As was suggested in the previous chapter, one of the reasons that increasing productivity through investment spending has never been seriously considered as a cure for inflation is because of the problem of excess demand during the investment payback interval. In the short term, investment spending tends to aggravate inflationary pressures by increasing demand. Only in the long run does increased efficiency resulting from capital investment tend to close the wage-productivity gap and reduce prices. If NMF investment is ever to be practical on a large scale, particularly during periods of high inflation, it will be necessary to complement NMF investment with a savings program of sufficient magnitude to prevent increased investment from producing any net increase in demand. Savings is the key to increasing investment without inflation. Savings takes money out of circulation and reduces both demand and consumption.
Savings, of course, is only deferred spending. At some future time, savings can be put back into circulation so as to restore demand and consumption. This implies that a nationwide savings program, if properly managed both from the standpoint of withholding money from circulation during periods of excess demand and of returning money to circulation during periods of insufficient demand, could maintain price stability even during periods of high investment spending. A flexible fast-acting savings program would be a mechanism by which supply and demand could be maintained in equilibrium during all phases of NMF operation – during the early stages when investment predominates, as well as during later stages when investments begin to pay off. The Demand Regulation Policy (DRP) that will be outlined in this chapter is designed to accomplish this purpose.
The DRP consists of two parts:
Part one deals with excess demand, a problem that has plagued almost all modern economies for years and shows no sign of being solved in the near future.
Part two deals with insufficient demand, a phenomenon that has occurred in the past only during periods of economic downturn or depression, but that could happen again if the full power of a technological economy were ever released to produce wealth at the maximum rate physically possible.
There are three principal components to aggregate demand: consumer demand, investment demand, and government demand. Government demand can be affected by budgetary policy, but, as was suggested in the past chapter, attempts to control inflation by budgetary policy are largely ineffectual and often counterproductive. Investment demand can be regulated by the classical tight-money techniques of monetary policy, but restricting investment is exactly the opposite of a policy designed to increase productivity by increasing investment. Therefore, the only significant component of demand that can be effectively used in conjunction with the NMF for controlling inflation is consumer demand.
Consumer demand is the largest single component of demand and also potentially the most controllable. The average consumer spends about 93 percent of his or her disposable income. This is a very constant percentage that has remained between 91 and 96 percent since the end of World War II.1 Consumer demand is thus a very predictable fraction of disposable income. This fact has long been recognized and is the basis for the Keynesian concept of controlling inflation through tax policy. The Demand Regulation Policy (DRP) suggested here is a method for controlling consumer demand that would have all the power of Keynesian tax policy, but would avoid most of the practical political difficulties.
Part 1: Dealing with Excess Demand
The DRP would reduce consumer purchasing power during periods of inflation by diverting some fraction of consumer income into savings bonds. This savings bond money would be held in escrow, and thus the amount of money immediately available for spending would be reduced. The effect would be to reduce demand and decrease inflationary pressures.
The DRP would effectively balance the money equation by taking out of circulation about as much as the NMF put in through its investment policies. The DRP would withhold money and restrain demand until increased supply resulted from increased productivity. Once that began to occur, the DRP would release the savings previously withheld so as to maintain consumer purchasing power in equilibrium with productive capacity.
The DRP would produce a much more direct effect on the largest component of demand than either fiscal or monetary policy, and it would produce no counterproductive effects on supply. DRP withholdings would also have a stronger deflationary effect than increasing taxes by the same amount. Tax money is taken away from consumers but then is spent by the government. This does little to reduce aggregate demand, but merely transfers demand from the private to the public sector. DRP savings bond money would not be spent at all and therefore would cause a net reduction in demand.
An important feature of the DRP is that it would not interfere with the availability of investment capital or with long-term investment planning. The DRP would only affect consumer income. It would operate completely independent of the capital markets. Investors would be able to plan for the long-term future with the assurance that prices would remain stable and consumers would always have sufficient purchasing power to prevent oversupply.
The diversion of consumer income into savings bonds would make it possible to keep track of how much money was withheld and from whom, so that when inflationary pressures receded (due to investment payback increasing supply faster than demand), then the savings-bond money could be returned to the same individuals from whom it was withheld.
It seems reasonable that savings bonds would be far more palatable to the public than tax increases because income would not actually be lost, but only temporarily converted into savings. Consumer purchasing power would thus be deferred but not permanently reduced.
An additional benefit is that DRP mandatory savings would guarantee that, whenever inflation needed to be checked, the discomfort would be equitably distributed to everyone and not concentrated upon the unemployed. DRP withholdings would be clearly and simply related to prices. The public would have no difficulty in perceiving the relationship and, hence, would always be able to understand the rationale for increased withholdings.
Simply deferring consumption, of course, only influences demand-pull inflation. But that is all that is necessary, since cost-push inflation is overcome by productivity increases due to NMF investment policies. When consumption is deferred, demand falls off and supply builds up, thus causing demand-pull pressures to recede.
