Seevers, Gary L.

English

Research Papers in Economics

CURRENT  ECONOMIC POLICY DILEMMAS
Gayi  L.  Seevers
Special Assistant to the Chairman
Council of Economic Advisers
I  wish  to concentrate  on today's  major  dilemmas  of  inflation
and unemployment.  This will lead us into several related dilemmas.
THE TRADE-OFF  FRAMEWORK
Almost everyone  is now familiar with the Phillips Curve  trade-
off  between  inflation  and  unemployment.  This  curve  can  be
envisioned by drawing a line through the most densely dotted areas
in  Figure 1, for example, through the dots representing  1969,  1967,
1964,  and  1963.  This  curve  shows  that  high  unemployment  has
been associated  with low inflation rates  and,  conversely,  that  low
unemployment  has  been  associated  with  high  inflation  rates.
According  to  this  widely  accepted  postulate,  one  goal  can  be
achieved on a sustained  basis only by sacrificing some of the other
one.  In this framework,  the dilemma confronting the policy maker
is  to weigh  the  benefits  from  reduced  unemployment  against  the
· 1951
*1948
6  _
*1970
*19691971
*1971
o
C  4-  *1968
1957
*1956
C  ^~~3  _  1967e
0  3
_'~-~  ~  1966.
0  *1958
2 - 1959
1965  //1960
1964®
1955e  19640  11954
1950 · · 1963  · 1961
1962
0
*1949
l  l  l  l  I
3  4  5  6  7
UNEMPLOYMENT  RATE
1952  and 1953  years  of Korean  controls  are  excluded
FIGURE  1.  Relationship  between  rates of unemployment  and inflation.
5costs of faster inflation,  and vice versa. The political process  must
balance these costs and benefits and arrive  at the "optimum"  com-
bination.  The political process  must also manage  fiscal and mone-
tary  policies to  achieve  the  objectives.
In  any one  period,  the  trade-off may be  temporarily  worse  or
better  than  the  average.  Recent  performance  of  the  economy,
inflationary expectations,  and structural  changes can  all move the
curve  and alter the trade-off.  Such factors make the curve unstable
and its  position  uncertain,  which  points  up  the pitfalls  in  placing
too  much  emphasis  on  a  two-dimensional  view  of the  economy.
It  is  the job  of economic  advisers  to  identify  the  achievable
combinations  in  any given  period,  and to recommend  the best  set
of policies to achieve  the objectives.  But in  the absence  of agreed
upon  social  preferences  between  inflation  and  unemployment,  it
is the job of the political process to pick the objectives.  Economists
can contribute  to the  selection  by  clarifying the  costs  of inflation,
and  the  costs  of unemployment,  and  it  is  not  at  all  uncommon
for  economists  to  place  their  own  values  on  the  costs  and  state
their  own  preferences.  In  the end  policy  makers  must  weigh  the
economic,  psychic,  and distributional costs of inflation and unem-
ployment.  Since  there  are  many  policy  makers,  and  they  weigh
each  cost  differently,  serious  conflicts  emerge  in  the  political
process.
The difficulty of obtaining less inflation  and less unemployment
at  the  same  time  has  rarely  permitted  the  economy  to  achieve
a satisfactory  balance.  This has given  rise to manpower  programs,
particularly when unemployment was high. It was thought that such
programs  could  improve  the  matching  of  skills  of  unemployed
workers  with the  requirements  of vacant jobs, and that they  could
improve  access  of the  hard-core  unemployed  to  the  mainstream
of productive  work.  In periods when  inflation was high, the search
turned  to  incomes  policies  and even  compulsory  controls.  Policy
makers  still  faced  a  dilemma.  Neither  manpower  policies  nor
incomes  policies  can  be  implemented  without  costs.  Manpower
programs  require  resources  to operate,  and  their  effectiveness  in
altering the  relationship  shown  on  the  Phillips  Curve  is  open  to
debate.  Incomes  policies on  a voluntary  basis  are of questionable
effectiveness,  and  compulsory  controls  diminish  individual  free-
dom  and can lead  to  serious  maladjustments  in the  economy.
Economists could identify other measures to improve the trade-
off  such  as  concentrations  of  economic  power,  import  quotas,
minimum  wage  laws,  and  a  whole  set  of protective  policies  and
regulations  in  transportation,  maritime  activities,  energy,  agricul-
6ture,  and  other  sectors.  Many  of these  proposals  would  reduce
the  level  of prices  (in  contrast  to  the  rate  of change)  and  make
better use of resources,  but they would also improve  the trade-off
between inflation and unemployment  on an interim basis. Altering
such policies,  however,  presented another dilemma because of the
