The direct addition of value inflation to the rate of price increases is quite small. The larger effect arises from secondary influences, in whose shaping human psychology plays an important part. These influences are triggered by the small value inflation component and its corollary, a slowing of the rate of net throughput increase relative to gross throughput increase. These secondary influences are self-reinforcing.
Expectations have been for decades and continue to be, that material living standards should continue to rise at a certain rate. Thus the effect of a slower rate of net throughput increase and an accompanying boost to the rate of price increases is to create pressure from the people to close the widening gap between expectations and reality.
Several developments can result.
- Pressure for increased money wages, and increasing expertise and militancy of workers’ unions and associations, transfers money from profits and accumulated money capital to wages and salaries. The ratio of savings to total money income falls as more money is diverted to purchasing goods and services immediately.
- The ratio of money borrowing to income rises as people try to make up the difference between what they can buy and what they think they ought to be able to buy.
- Governments borrow more to meet rising public sector wages, welfare transfer payments, and construction and procurement costs without politically impossible tax increases.
- The private sector borrows ever more to meet the ever increasing amount of investment required, because of the increasing difference between gross and net throughput, to structure each unit of goods and services and to improve technology so as partly to counteract the effect of wealth depletion.
- With borrowing rising faster than saving, the rate of increase of the amount of money available for investment falls behind the rate of increase of borrowing demand.
- True inflation is boosted because the number of money units available for spending on goods and services rises faster than the flow of goods and services, so ever fewer goods and services are commanded by the same number of money units.
- Interest rates are forced up by growing pressure on loanable funds and by increased inflation.
If governments were to increase direct taxes as well as borrowing more, this would reduce take-home pay and people would then feel a need to borrow more. This upward pressure on borrowing would be worsened by downward pressure on savings. Increasing direct taxes through purchase tax or GSt or VAT would discourage consumption and borrowing while encouraging the accumulation of loanable funds in the form of savings and reducing the need for government borrowing. It would also slow resource depletion. More will be said on taxes in another post.
Implied in the last paragraph is the belief that people’s expenditure is to an important extent determined by what they think they ought to have rather than what they can afford.
The marginal efficiency of capital, a quantitative expression of business confidence and a function of expectations, falls because of rising inflation and interest rates. This puts downward pressure on investment in new ventures in economic activity, or new investment in existing ones.
Jobs are eliminated by money wages rising faster than the money value of goods and services being structured. The jobs made vacant are either neglected or done by fewer workers using greater mechanisation, more sophisticated structuring technology.
This job attrition is particularly marked at the lower end of the labour market, the lower skill and lower value jobs. Jobs and their loss will be discussed again in other posts.
Finally, the proportion of money flowing through the wages channel in the economy increases relative to the proportions flowing through the other channels. This moves the economy further away from the optimum proportionate flow status. What the optimum might be, varies depending on other factors. This subject will recur in future posts.
The effect of all these depressive influences is to reinforce themselves and each other by exacerbating the cause – living standards falling behind expectations.
So we have the “stagflation” of the 1970’s and early 1980’s – unemployment, interest rates, and the rate of price increases all high together due to the same seed cause – the conflict between the limits to the earth’s wealth on one hand and, on the other, the chase after the realisation of expectations of endless steady rates of throughput increase.
Posts in this Series
- Review of 1988 edition of Economics for a Round Earth
- Ends and Means
- Evolution Not Revolution
- Notes on Evolution Not Revolution
- Concepts and Terms – What is ‘wealth’?
- The Throughput Chain
- The Derivatives of Wealth
- Global Inequalities in Wealth
- Economic Growth Redefined
- Misconceptions in Practice
- Borrowing to Invest to Get Rich
- Environment versus Economic Progress
- Digression: Pollution Red Herrings
- Digression: Depletion and Inflation
- Value Inflation – the Trigger, not the Bullet
- Living Standard and Quality of Life
- Digression: Resource Consumption, Jobs, and Hands Off
- When the Boom comes
- The Effect of People’s Expectations
- Hard Work – Virtue or Vice?
- Who needs the Snail Darter?
- More Dollars for Conservation?
- Non-renewable Resources – Leave Them in the Ground?
- Digression: Fast Breeder Nuclear Fission Reactors
- Minerals in National Parks – Leave Them in the Ground?
- Population and Wealth
- Left, Right and The Environment
- Digression: “So Long As We Profit, Costs Elsewhere Aren’t Our Problem”?
- Limits to Growth?
- Solar Energy – a Special Case
- The Solar-Powered Car
- Money Supply, Throughput and Inflation
- Real and Money Wages: Living Standards
- Digression: Caution about “Increases” and “Decreases”
- The Idea of Proportionate Flows Applied to Wages: the Great Depression
- Deficit Financing
- The Optimum Proportionate Flow Condition
- Digression: Thrift versus Spendthrift
- Digression: the Private Motor Car – a Basic Necessity?
- The Idea of Proportionate Flows Applied to Wages – the Stagflation of the 1970’s and 80’s
- Excessive Wages Can Cost Jobs
- Fight Unemployment or Inflation First?
- Digression: Work and Jobs
- Other “Job Creation” Schemes
- Visual and Noise Pollution
- Digression: Renewal and Recycling of Resources; Wages and Jobs
- Ratio Distortion and Consumption
- Aggregate Demand – Components and Internal Ratio
- The Slave Economy
- Employment and the Steady State
- Consumer-Led Recovery
- Interest Rates and Ratio Distortion
- Demographic Trends and Living Standards
- Digression: Bad Economics Good for Conservation?
- Coping with Aging Populations
- Stabilising the Human Population
- Costs – What Really Costs Us and What Doesn’t?
- Digression: Other Comments on Statements in UN Report
- Discussion of Costs Resumed
- Budget Balancing Methods – Cost or Gain?
- Digression: Government Expenditure – Government Employees
- Expenditure on Weapons