After the economy has suffered through doses of deep recession, reduced output, high interest rates and record unemployment, experts say inflation has now been brought under control, at least for the time being. But are the benefits of lower inflation worth the price paid to achieve it?
In the short run, the unemployed worker may say it isn't worth it. But in the long term, lower, more stable prices generally are a boon to most consumers, businesses and, in particular, to bondholders whose assets increase in value as interest rates decline.
"If there ever was a time when inflation was not viewed as a serious problem, it is long gone," economist Otto Eckstein has written. "Today, inflation is associated with declining real purchasing power of workers and businesses and with the loss of the productivity trend which has lifted theU.S. economy for over a century. U.S. exports are losing their share of world markets and foreign goods are displacing our own at home."
Many economists insist that inflation in itself is not harmful to the economy if it is anticipated, so that businesses and individuals can plan for it.
But unanticipated inflation causes instability in economic markets and creates hardship to business and consumers who must constantly readjust their economic decisions. Erratic shifts in the rate of inflation harm the economy because these fluctuations disturb the distribution of income and the wealth that results and also creates a general climate of uncertainty.
This in turn leads businesses to make more short-term investments rather than investing in capital, which could increase the productivity that is key to economic growth.
In addition, reducing and containing inflation may involve serious costs, particularly since it usually leads to reduced output and higher unemployment, economists say. A 1982 study, done under the auspices of The Brookings Institution, said a 5 percent drop in inflation would cost 29 percent of the GNP, or $760 billion in 1980 dollars.
If the inflation rate is 4 percent by the year 1987, that cost will be measured in an unemploment rate "that remains modestly above the levels of early 1981 at least until 1988," or about 7.5 percent, the study said.
As a result of the current inflation-fighting efforts, unemployment rose to a record 10.8 percent of the civilian labor force last December, including many people who were out of work for extended periods.
The inflation rate this year is expected to be the lowest in more than a decade--about 4 percent--largely because of tight money policies that reduced demand and led to a slowdown in spending. The drop in purchases led to a contraction in output, layoffs of thousands of workers and a reduction in real wage rates.
But already there are signs that the deceleration in inflation may have reached its trough as food prices and costs of raw materials rise. Moreover, the success of the recovery may place upward pressure on wage rates, despite still abnormally high unemployment levels.
"This year's wage increase pace is the lowest since the mid-1960s," according to a recent issue of the Morgan Guaranty Survey. "With labor costs accounting for two-thirds of total costs, the wage slowdown has played a big role in the remarkable waning of inflation."
Yet some economists point to the summer's drought and its effect on feed crops as a sign that inflation may start growing again. "Some analysts tell us to beware of the rustling in the leaves, the winds of inflation are rising," said University of Minnesota economist Walter W. Heller. "They feel it in the 16 percent rise in volatile commodity prices since last year's low. They sense it in the firming of some industrial prices."
However, economists also note that there is still a great deal of unused industrial capacity that can absorb growth instead of pushing prices up. And they point out that the money supply declined in August, diminishing inflationary pressures.
Most economists agree that the costs of keeping inflation down are worth the benefits it generates through increased real growth. "Inflation is probably the single most important obstacle to long-term growth," said Robert Ortner, the Commerce Department's chief economist. "The economy can keep growing as long as inflation is down."
The Wharton Quarterly Model Outlook for September attributed the weak 0.8 percent real growth between 1979 and 1982 to "the cost of excessive inflation during the decade of the 1970s." In contrast, with inflation slowed to a crawl during the second quarter this year, economic growth surged forward at 9.2 percent, at an annually adjusted rate.
With high inflation, consumers tend to lose purchasing power, even though some government benefits and contracts provide indexing to inflation. The harm occurs in lags in implementing cost-of-living increases or under long-term contracts which cannot protect workers during periods of unanticipated inflation. Thus in 1980, when inflation roared at 12 percent, real hourly earnings declined 4 percent for the year although nominal hourly earnings increased 9 percent, Ortner said.
In comparison, as inflation dropped to about 4 percent in July, real hourly earnings rose 2 percent, Ortner said.
One of the major effects of reduced inflation is that it leads to lower interest rates. And as interest rates drop, bond and some stock prices rise, increasing their value. Even if the bonds are not cashed in, just knowing their assets are worth more creates an uplifting psychological effect, even for people who don't own bonds, economists said.
"The drop in inflation has had a double-barreled impact on consumers," Ortner said, in that it makes them feel good and it results in many people heading for automobile showrooms and the like and "parting with a lot of money."
With the rally in bond and stock markets from reduced inflation, the benefits now drift down to corporations, which have more cash on hand for investment. According to Data Resources Inc., before-tax profits, following a 23.2 percent decline last year, are expected to grow 16.3 percent this year and 22.9 percent in 1984. And most of this improvement results from increased consumer spending, which is powered by lower inflation and increases in real income.
Corporations also benefit because lower inflation tends to produce lower wage demands from workers, which keeps business costs low, economists said. Even though wages rose less rapidly than when inflation was rampant, workers' real wages have only recently begun moving up after declining for the last several years.
Another cost of inflation is that cash balances are depleted as businesses and individuals attempt to get rid of money as soon as they get it, because with inflation money quickly loses its value.
Inflation also distorts market activities as information about prices soon becomes obsolete. Reduced, stable inflation tends to improve long-term planning by companies as well as consumers which, in turn, leads to more investment, economists say.
Also, businesses that are owed money lose as the value of the dollar declines with inflation. On the other hand, debtors attempt to hold off their payments for as long as they can, since their debts become relatively lower as inflation reduces the value of money.
Another large benefit of reduced inflation is that it curbs speculation that diverts funds from investment in real goods and services that help the economy expand. Lower inflation tends to reduce nonproductive speculative investment in works of art and collectibles, which are considered to be better hedges of inflation than investment in plant and equipment.
Many economists are now predicting inflation this year will be about 4 percent, rising to about 5 percent in 1984 and 6 percent in 1985. With relatively stable growth in prices, businesses and consumers will benefit and the economy is expected to continue to expand, economists said.