More on Inflation: Reply

Author(s): James Tobin

Reviewed work(s):
Source: Journal of Money, Credit and Banking, Vol. 5, No. 4 (Nov., 1973), pp. 982-984
Published by: Ohio State University Press
Stable URL: http://www.jstor.org/stable/1991113 .
Accessed: 03/10/2012 10:45
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp
.
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.
.
Ohio State University Press is collaborating with JSTOR to digitize, preserve and extend access to Journal of
Money, Credit and Banking.
http://www.jstor.org
More on Inflation
A Reply by James Tobin
The virulence and stubbornness of inflation in the United States, and indeed
throughout the world, has been a nasty surpnse to most economists, certainly in-
cluding me. Events of the past seven years seem to deviate markedly from the rela-
tionships, econometric and informal, inferred from previous observations. If it all
happened according to an advance script of Mr. Tullock's, then he and his analysis
deserve great credit and credence. l
A common hypothesis, not Mr. Tullock's, is that it never would have happened in
the United States if Lyndon Johnson had not opened Pandora's box. His rapid
escalation of Vietnam war spending without taxes to match violated the fiscal pre-
cepts of economists of all schools, including his own advisers. It drove the unem-
ployment rate far below anything experienced for fifteen years and far below the
government's own target of 4 percent. In this unexplored territory, the Phillips
curve proved steeper than expected, and subsequently the inflation entrenched by
high-pressure war years proved much more resistant than expected to relaxation of
demand pressure and recession. Nevertheless, the presumption would be that in the
absence of Vietnam and Johnson's fiscal policy, the dimensions of our inflation-
unemployment problem would not be greatly different from those of 1953-1965.
A second hypothesis, which complements and modifies the first, is that the struc-
ture of labor markets and of the labor force changed adversely during the sixties.
Dispersion among labor markets increased; given that wages respond more to excess
demand than to excess supply, an increase in dispersion adds to overall inflationary
bias. At the same time the labor force, especially the unemployed, became more
heavily weighted with teenagers, women, and other workers who spend more time
in voluntary job search than do primary breadwinners and have less effect on wage
setting.
A third hypothesis is that inflation is merely one economic symptom of a general
disintegration over the past seven years of the bonds of social consent and trust.
Economic and political interest groups have obtained and exercised new power to
enlarge and protect their members' incomes. Disillusionment with the fairness of
government and of competing groups has weakened the legal, moral, and political
constraints which previously held this process within tolerable bounds. Inflation
arises because the powers of the various interest groups are mutually inconsistent;
lGordon Tullock, "Inflation and Unemployment: The Discussion Continued," Joarnal of
Money, Credit, and Banking, 3 (August, 1973) 826-35.
James Tobin is Sterling Professor of Economics at Yale University.
COMMENTS AND REPLIES: 983
their income claims exceed the nation's capacity to produce. There is no residual
group so weak that it has to acquiesce to the share the others would leave for it
without fighting back in some political or economic arena. In this view, the same
disintegration has undermined the social contract in noneconomic contexts, ex-
emplified by racial, ethnic, and intergenerational conflicts and by the readiness of
many of the participants to pursue them by means outside the conventional rules of
the game.
Mr. Tullock's explanation is different from all of these. He attributes the ex-
perience since 1966 to the whole history of demand management since 1930, not
especially to the war finance of the Johnson Administration or to other con-
temporaneous events. Repeated use of Keynesian medicine, encouraged by the
fallacy that fiscal (and monetary?) policy can and should aim at a full employment
target, was bound to trigger an explosion of inflationary expectations sooner or
later. Since continuous causes could have delayed and discontinuous "threshold"
effects, we cannot reject Mr. Tullock's claim that our recent troubles are to be at-
tributed not to contemporaneous events but to a cumulative history.
But Mr. Tullock has not provided very convincing evidence for his view. He gives
us an admittedly "unoriginal" recapitulation of the natural rate or accelerationist
argument in its most rudimentary, aggregative, and equilibrium form. (His excuse is
that I need such instruction.) The scatter diagrams can hardly be considered a sig-
nificant addition to the voluminous, sophisticated, econometric work that has been
published on the subject. They tell us that the trade-off has worsened, but they
don't tell us why.