large  political  costs  that  policy  makers  often  decided  were  too
heavy  to bear.
THE 1970-1971  EXPERIENCE
The combinations  of unemployment  and inflation that emerged
in  1970  and  1971  raised  another  dilemma that  was  more  serious
than the ones already mentioned. The trade-off became worse than
the economy had experienced for some  time. This raised the  pros-
pect  that the  Phillips  Curve  had  shifted,  perhaps  permanently,  to
an unacceptable  position (both high  unemployment  and high rates
of  inflation),  or  even  that  the  relationship  no  longer  could  be
depended  upon at  all.
Needless  to say, this experience  confronted  policy makers  and
their advisers  with new and challenging  dilemmas.  What has been
done  is  well  known.  The  Economic  Stabilization  Program  was
adopted  to  reduce  cost-push  inflation,  and  expenditures  on  man-
power programs  have  risen from $2.3  billion  in  fiscal  1969  to over
$5  billion this  year. These  were attempts to get back  toward more
acceptable  levels of inflation  and unemployment.
But  several questions  still  remain.  Is  there  any  such  thing  as
a  Phillips  Curve?  If there  is,  has its  position  changed?  What can
be  done  to  improve  the  trade-off?  These  are  questions  that  are
under careful  study  by groups  inside  and outside  government.
Two  explanations  of the apparent  Phillips Curve  shift  are  cur-
rently  popular.  First,  inflationary  expectations  have  become
ingrained  in  economic  behavior  so that  any given  unemployment
rate corresponds  to faster inflation.  Second, there  is evidence that
changes  in  the  composition  of the  labor force  have  caused  any
given inflation rate to correspond to a higher overall unemployment
rate.  Today's labor force  contains  a  higher  proportion  of women
and teen-agers  who typically have much higher rates of unemploy-
ment.  As  a  consequence  the  same  overall  unemployment  rate
would correspond  to  more  tightness  in  labor  markets  and greater
inflation.  Also  the  proportion  of the  labor  force  employed  in  the
public  sector is  growing  (although  not  in  federal jobs),  and along
with  substantial  wage  increases  this  may  have  affected  behavior
in  private labor  markets.
Another  school of thought  argues  that  there  is  no  permanent
7trade-off.  Instead  there  is  a  natural  rate of unemployment  which
depends  on  structural  impediments  in  the  economy  and  the
behavior of job seekers.  Policies to expand aggregate  demand  will
only  temporarily  reduce  the  unemployment  rate,  and  will lead  to
a higher rate of inflation  at the natural  rate  of unemployment.
IS THE PHILLIPS  CURVE  USEFUL?
A  promising line of work now under way  is the  effort to better
understand  the  behavior  of micro  labor  markets.  This  will  help
provide  a  theoretical  basis  for the  Phillips  Curve,  if a  stable  one
exists,  and  at  the  same  time  identify  labor  policies  to  improve
the  trade-off.  It  may  well turn  out,  for  instance,  that  manpower
programs  are  most  productive  in  periods of high  employment  and
should be aimed at tight labor markets rather than at the hard-core
unemployed.
Another question should be asked:  Is the Phillips Curve a use-
ful guide to policy? Here there are two problems.  First, the Phillips
Curve  is  clearly  unstable  in the  short  term,  and  therefore  it  is  an
uncertain  guide  to  what  the  economy  can  achieve  in  any  given
period.  Second,  it  places  the  emphasis  on  unemployment,  not
employment.  Year-to-year  policy  management  might  be  better
designed  by  a  guideline  that  stresses  expanding  employment,  but
without  increasing  demand  so rapidly  that  the  economy  becomes
overheated.  Critical  sectors  where  supply  restraints  loom  as
inflationary  threats  could  be  treated  on  an  ad  hoc  basis.  In  this
approach there may be particular periods  like the  mid-1960's  when
the  sensible  policy  would  be  to  curtail  the  growth  of aggregate
demand  so  that full  employment  is  approached  more  gradually  to
avoid  generating  demand-pull  inflation.  In  other  historic  contexts
like  the  recent  past,  temporary  controls  may  be  the  appropriate
remedy.
THE  DILEMMA  OF CONTROLS
This brings  me to  the "controls  dilemma."  While  prognostica-
tions  about their  future  differ  widely,  there  is  general  agreement
about  certain elements  that  gave  rise to  the controls.  This  agree-
ment  focuses  on  the  following  sequence  of events.  First,  fiscal-
monetary  policy  in  1966-1968  seriously  expanded  the  economy
