Phillips curve ; Monetary policy ; Inflation (Finance)

Henry C. Wallich

English

Research Papers in Economics

Insights
It seems you can hardly
pick up a paper or turn on the
news these days without see-
ing something about all the
efforts on Capitol Hill to rede-
fine the way Congress and the
president carry out their fiscal
responsibilities. The balanced
budget amendment. A line-
item veto. Legislation to limit
unfunded federal mandates.
When you stop and think
about it, you have to wonder
how things got so bad in the
first place.
Traditionally, Americans
have expected prudence in
government spending. The
government and public took
it for granted that budgets
should be balanced, except,
perhaps, in major emergencies
or extraordinary circum-
stances, such as war or depres-
sion. But once Keynes con-
vinced us that the budget was
a legitimate policy tool to be
manipulated to fine-tune the
economy, the moral commit-
ment to a balanced budget
withered away. I would argue
that much the same thing has
happened to our resolve
against inflation.
The advantages of price
stability, or a stable value of
the dollar, are many and var-
ied. Price stability is a worthy
goal in itself, and it also offers
the best financial environment
for achieving other important
FEDERAL RESERVE BANK OF DALLAS  VOLUME 1, NUMBER 1
national goals, such as maxi-
mum output and employment
growth. Since many of the
advantages of price stability
are self-evident, I am some-
what perplexed as to why the
constituency for it seems so
weak among the business
community and the public.
One gets the impression that
most people are content with
3-percent inflation, even
though the rule of 72 says that
prices will double every 24
years with 3-percent inflation.
It is true that 3-percent
inflation is good by the stan-
dards of the 1970s, and even
the 1980s, but it’s not so good
by earlier standards. Recall
that President Nixon declared
a national emergency and im-
posed price and wage controls
in 1971 when inflation had
climbed to the dangerous level
of 4 percent.
For much of our history,
sound money was imposed
externally by our commitment
to gold convertibility, directly
or indirectly. Going off the
gold standard in the early
1970s may have been the
smart thing to do under the
circumstances; it may even
have been the only alternative
at the time. I must admit,
however, that our experience
with price stability since then
has not been as good as it was
before.
One problem with our
national commitment to sound
money probably is the
progress we have made on
inflation since the 1970s. With
that experience fresh in our
minds, we willingly under-
went wrenching adjustments
in the early 1980s to break the
back of inflation. As progress
was made and our memories
faded, our determination has
waned. We have stopped
thinking of sound money as
honest money.
When our government is-
sues money, we have a right
to expect that money to be
worth tomorrow what it is to-
day. If that is too high a stan-
dard, shouldn’t we at least
try?  We have a right to expect
that what we save for our
children’s education or for
their inheritance will hold its
value. If you think about it,
government-issued money is
a contract with the people.
Inflation is taxation without
representation.
People wiser and more ar-
ticulate than I have given elo-
quent voice to my thoughts
about money. One was the
Rev. Robert Sirico, president
of the Acton Institute for the
Study of Religion and Liberty,
who addressed a group of
business leaders during a lun-
cheon at the Dallas Fed. He
spoke of the concept of hon-
est money as it is founded in
the Bible.
The other person who
stated the case for honest
money so eloquently was the
late Henry Wallich, former
college professor, columnist
and member of the Federal
Reserve Board of Governors.
He did so in a commencement
address 17 years ago. I find it
somewhat comforting that his
remarks still ring true today.
In this first issue of Eco-
nomic Insights, I am sharing
the honest money messages
of Father Sirico and Henry
Wallich. I’d enjoy hearing
what you think. Please write
me at the address on the back,
or fax me your thoughts at
(214) 922-5268. ª
Rediscovering the
Value of Honest Money
Bob McTeer
President and Chief Executive Officer
Federal Reserve Bank of Dallas
We have stopped
thinking of sound
money as honest
money. When our
government issues
money, we have a
right to expect that
money to be worth
tomorrow what it is
today. If you think
about it, government-
