The Role of the Monetary Environment in Cost-Inflation

Abstract

The persistent rise in prices observed in so many nations since the outbreak of the Second World War has formed the backdrop of a dispute among economists concerning the possibility, the extent, and the significance of the phenomenon called cost-inflation. The latter term implies that prices may be pushed up from the cost side even in the absence of excessive demand. Some observers have denied the possibility of such an occurrence. Others, while recognizing the theoretical possibility of such upward pressure, have doubted that the phenomenon is a significant one, and have insisted that virtually all of the rise in prices can be explained in terms of aggregate demand. Analysis of the problem has tended to divide into two interrelated but separable strands: (a) the influence of pressure from unions and other organized groups on wages and prices, and (b) the influence of the monetary framework within which the observed increases in wages, costs and prices take place. In discussing the former aspect of the issue, some theorists, backed by a large number of labor specialists, have questioned the power of unions.' In this paper, I shall confine my remarks to an appraisal of the monetary framework, and I shall disregard the strength of unionism, save insofar as it affects the monetary environment. In general it may be observed that those who have argued that inflationary pressure may arise on the cost side have tacitly assumed the existence of a 'permissive' monetary environment-in which the authorities are willing to increase the money supply to accommodate the growing number of transactions inherent in rising output, and may be forced to expand sufficiently to finance national output at rising levels of costs and prices. The assertion that as a practical matter it might be impossible to maintain stability of the price level since cost advances outstrip increases in productivity, has evoked three distinct reactions(a) a denial of the problem, (b) a suggestion that the monetary authority use its power to induce readjustments of any spontaneous changes in the wage-price level, and (c) a suggestionn that the Central Bank recognize the fait accompli and allow the price level to adjust to the new cost level.