chiefly because of the inclusion of dwelling rents and the greater relative importance of rural products. In terms of the Consumer Price-Level, therefore a more than proportional change in real wages is likely to be associated with a change in prices.
- 16.
Such is the paradox to which we are led by our usual argument that wage increases are “inflationary”. The influence of the Arbitrations system on the actual level of earnings should not be too highly discounted. Since 1938–1939, average earnings have risen only 7% more than Award Wages (Nominal Wages, Adult Males), and since 1945–1946 scarcely at all. Award Wages in turn, have risen only 8% more than the Basic Wage since 1938–1939, and only 3% more since 1945–1946. Further, it is much easier for earnings to depart from the trend of Awards upwards than downwards.
- 17.
Or its equivalent in terms of some combination of exports “stabilization” charges, home consumption prices and import subsidies.
- 18.
The figures square generally with H.P.B.’s February “preview” of the 1949–1950 National Income estimates, except that exports and rural income have been reduced by £60–80 m., to eliminate the effect of the export of wool from stock and of the exceptional wheat harvest. This is desirable if the Table is to serve as a base for examination of further changes. There are also some minor adjustments made to ensure internal consistency. In addition, there are some differences of definition. For present purposes, it is convenient to include with the wages bill the imputed wages of working proprietors engaged in Industrial and Commercial Enterprises (£180 m) and in the group of rural enterprises described as “Home” enterprises (£30 m); hence the total wage and salary incomes shown are £210 m higher than H.P.B.’s estimates. No wages have been imputed to working proprietors in “export” rural enterprises. The transactions of financial Enterprises are included with those of Public Authorities.
- 19.
The system of income tax rates is assumed to be given, as in Table 12.5.
- 20.
Perhaps with some time-lag, which is of course irrelevant to the equilibrium situation.
- 21.
It is quite conceivable that, over a certain range of variation of wages, the positive influence of Eq. (2) on aggregate demand might outweigh the negative influence of Eq. (3). But if wages rise high enough they must inevitably reach some point at which all exports have disappeared and import competition is overwhelming; and it some probably that ordinarily (3) would be more powerful than (2). Nevertheless, this possibility does raise the interesting point than an “equilibrium” full employment position itself, in relation to wages, might in some circumstance be a position of unstable equilibrium, in which a rise in wages, would (for a time) cause excess demand to emerge, and so force wages even higher; while a fall would cause unemployment.
- 22.
Or if indirect taxes and rents are falling.
- 23.
Except to the extent that “backlogs” of investment may not accumulate, and the public's liquidity may be reduced.
- 24.
E.g. part I (passim), or Part II (especially paragraph 34).
- 25.
- 26.
A policy of the “full employment without inflationary pressure”, or Blondinian variety.
- 27.
i.e. The effect of price movements on the cost of the present real volume of Government expenditure is likely to be roughly offset by tax receipts corresponding with the associated income changes; net borrowing will, of course, need to be increased if a greater real volume of expenditure is to be financed.
- 28.
At least they should be ruled out unless they also imply a big decline in real incomes other than wages, especially from incomes.
- 29.
In “investment” we shall henceforth include not only private investment but also public authority expenditure on goods and services.
- 30.
We speak of imports, and of the relative prices level in relation to import prices, because in practice the bulk of any increase in the surplus of imports over exports must take the form of increased imports, in view of the well-known rigidity of the volume of Australian exports (in the short run at least, and apart from the seasons).
- 31.
Provided that import prices change proportionally with export prices, which they do—more or less—with appreciation, but do not in the course of the trade cycle.
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Swan, P.L. (2022). T. W. Swan: “The Anatomy of Inflation”. In: Trevor Winchester Swan, Volume I. Palgrave Studies in the History of Economic Thought. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-031-13737-2_12
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