issued money is a
contract with the
people. Inflation is
taxation without
representation.
EconomicYet the case is much the
same when we are dealing
with monetary values.
 The moral issues posed
by inflation go beyond what I
consider deceit. Inflation is a
means by which the strong
can more effectively exploit
the weak. The strategically
positioned and well-organized
can gain at the expense of the
unorganized and the aged.
In the eyes of economists
and of government, inflation
becomes a means of exploit-
ing labor’s money illusion, its
supposed failure to anticipate
inflation correctly. The device
through which this mecha-
nism operates is the well-
known Phillips curve, the al-
leged trade-off between un-
employment and inflation. It
is believed that labor will re-
spond to a seemingly large
wage offer that subsequently
is eroded by inflation. If labor
fails to notice the trick, it will
keep working for less than it
really had demanded, and
employment will be higher. A
government pretending to
serve a nation’s interest by,
say, misinforming the people
about its military plans would
be harshly taken to task.
Why should trading on the
people’s money illusion be
regarded any differently?
Meanwhile, planning
ahead becomes more diffi-
cult for business. Investment
lags because long-term com-
mitments involve risks that
inflation makes incalculable.
The need to guard against
these unknowable risks
compels each party to any
transaction, buyer and seller,
employer and employee,
lender and borrower, to in-
troduce a risk premium into
his pricing. Each must de-
mand a little more or offer a
little less than he would un-
der noninflationary condi-
tions. That reduces the range
of possible bargains and the
level of economic activity.
Fewer jobs and less output
in the private sector are the
results.
Inflation also undermines
the honesty of our public poli-
cies. It allows the politician to
make promises that cannot be
met in real terms because, as
the government overspends
trying to keep those promises,
the value of the benefits it
delivers shrinks.
Finally, inflation becomes
a means of promoting changes
in our economic, social and
political institutions that cir-
cumvents the democratic pro-
cess. Such changes could be
forced upon a reluctant nation
because inflation may end up
making the existing system in-
viable. One instance is the di-
minishing ability of house-
holds to provide privately for
their future. Personal savings,
insurance and pension funds
all become inadequate. Money
set aside in any of these forms
for old age, for sickness, for
education could be wiped out
by accelerating inflation. One
may indeed ask whether it is
not an essential attribute of a
civilized society to be able to
make that kind of provision
for the future. But that is not
the point I want to stress.
Rather, I want to emphasize
that the increasing uncertainty
in providing privately for the
future pushes people who are
seeking security toward the
government.
By one route or another,
inflation creates a vacuum in
the private sector into which
the government moves. By
making the performance of
the economy inadequate, in-
flation is likely to induce ex-
panded government activity.
Of the three great dimensions
of our society—private rather
Honest
Money
The following is an edited
excerpt  from Henry C. Wallich’s
commencement address delivered
to the Fordham Graduate School of
Business on June 28, 1978.
At this time, you are pre-
sumably looking at your fu-
ture role in the world in the
broadest possible sense, in-
cluding a moral sense. Today,
I would like to talk to you
about one aspect of your fu-
ture that has a moral dimen-
sion, although it is technically
an economic problem. I mean
the breakdown in our stan-
dards of measuring economic
values, as a consequence of
inflation.
Inflation introduces an el-
ement of deceit into most of
our economic dealings. Every-
body makes contracts know-
ing perfectly well that they will
not be kept in terms of con-
stant values. Everybody ex-
pects the value of the dollar
to change over the period of
a contract. But any specific
allowance made for inflation
in such a contract is bound to
be a speculation. The most
valuable part of the contract
may turn out to be the paper
it is written on. This condition
is hard to reconcile with
simple honesty.
If our contracts were
made in terms of unpredict-
ably shifting measures of
weight, time or space, as we
buy food, sell our labor or
acquire real estate, we would