beyond  its  limits  to  produce  and  generated  genuine  demand-pull
inflation.  Second,  a few  highly  visible  wage  settlements  triggered
a  sequence  of catch-up  wage  settlements.  Third,  rapid  inflation
became  anticipated  and  was  built  into  behavior  throughout  the
economy.  This  propelled  the  rapid  rise of wages  and  prices  even
after  excess  aggregate  demand  had  subsided.  Moreover,  this
dynamic  process  was  compounded  by  structural  factors  such  as
8protective  institutions  for  organized  labor  and  a  host  of
government-sanctioned  protections  for  particular  sectors  of  the
economy.  The  popular  proposition  that  concentrations  of  eco-
nomic  power  caused  inflation  has  much  less  support,  largely
because  this  is  not  a  new  element  in  the  economy.  There  is,
nevertheless,  some  support for the view  that concentrated  groups
were  more  prone to  use  their  position than  in  the  past.
If this  is  an  accurate  characterization  of what  happened,  we
can draw  several conclusions  about future  economic  policy.  First,
aggregate  demand  policy  should  not  expand  the  economy  so fast
that full employment  is exceeded,  or even  approached too  rapidly.
This will  require  new  restraint  in  financing  federal  programs.  The
current  annual  appropriations  decisions  are  made  one by  one  and
usually add up to more than was originally envisioned  as desirable.
And  new  programs  are  enacted  without  any  systematic  review
of their budgetary implications for future years.  As a consequence,
the  uncontrolled  element  in the federal  budget  grows almost with-
out  limit.
Second, there may well be  a place  for a permanent  pre-emptive
mechanism  for dealing  with excessive  wage  settlements  and price
increases  in  the  private  sector,  and  perhaps  even  in  the  public
sector.
Finally, inflationary  expectations  have to be reduced to achieve
greater  price  stability,  and this will  itself require  a  period of price
stability.  The  current  "food  price  dilemma"  demonstrates  the
enormity ofdealingwith inflationary expectations. Perhaps more than
in any other sector, market forces determine the price of food. In the
past nine months these forces, with some restraint from the controls
program, have generated food price increases at slightly higher than
a 4 percent annual  rate. This  is not exorbitant,  although  it is faster
than  nonfood  items.  Historically  food  prices  have  increased  at
about the same rate as overall consumer prices,  and I would expect
food  price  increases  to taper off within the next year.
In  the  meantime,  food  prices  seem  to  be  a  major  irritant  to
consumers.  Somehow  consumers  perceive  a  4  percent  rate  to  be
runaway  inflation.  The gap  between  reality  and belief is immense.
This  problem  is  magnified  by the tendency  of people  to give  con-
siderably  more weight to food  prices in forming inflationary  expec-
tations than their actual  expenditures  warrant.  There  is one bright
spot  in this dilemma.  Food  prices typically  level  off after a period
of  increases,  and  if  consumers  perceive  this  when  it  occurs,
inflationary  expectations  will  probably  begin  to  ease.
9SUMMARY
Let me summarize  by mentioning  four major  policy issues that
the next administration  will need to grapple  with,  no matter which
political  party  sits  in the  White  House.
1.  Demand  management.  Principles  and  procedures  need  to
be  developed  for  fiscal  and  monetary  policy  that  will  prevent
demand from growing too rapidly.  Discipline in the budgetary  pro-
cess will be  the key  element.
2.  Unwinding  the  controls.  The  administration  will  need  to
decide  what  form  the  next  phase  will  take  and  when  to  drop  or
modify the current control system which was intended to deal with
a unique cost-push  situation.
3.  Government  programs.  In  the  past,  government  programs
and  regulations  have  been  more  oriented  to  the  interests  of pro-
ducers  than  consumers.  In  the  future,  more  attention  should  be
given  to the price  effects  of government  decisions.
4.  The unemployment objective.  It will be necessary  to decide
what  level  of unemployment  is  consistent  with price  stability.  At
present we do  not know what level of unemployment  is consistent
with  price-stable  demand  management.  Clearly  some  level  of
unemployment  is voluntary,  but the government  has a responsibil-
ity to  improve  choices  of job seekers  so  they  can find  work more
easily.
10PART II
Who  Will Control
Agriculture?

CURRENT ECONOMIC POLICY DILEMMAS

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics