Calimera Wrote:
Helsworth, I find your economic theory very interesting, even though I don't agree with you on many things economically.

But well, let's get to the point: I think you look to much at the Demand side of the economy and too little at the supply side. Some problems simply cannot be solved by increasing demand. Like when there is a situation of stagflation.

My whole argument is based on optimizing real terms of trade and domestic output. Excess aggregate demand beyond full output needs to be drained via taxation.
Stagflation is not a "natural" phenomenon; it's a political one.

Quote:
The ‘golden age’ from WWII was said to have ended around 1973. Inflation and employment was remembered as relatively low, productivity high, the American middle class thriving.

Why? Keynes was sort of followed. The Kennedy tax cuts come to mind. But also of consequence and ignored was the fact that the US had excess crude production capacity, with the Texas Railroad Commission setting quotas, etc. to support prices at maybe the $2.50-$3.00 price range. And stable crude prices, though maybe a bit higher than they ‘needed’ to be, meant reasonable price stability, as much was priced on a cost plus basis, and the price of oil was a cost of most everything, directly or indirectly.

But in the early 1970′s demand for crude exceeded the US’s capacity to produce it, and Saudi Arabia became the swing producer, replacing the Texas Railroad commission as price setter. And, of course, price stability wasn’t their prime objective, as they hiked price first to about $10 by maybe 1975, which caused a near panic globally, then after a too brief pause they hiked to $20, and finally $40 by maybe 1980.

With oil part of the cost structure, the consumer price index, aka ‘inflation’, soared to double digits by the late 70′s. Headline Keynesian proposals were largely the likes of price and wage controls, which Nixon actually tried for a while. But it turned out the voters preferred inflation to their government telling them what they could earn (wage controls on organized labor and others) and what they could charge. Arthur Burns had the Fed funds rate up to maybe 6%. Miller took over and quickly fell out of favor, followed by tall Paul in maybe 1979 who put on what might be the largest display of gross ignorance of monetary operations with his borrowed reserve targeting policy. However, a year or so after the price of oil broke as did inflation giving tall Paul the spin of being the man who courageously broke inflation. Overlooked was that Jimmy Carter had allowed the deregulation of natural gas in 1978, triggering a massive increase in supply, with our electric utilities shifting from oil to nat gas, and OPEC desperately cutting production by maybe 15 million barrels/day in what turned out to be an unsuccessful effort to hold price above $30, as the supply shock was too large for them and they drowned in the flood of no longer needed oil, with prices falling to maybe the $10 range where they stayed for almost 20 years, until climbing demand again put the Saudis in the catbird seat. Meanwhile, Greenspan got credit for that goldilocks period that again was the product of stable oil prices, not the Fed.

So back to the 70′s, and continuous oil price hikes by a foreign monopolist. All nations experienced pretty much the same inflation. And it all ended at about the same time as well when the price of crude fell. The ‘heroes’ were coincidental. In fact, my take is they actually made it worse than it needed to be, but it did ‘get better’ and they of course were in the right place at the right time to get credit for that.

So back to the 70′s. With the price of oil being hiked by a foreign monopolist, I see two choices. The first is to try to let there be a relative value shift (as the Fed tries to do today) and not let those price hikes spill into the rest of the price level, which means wages, for the most part. This is another name for a decline in real terms of trade. It would have meant the Saudis would get more real goods and services for the oil. The other choice is to let all other price adjust upward to keep relative value the same, and try to keep real terms of trade from deteriorating. Interestingly, I never heard this argument then and I still don’t hear it now. But that’s how it is nonetheless. And, ultimately, the answer fell somewhere in between. Some price adjustment and some real terms of trade deterioration. But it all got very ugly along the way.

It was decided the inflation was caused by unions trying to keep up or stay ahead of things for their members, for example. It was forgotten that the power of unions was a derivative of price power of their companies, and as companies lost pricing power to foreign competition, unions lost bargaining power just as fast. And somehow a recession and high unemployment/lost output was the medicine needed for a foreign monopolist to stop hiking prices??? And there was Ford’s ‘whip inflation now’ buttons for his inflation fighting proposal, and Carter with his hostage thing adding to the feeling of vulnerability. And the nat gas dereg of 1978, the thing that actually did break the inflation two years later, hardly got a notice, before or after, and to this day.