probably regard that as
cheating and as intolerable.
Inflation introduces
an element of deceit
into most of our
economic dealings.
Everybody makes
contracts knowing
perfectly well that they
will not be kept in
terms of constant
values. This condition
is hard to reconcile
with simple honesty. Inflation is a
means by which the
strong can more
effectively exploit
the weak. The
strategically
positioned and well-
organized can gain
at the expense of the
unorganized and
the aged.
than public ownership, deci-
sion-making by the market
rather than by central plan-
ning and democracy rather
than authoritarianism—pri-
vate ownership and market
decision-making will then be
in retreat. No one can say how
long, under such conditions,
a shift also in the third dimen-
sion, away from democracy
and toward authoritarianism,
can be avoided.
What can be done? Be-
fore we look for remedies, we
must examine the causes. In-
flation is like cancer—many
substances are carcinogenic,
and many activities generate
inflation. The sources of in-
flation can be diagnosed at
several levels. The familiar de-
bate about the sources of vio-
lence provides an analogy. Do
guns kill people? Do people
kill people? Does society kill
people? Some assert that
money, and nothing but
money, causes inflation—the
“guns kill people” proposition.
Some assert that the en-
tire gamut of government
policies, from deficit spend-
ing to protectionism, to mini-
mum wage to farm price sup-
ports, to environmental and
safety regulations, causes
inflation—the “people kill
people” proposition. Some
argue, finally, that it is social
pressures, competition for
the national product, a revo-
lution of aspirations, which
is at the root—the “society
kills people” proposition.
The first view holds the cen-
tral bank primarily responsible
for inflation, the second the
government in general, the
third the people who elect
and instruct the government.
In addition, time prefer-
ence, the social discount rate,
enters into the equation. In-
flation usually is the final link
in a chain of well-meant ac-
tions. The benefits of a tax cut,
of increased public spending,
are felt within a few weeks or
quarters. The penalty in terms
of inflation may not come un-
til after a couple of years or
even later. Inflation is the
long-run consequence of
short-run expediencies. Life,
to be sure, is a succession of
short runs, but every moment
is also the long run of some
short-run expediency of long
ago. We are now experienc-
ing the long-run conse-
quences of the short-run
policies of the past. These
consequences are as unac-
ceptable as rain on week-
ends and just as easy to
change. If we continue to
meet current problems with
new short-run devices, the
bill will keep mounting.
We will not defeat infla-
tion if we always take the
short view. We will then al-
ways find that the cost of fight-
ing inflation is too high, the
short-run loss of output and
employment too great. We
shall find ourselves ignoring
inflation, in the hope that it
will somehow not grow
worse. That is pure self-
deception. Cancer ignored
does not become stationary,
and neither does inflation. In-
flation ignored accelerates.
A long view is needed on
inflation. It is a view very dif-
ferent from that of the politi-
cian, who is under enormous
pressure to do quickly some-
thing that looks good. Harold
Wilson said that in politics one
week was a long time. More
charitably, the pressure is un-
til the next election. If the
people will not instruct their
elected representatives to do
the things that are needed to
end inflation, if they turn them
out of office because the rem-
edies take time and are tem-
porarily painful, we will keep
getting a little more employ-
ment and output now at the
expense of much more unem-
ployment and loss of output
later. And we will get more
inflation all along the way,
down to its ultimate conse-
quences. We need to make
the ending of inflation our
first priority. That must be
our overall policy.
If inflation is a moral
problem, we require a moral
solution—that is, a recognition
that public policies have led
to serious inequities affecting
people in different and un-
equal ways and a commitment
to new policies that will cor-
rect the cumulative distortions
and contribute to desired eco-
nomic progress. Nothing will
stop inflation overnight, and
in the short run, the gains will
always seem dearly won. But
without such a long-run ap-
proach, the damage will
mount and the ultimate costs
will escalate. ª
Henry C. Wallich served as a