Supply, however, must not be allowed to surpass demand to the point where profits become uncertain. If this were to happen, businesses would simply cut production and lay off workers. The result would be recession or depression, together with long-term shortages. Thus, the DRP must not withhold too much income – only enough to reduce demand so that it equals supply, and no more.
It is important that the amount of consumer income withheld by the DRP be carefully computed and adjusted frequently so that there is no tendency for demand to either fall behind or run ahead of supply. The exact formula for withholdings should be based on the best available price indicators and predictors. Modern computer techniques have been sufficiently successful at making quantitative short-term predictions that such a formula seems well within the capabilities of present-day economic science.2
A simple example of a withholding formula based on the consumer price index might be the following:
W = 4 x E x T (I + 20 x R)
Where
W = the amount withheld from each person´s income biweekly
E = the per-annum inflation rate as measured by the consumer price index
T = the individual´s income tax rate
I = the individual´s biweekly income
R = the increase in biweekly income since the same date two years earlier
As can be seen, the formula would take into account not only the inflation rate but the income of the individual, his or her tax rate, and the rate of increase in the individual´s income. The formula states that the percentage of consumer income withheld should roughly equal the annual rate of inflation. (The assumption is that four times the average federal income tax rate is approximately equal to unity.)
As an illustration: If the inflation rate is three percent per year, a person´s income tax rate 25 percent, and biweekly income $500, savings-bond withholding rate would then be $15 per pay period. If that person had received a raise during the past year of $25 per pay period, withholding would be $15 additional, or $30 per pay period, total.
The above formula would make the withholding rate progressive. Persons with large incomes would have a larger percentage withheld than persons with small incomes. It would also mean that persons whose wages were increasing would have significantly more withheld than persons with fixed incomes. The withholding rate would, of course, be proportional to the rate of inflation. During periods of high inflation, more would be withheld than during periods of lower inflation. The overall result would be to defer consumer spending during periods of excess demand through mandatory savings and to put the greatest burden on those most able to defer spending; i.e., those with large incomes and those with rising incomes.
The particularly heavy withholding rate levied on rising incomes is especially important in preventing inflation during periods of high investment spending by the NMF. Once NMF investment rose to a level approximately equal to the private investment rate (i.e., in the neighborhood of $200 billion per year), it must be expected that personal income would rise by an equal amount since investment spending must eventually wind up as personal income. To a large extent, this increase in income would be due to reduced unemployment, to overtime, and to many new workers entering the labor force who were previously not counted as unemployed. Some of the increase would also go into higher wages for those already employed, as well as into larger dividends for the owners of capital. On the average, these increases would amount to about $2000 per year per worker. In the long run, higher incomes would be matched by the increased output of goods and services that result from the productivity improvements caused by investment. It must be remembered that NMF investment would not simply be a means of temporarily increasing employment, although that would certainly be one of the side effects. NMF investment would produce new capital equipment, new factories, new machines, new transportation facilities, new pollution abatement devices, and new technological innovations of all kinds that would pay a return on investment for many years into the future. In the short run, however, during the investment-payback delay, the large increases in personal income due to NMF investment activity would be highly inflationary.
Thus, the DRP savings formula is calculated to withhold a high percentage of the increased income so as to defer a rise in consumer demand until after a commensurate increase occurred in the supply of goods and services.
DRP savings bonds would be redeemable after a period of five years, which is about the average payback delay for sound capital investments. Thus, the increased personal income from NMF investment activity would be impounded during the investment-payback delay only to be released when the increased supply of goods and services resulting from those investments began to flow onto the market. As a result, demand would keep pace with supply, and prices would remain stable despite a rapidly rising standard of living.
In order to assure that there would be no loss of purchasing power experienced by the holders of DRP savings bonds, the interest rate would be indexed to the inflation rate. Interest would be set at four percent above current inflation. This would make the withholding of savings from consumer income during periods of inflation much more palatable to the average person. Consumer demand would be deferred, but not lost or even diminished due to inflation.
The technique of indexing interest rates on savings to the inflation rate is now being used successfully in Brazil3 and for years has been advocated for use in the United States by the conservative economist Milton Friedman.4
DRP withholdings would provide negative feedback stabilization of consumer prices. This type of feedback is known to be most effective when applied with a minimum of time delay. Thus, the savings-bond withholding rate and interest rate would be adjusted monthly and would be based on predictions for price behavior during that month. This would make the negative feedback effects of the withholding program fast acting and able to cope with inflation in its early stages, before inflationary momentum could build up. As a result, inflation rates would never grow very large, and hence, bond withholdings would never cause any severe hardship on consumers. Once the program went into full-scale operation, it is highly unlikely that the mandatory withholding rate would ever exceed three percent for anyone with a fixed income below $10,000 per year. This would mean that, for a person with a fixed income of $800 per month, withholdings would hardly ever exceed six dollars per week. Variations in that withholding rate from one month to the next would ordinarily be less than one dollar per week.