As today, the problem back then was no one of political consequence understood the monetary system, including the mainstream Keynesians who had been the intellectual leadership for a long time. The monetarists came into vogue for real only after the failure of the Keynesians, who never did recover, and to this day I’ve heard those still alive push for price and wage controls, fixed exchange rates, etc. etc. in the name of price stability.

So in this context the rise of Thatcher types, including Reagan, makes perfect sense. And even today, those critical of Thatcher type policies have yet to propose any kind of comprehensive proposals that make any sense to me. They now all agree we have a long term deficit problem, and so put forth proposals accordingly, etc. as they are all destroying our civilization with their abject ignorance of the monetary system. Or, for some unknown reason, they are just plain subversive.

Thatcher?
It was the blind leading the blind then and it’s the same now.
And that’s how I remember it/her.
And i care a whole lot more about what happens next than about what happened then.

~Warren Mosler


Stagflation in the 1970s: A Post Keynesian Analysis

The portmanteau word “stagflation” (stagnation + inflation) refers to the economic problems of the 1970s. We need a clear definition of stagflation, and there are in fact two senses in which it is used:
(1) the simultaneous occurrence of stagnation (low or no growth) and high inflation (the original definition of the term when it was coined by Ian Macleod, in a speech to the British House of Commons, in 1965);

(2) the simultaneous occurrence of rising unemployment rates and rising inflation.
It is sense (2) in which the word is normally used in economics, and it describes high unemployment and high inflation rates (even during recessions) occurring simultaneously. Thus the years from 1975-1977 in the US were not technically stagflation: these were years of an expansion in the business cycle with disinflation (falling inflation rates), rising employment, and rising real output growth.

The most serious periods of stagflation were in 1973–1974/1975 and 1979-1981 when many countries entered recessions and experienced rising unemployment and rising inflation. In most countries, these severe years of surging inflation and unemployment were the result of the first (1973-1974) and second oil shocks (1979-1980), and the double digit inflation rates in many countries (though not all) that provoked the sense of crisis in these years were caused by the high price of energy, a major factor input. But it is also true that from 1968–1970 many countries experienced an unusual rise in wages and prices, with further surges in prices from 1972-1973 before the first oil shock hit their economies. This requires an explanation.

There is no doubt that the era of stagflation was a theoretical and practical problem for neoclassical synthesis Keynesians, with their flawed Hicksian IS-LM models.

But Post Keynesians never had any difficulty explaining stagflation and offering effective cures for it. In particular, Geoff Harcourt explains in the video below (from 20.00 minutes onwards) how Keynes’s General Theory was easily capable of showing that rising unemployment can occur with rising inflation. Harcourt also talks about Lorie Tarshis and his textbook summary of Keynes’s General Theory for American universities in the 1940s, which was attacked by conservatives. Tarshis’s accurate summary of Keynes was rejected for Paul Samuelson’s neoclassical version of Keynesianism (the neoclassical synthesis), and if Tarshis’s book on Keynes had been used instead of Samuelson’s textbook, many of the theoretical problems of neoclassical synthesis Keynesianism would have been avoided.



One of the best analyses of stagflation is by Nicholas Kaldor:
“Inflation and Recession in the World Economy,” Economic Journal 86 (December, 1976): 703–714.
My analysis here is based on Kaldor and other Post Keynesian work.

When we buy many commodities we do not engage in some kind of haggling over price in each individual transaction, or compete with others to bid for a product as in an auction, nor do the prices of many commodities change even though demand has changed. For example, when you go to the supermarket, you do not see daily or weekly fluctuations in the price of milk or bread in accordance with demand for, and sales of, those commodities.

Real world capitalism has developed numerous markets where prices are not set, or explicable, by demand and supply curves. Instead, prices can be (1) administered by business institutions or (2) cooperation between businesses that produce commodities (the familiar concepts of monopoly, oligopoly and cartels). But modern corporations are often institutions that also administer prices, and prices can be stable or unchanged for significant periods of time. Nor do they not respond immediately to demand or sales fluctuations:
“In studies of price determination, business enterprises have stated that variations of their prices within practical limits, given the prices of their competitors, produced virtually no change in their sales and that variations in the market price, especially downward, produced little if any changes in market sales in the short term. Moreover, when the price change is significant enough to result in a significant change in sales, the impact on profits has been negative enough to persuade enterprises not to try the experiment again. Consequently administered prices are maintained for a variety of different outputs over time … The pricing administrators of business enterprises maintain pricing periods of three months to a year in which their administered prices remained unchanged; and then, at the end of the period, they decide on whether to alter them.” (Lee 2003: 288).
What disturbs this?

The price of commodities produced in an economy depends on the costs of factors of production, in particular the wage bill, and then the mark-up over the costs of factor inputs (Musella and Pressman 1999: 1100).

The factors of production are
(1) primary commodities or natural resources, including land, raw materials, water, and energy;
(2) labour, and
(3) capital goods.
Thus inflationary pressures can result from
(1) surges in the prices of primary commodities or energy, especially when the prices of these factor inputs are set on world markets or are influenced by supply shocks;

(2) workers pushing for wage rises, and

(3) business firms increasing their pricing mark-ups.
A vicious circle can result when (a) workers demand wage rises and then (b) firms increase their mark-ups, causing a circle of (a), (b) etc. The distinction must also be made between (1) demand-pull inflation, and (2) cost-push inflation, when the latter has a supply-side cause.

During the most of the Golden Age of Capitalism (1945–1973), primary commodity buffer stocks had ensured price stability. But this policy was changed in the 1960s when the US modified its buffer stock polices:
“… the duration and stability of the post-war economic boom owed a great deal to the policies of the United States and other governments in absorbing and carrying stocks of grain and other basic commodities both for price stabilisation and for strategic purposes. Many people are also convinced that if the United States had shown greater readiness to carry stocks of grain (instead of trying by all means throughout the 1960s to eliminate its huge surpluses by giving away wheat under PL 480 provisions and by reducing output through acreage restriction) the sharp rise of food prices following upon the large grain purchases by the U.S.S.R. [in 1972–1973], which unhinged the stability of the world price level far more than anything else, could have been avoided.” (Kaldor 1976: 228).
From 1968–1971 there were the beginnings of inflationary pressures, in both wages and prices in many industrialised nations. Around 1968–1969, this was reflected in wage rises in Japan, France, Belgium and the Netherlands, and from 1969–1970 in Germany, Italy, Switzerland and the UK, which Kaldor attributes to demands by unions for wage rises (Kaldor 1976: 224). There is of course an eternal struggle in modern capitalism between labour and capital over distribution of income, and sometimes this can get out of control. Post Keynesians recognise the need for some kind of control over wages in modern capitalism, when wage gains become excessive, and the method required is incomes policy of some type. This does not require hostility or opposition to trade unions, however, and Post Keynesian labour theory is, if anything, supportive of organised labour.

But the prelude to stagflation was also marked by a significant explosion in commodity prices that occurred in the second half of 1972. Part of the problem was the failure of the harvest in the old Soviet Union in 1972–1973 and the unexpectedly large purchases on world markets by the Soviet state. That was exacerbated by the uncertainty caused by the break up of the Bretton Woods system,
after Richard Nixon had ended the convertibility of the US dollar to gold on August 15, 1971, an event you can see Nixon announcing in the video below.



The end of Bretton Woods (the post-WWII international monetary system) was momentous: inflation expectations and instability on financial and commodity markets resulted, as well as a rise in commodity speculation as a hedge against inflation. This contributed to the cost-push inflation that was being felt in many countries after 1971. As Kaldor noted, this could have been averted had the United States not dismantled its commodity buffer stock in the 1960s.

The final factor that caused the severe inflation of the 1970s was the first oil shock from October 1973, when various Middle Eastern producers of oil instituted an embargo that lasted until March 1974 (Kaldor 1976: 226). In most countries, the double digit inflation of the 1970s was caused by the oil shocks. This fed into wage-price spirals in a number of countries.

A long-term solution to stagflation proposed by Kaldor was an international system of buffer stocks in major commodities. This could be used to raise commodity prices when they fell to too low a level by buying on the market (which would help incomes in developing nations and other producing nations), and to lower prices by selling into the market when prices were rising too high (Kaldor 1976: 228–229).

In short, Post Keynesian economics can easily understand and deal with stagflation. The wage-price spirals that broke out by the end of the 1960s in some industrialised nations could have been dealt with by incomes policy (national wage arbitration/wage-price controls), and the long-term solution was, and still is, an international system of commodity buffer stocks.

Source: http://socialdemocracy21stcentury.blogsp...esian.html