National Income and Flow-of-Funds Analysis

By John P. Powelson | Go to book overview
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Chapter 20

At this point it is necessary to foreclose on what is perhaps the commonest error in contemporary attitudes toward inflation, although the point is well understood by economists. This is the almost inevitable temptation to regard increased production as a remedy for inflation. It is the most natural of errors; the first thoughts on the matter are wonderfully simple and forthright. If inflation is caused by output pressing generally on capacity, then one need only get more capacity and more output and thus insure that this tension no longer exists. But as just a moment's further thought will suggest, additional all-around production, even when it can be readily obtained from existing capacity, will pay out, in wages and other costs, the income by which it is bought. We have seen, moreover, that wants do not have an origin that is independent of production. They are nurtured by the same process by which production is increased. Accordingly, the effect of increased production from existing plant capacity is to increase also the purchasing power to buy that production and the desires which insure that the purchasing power will be used.*

Will an increase in the gross national product, or an increase in the productivity of factors of production, serve as an antidote to inflation? The question is not an easy one; if a one-sentence answer is demanded, it can only be that "sometimes it will and sometimes it won't." For productivity and output changes are only two among the numerous variables affecting the level of prices, and much depends on whether they are accompanied by higher wages and dividends, and on how great is the marginal propensity to spend the consequent increments of income.

Galbraith's restatement of Say's law, which is quoted above, is correct in so far as any partial presentation of a problem can be correct. But the answer is not so simple as Galbraith would imply. Increased production, he argues, is not an answer to inflation, because it brings with it the higher money incomes with which more goods may be demanded. But the question is whether they will be demanded. If, for example, the marginal propensity to consume is less than 100%, say, 80%, then an increase in

J. K. Galbraith, The Affluent Society, Boston, Houghton Mifflin, 1958, p. 215.


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