Paul Mattick’s article on the demise of deficit hawkishness in the October Field Notes stimulated the following letter of criticism, for which we are grateful, as we are for any public discussion of issues raised in the section.
The article “Money Magic” in the October Field Notes explains the “stagflation” of the 1970s by arguing that the extra tax and interest charges imposed on businesses by government deficit spending meant that “businesses defended their bottom lines by raising prices” with the result that “prices increased throughout the economy as different business sectors struggled to make others pay the costs of the debt: the dread stimulus-induced inflation.” This would seem to be endorsing the view that inflation—as a rise in the general price level, i.e. a rise of all prices together without changing the price of goods relative to each other—is caused by capitalist firms raising the prices of what they sell.
The explanation offered as to why quantitative easing (QE) has not led to inflation also seems to accept this theory, in the opposite sense that, due to the stock exchange boom it causes, “there is no motivation to raise prices—especially under the deflationary conditions of a global business slowdown—producing an inflation-free expansion.”
In both cases, the explanation is based on the same assumption: that businesses can fix at will the price of what they are offering for sale. In the one case, they chose to exercise it; in the other they chose not to. So, it’s as a result of different business decisions that Keynesianism led to inflation but QE doesn’t.
This explanation doesn’t hold up. In fact, it is somewhat self-contradictory, as one of the reasons given why QE has not resulted in inflation is that businesses had no motivation to increase prices “especially under the deflationary conditions of a global business slowdown.” Yet this is the situation that existed when Keynesian policies were applied and to which businesses are said to respond by increasing their prices.
Businesses fix prices by what the market for their product will bear, i.e. the highest price they can get that will secure them the largest profit; if they fix it above this level they will lose sales to their competitors, and if they fix it below they will not be making as much profit as they could. This means that, if the market will not bear it, they cannot raise their prices without jeopardizing their sales and profits. Sometimes they may be able to raise them without doing this, sometimes they can’t; it all depends on market conditions. In any event, not all businesses will be able to do it at the same time and so bring about a rise in the general price level.
Inflation, as the word indicates, originally meant a rise in the general price level caused by a government issuing too much of an inconvertible currency in relation to what the economy requires. But it has now come to mean any rise in the price level, whatever the cause. For instance, in a boom the price level tends to rise because overall demand tends to run ahead of supply. In a slump, it’s the other way around, and there’s a tendency for the price level to fall—a reason why, in those circumstances, businesses won’t be able to raise their prices in response to increased taxation or higher interest charges.
So, to return to Keynesianism and QE, what caused a general price rise in the one case but not in the other?
Keynesianism applied in a slump leads to inflation to the extent that the extra government spending is financed by it creating more money than the economy requires (if it isn’t more than this there won’t be a rise the general price level); this depreciates the currency, which is reflected as a rise in the price of all goods. As the government spending does not in fact stimulate the private profit-making sector the result is stagflation, continued stagnation accompanied by inflation.
QE has not led to inflation (as a rise in the general price level) because, although the government has created more “money,” this is in the form of extra reserves that the commercial banks keep with the central bank. The government does not spend anything into the economy and so there is nothing to translate into more currency than necessary in circulation. However, it does lead to an increase in the price of government bonds (as it involves the government buying them) and, later, in the price of shares and corporate bonds (as the rise in government bond prices, which lowers their yield, makes investing in shares and their dividend yields more attractive in comparison). So the rise in prices is limited to stocks and shares while the rest of the economy remains unaffected, and not because businesses don’t feel the need to increase prices.
–Adam Buick, London
Paul Mattick responds:
Adam Buick accepts the monetarist explanation of inflation as due to an excess of money relative to economic growth, the 20th-century version of what in the 18th century was called the quantity theory of money (roundly criticized by Karl Marx in his own theory of money). This conception is a natural correlate to the idea that, apart from distortions due to governmental monetary policy, prices are normally set by “what the market … will bear” as businesses compete for maximum profits.
The reality of business life is not as simple as this picture suggests. Prices are affected by a multitude of factors besides supply and demand, including subsidies, quasi-monopoly positions of producers, and international exchange rates, as well as government credit and money policies. To take some recent extreme examples: Amazon, founded in 1995, did not make a profit until 2001, devoting its efforts in the meantime to driving other book purveyors out of business by keeping its prices ultra-low. Uber has followed this model, regularly posting multibillion dollar quarterly losses. On the other hand, prices (and profits) in the healthcare sector have risen steadily thanks to a complex system of government subsidy and other forms of business protection. To return to the stagflation years, the increased price of oil engineered by Organization of the Petroleum Exporting Countries (OPEC) in 1973—almost 10 years after a decline in corporate profits had become visible—was transmitted throughout the fossil fuel-based economy, despite the serious downturn often blamed on the “oil shock.” In 1974, while the recession was in full flood, according to the US Department of Commerce 60 percent of profits of American firms were “inventory profits,” measured by the difference between the prices paid for materials used and the (increasing) prices of finished products.
During the post-World War II period government economic policy became an increasingly important aspect of the capitalist economy, affecting the workings of the market mechanism (which had never really existed as a pure phenomenon). Worried about a resurgence of social unrest should unemployment and other forms of social misery increase too much, governments continued the expansionary monetary and fiscal policies evolved during the Depression and the war. In Europe, much government spending took the form of an enlarged welfare state, while the US put its money more into war and production for war, which combined an enlargement of production with keeping the world safe for democracy. Production for government use—although it merely redistributed already-produced profit to favored companies—maintained sufficient demand for business in general, experiencing declining profits and taxed to pay for government spending, to raise prices competitively in an attempt to boost bottom lines. Contrary to Adam Buick’s conception of inflation, all prices do not rise simultaneously, and in particular the price of labor power, wages, rises more slowly than commodity prices, improving business profitability.
At the present time, in contrast, already very low wage rates, historically low rates of business taxation, and a stagnant, low-growth economy have removed earlier “cost-push” reasons for price increases for many firms. Hence we have an expansion of the money supply, this time feeding financial speculation rather than industrial production, with a low level of general inflation.