member of the Federal Reserve
Board of Governors from 1974 to
1986. For a copy of the complete
text of his commencement address,
please write to the Federal Reserve
Bank of Dallas, Public Affairs Dept.,
2200 N. Pearl St., Dallas, Texas,
75201, or fax your request to the
Public Affairs Dept. at
(214) 922-5268.Economic Insights
is a publication of the Federal Reserve Bank
of Dallas. The views expressed are those of
the authors and should not be attributed
to the Federal Reserve System.
Please address
all correspondence to
Economic Insights
Public Affairs Department
Federal Reserve Bank of Dallas
P.O. Box 655906
Dallas, TX  75265-5906
Examining the
Moral Dimensions of
Monetary Policy
The following excerpts are
from the Rev. Robert A. Sirico’s
luncheon address delivered at the
Federal Reserve Bank of Dallas
on February 25, 1994.
Before the turn of this
century, an entire generation
of preachers and ministers
concluded that a moral mon-
etary policy was an easy-
money policy. “Give the
people more money and
credit,” was the cry of the
populist ministers. “Down
with gold, up with silver.”
They mistakenly believed that
the Treasury’s printing press
was the key to earthly salvation.
Even as late as the 1940s,
this ideology is evident in film.
As much as I love the Christ-
mas classic, “It’s a Wonderful
Life,” a careful viewer can de-
tect its social credit homiletics.
Even today, no matter
which party holds the White
House, the Federal Reserve
consistently faces pressure to
keep interest rates artificially
low, buy more government
debt and trade quick eco-
nomic fixes for long-term capi-
tal accumulation.
Yet, it seems to me, hon-
esty and morality weigh in on
the side of the grand tradition
of sound and stable money.
Holy Scripture speaks of
money in terms of weight, just
as it was spoken of through-
out history. In the list of com-
mandments, tampering with
Certainly, if it is wrong
for individuals to
deceitfully change the
weights and measures
in their transactions,
it is also morally
incumbent upon other
institutions, especially
government, to keep
honest weights and
measures.
those weights ranked among
the behaviors condemned
from Above. Certainly, if it is
wrong for individuals to
deceitfully change the weights
and measures in their trans-
actions, it is also morally in-
cumbent upon other institu-
tions, especially government,
to keep honest weights and
measures.
Allow me to provide a
few examples. God told the
Israelites that economic trans-
actions should take place with
honest weights. Leviticus
19:35–37, instructs, “You shall
do no wrong in judgment, in
measure of weight, or capac-
ity. You shall have just bal-
ances and just weights.”
This was long before the
followers of Keynes revealed
to us the dangerous “liquidity
trap” that might result from
such “outdated” morals.
Again, Proverbs 11:1 an-
nounces that, “A deceitful bal-
ance is an abomination before
the Lord: but a just weight is
His will.” But, of course, this
was before we discovered the
mysterious “magic” of debt
monetization.
Proverbs 20:10 says, “Di-
verse weights and diverse
measures, both are abomi-
nable before God.” Would that
Solomon had known about
the trade-off between inflation
and employment, as revealed
by the Phillips curve, now
back in vogue.
It is true that Isaiah (1:22)
warned that “faithless princes”
can turn silver “into dross.”
But that was before we knew
how much debtors can gain
from paying back dollars that
are cheaper than those they
borrowed.
I’ll grant that the proph-
ets Amos (8:5) and Micah
(6:10) condemned deceitful
balances when selling wares. But
neither knew much of the bal-
ance of trade with Japan.
Actually, all these scrip-
tural references make an im-
portant moral and economic
point. The long history of in-
flation reveals the tragic con-
sequences of excessive money
creation. It can, literally, turn
a society upside down. It did
in Germany, in the famous
hyperinflationary period of
1921–23. It did in this country
in the late 1970s. It has in
innumerable developing
countries. Control of the print-
ing presses is probably a first
order condition to a solid
economy and stable social or-
der. So much for the magic of
credit expansion. ª
The Rev. Robert A. Sirico is founder
and president of the Acton Institute
for the Study of Religion and Liberty,
based in Grand Rapids, Michigan.

Honest money

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Honest money

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