Is there any rate of unemployment which will be consistent, in the short or long
run, with zero inflation or with any other stable rate of inflation? If so, does that
amount of unemployment represent an economically efficient use of manpower?
Does it represent a socially tolerable and viable state of affairs? If the answer to any
of these questions is negative, what structural policies can enable us to escape from
the impasse? Mr. Tullock does not tell us his answers. His major recommendation
appears to be abandonment of the use of fiscal and monetary policy to manage ef-
fective demand. Presumably he has in mind a "neutral" fiscal and monetary policy,
which persistently pursued will eventually cause unemployment to gravitate to its
natural or equilibrium rate without inflation, or anyway, without accelerating
inflation.
He does not tell us what this neutral policy would be. He is discussing my
Presidential address, but he does not consider my point that the zero-inflation un-
employment rate is neither wholly voluntary nor optimal. Nor does he discuss my
suggestion that unemployment, wage inflation, and Phillips trade-offs are phe-
nomena of persistent but shifting sectoral disequilibrium, not to be understood by
equilibrium macroeconomics which treats the economy as a single labor and product
market. He regards evaporating money illusion as the obvious explanation of the
fact that the long-run Phillips curve is steeper than the short-run curve, and says that
the "relative wage" model of my address cannot account for this phenomenon. But
that model does allow for a "wage-wage" feedback: wage increases in some sectors
984: MONEY, CREDIT, AND BANKING
are transmitted to others by emulative patterns as well as via cost of living effects.
The model therefore "predicts" that sustained high demand pressure will shift the
Phillips curve upward and tilt it toward the vertical. It also points out the essential
instability that concern for relative wages contributes to the overall rate of wage
inflation.
Mr. Tullock wonders at the absence of topical policy prescriptions in the ad-
dress. Apparently he regards the New York Review of Books as the place for theory,
and the American Economic Review and this journal as the places for discussions of
current policy. In any case, I must admit to considerable puzzlement and uncer-
tainty. While wage and price controls through 1972 worked better than I had
anticipated, their relaxation in 1973 was followed by more inflationary pressure
than I expected. So I agree with Mr. Tullock's conclusion that "we face a really very
difficult problem" and with his suggestion that "we concentrate our efforts on find-
ing a way out." I am glad to see these signs of humility in Mr. Tullock, for, as
Mr. Ross and I indicated in our earlier reply to him, we all have a lot to be humble
about. No one can be very confident of any diagnosis of the sources of inflationary
bias in the modern world or of any prescriptions for dealing with them.
Mr. Tullock's ire was originally directed at a short, topical piece on inflation and
economic policy which Leonard Ross and I published in the New York Review of
Books. In our reply we tried to indicate how the theory we had in mind differed
from his inferences. In my Presidential address, of which Mr. Ross is wholly in-
nocent,2 I attempted to give a more complete exposition of the theoretical frame-
work from which I approach these issues. I don't agree with Mr. Tullock that it is
basically different from the one underlying the Ross-Tobin pieces, but I can't
imagine who cares. The Presidential address, to which Mr. Tullock has now shifted
his attack, is I hope a more appropriate target for discussion in a professional
journal.
A final word. Mr. Tullock brings out that perennial touchstone, the minimum
wage, so frequently used to challenge and embarrass economists suspected of
"liberal" politics and/or trade union sympathies. I am against minimum wage
legislation and have said so.3 It diminishes job opportunities, ceteris paribus, and it
is an inefficient and haphazard tool for income maintenances or redistribution. At
the same time, it does contribute to the existence of a Phillips trade-off, at least in
the short run; this is because it makes for asymmetry in the response of wages to
changes in demand and in rates of inflation.
2So is Mr. Tullock, notwithstanding the insinuation of his footnote 3. The address was vir-
tually complete prior to my receipt, thanks to the courtesy of the editor of this journal, of the
first version of Mr. Tullock's blast- his comment did not influence the text.
3"0n Improving the Economic Status of the Negro," Daedalus, 94, No. 4 (Fall, 1965), Pro-
ceedings of the American Academy of Arts and Sciences.