During periods of stable prices, the DRP formula for savings-bond withholdings would reduce the withholding rate to zero. At the same time, the interest rate on DRP bonds would be reduced to four percent. Stable prices would indicate that demand was in equilibrium with supply and no corrective action was needed. When prices were stable, the DRP would not withhold any more money, and the bond interest rate would roughly equal normal interest on savings accounts.
Part 2: Dealing with Insufficient Demand
If there ever developed any tendency for aggregate prices to decline due to excess supply or insufficient demand, the DRP would encourage redemption of the special bonds. This could be done by declaring DRP bonds mature at an earlier date than normal and encouraging their redemption by reducing the interest rate below four percent. This, of course, would force money out of savings and into circulation, thereby increasing demand.
It is quite possible, however, that, once NMF investment began to pay off, supply might continue to increase faster than demand, even after all the DRP savings bonds withheld during periods of excess demand had been redeemed. In such an event, the DRP could still maintain demand in equilibrium with supply by directing the Federal Reserve Bank to create new money and distribute it directly to the public in the form of bonus payments added on to the regular NMF payments. The size of these bonus payments would be calculated on the basis of the monthly price index. Payments would be adjusted so as to prevent any long-term changes in the price index. Monthly bonus payments would be made to every adult citizen, and everyone would receive exactly the same amount. A reasonable formula might be the following:
MP = PMD x MS/AP
Where
MP= Monthly payment
PMD = Previous Month´s Drop in the price index
MS = Money Supply
AP = Adult Population
In 1970, the nation´s liquid money supply was about $600 billion.6 Thus, for an annual deflation rate of three percent, the monthly bonus payment to each adult citizen would be about $11.30 per month.
To some, the notion of printing money and distributing it directly to the public seems an impossible utopian fantasy. To others, it simply sounds like fiscal irresponsibility. It is neither. Maintaining demand in equilibrium with supply ensures that prices will remain stable. This is an eminently responsible economic goal. Stable prices with rapid economic growth has been the goal – indeed the dream – of economists even before Adam Smith. If demand is inadequate to prevent falling prices and printing money is the only way demand can reasonably be increased, then there is nothing irresponsible in printing money. If the NMF were to make investment capital available for the modernization of industry and the construction of computer-controlled factories on the scale suggested in previous chapters, it seems quite likely, indeed probably inevitable, that the supply of goods and services in future years would rise at such a rapid rate that nothing short of printing money could increase demand fast enough to keep up with it. In that case, there would be nothing utopian or fantastic about DRP bonus payments. They would constitute a simple recognition of the fact that the nation´s real wealth was increasing. Under such circumstances, they would be an economic necessity instituted in order to ensure price stability.
Furthermore, there is nothing particularly revolutionary, or even novel, about distributing newly created money to the public. In a roundabout way that is exactly what happens whenever the government shows a budget deficit. In order to finance deficit spending, the government borrows money by selling bonds. Printing bonds is not essentially different from printing money. The borrowed money comes either directly or in-directly from new money created by the Federal Reserve Bank.7 This money finds its way into the pockets of consumers in the form of salary checks from government jobs or government contracts. Thus, deficit government spending is essentially equivalent to direct payments of newly created money to the public.
Some persons might argue that money passed out through government salaries and contracts at least creates jobs, whereas DRP bonuses would not. However, this simply is not true. To begin with, if the NMF were creating wealth fast enough that it were necessary for the DRP to pay bonuses, then it would be extremely unlikely for unemployment to be a problem. Furthermore, even if it were, the fact that people tend to spend more than 90 percent of their disposable income on goods and services means that giving money to people to spend would create almost exactly the same number of jobs as giving money to the government to spend. There is no reason to believe that jobs created in response to consumer spending would be essentially different from jobs created by government spending. Besides, the fundamental drawback to unemployment is lack of income and not joblessness per se.
Aside from the question of jobs and employment, however, there are several reasons why distributing new money by direct cash bonuses would have far more beneficial results than the present method of deficit government spending.
First, the distribution of benefits would be more equitable. Each adult citizen would receive exactly the same amount. Those most in need of income would not be left out, as is often the case with government employment.
Second, fluctuations in the amount of direct cash payments would affect everyone equally. If DRP bonuses were increased to prevent prices from falling, everyone would equally share the increased wealth. If the bonuses were reduced or if withholdings were required to prevent inflation, everyone would share the burden equally. Cutbacks would not cause some individuals to lose their jobs while others felt no hardship whatsoever.
Third, direct cash bonuses could easily be adjusted on a monthly basis so as to provide an immediate response to changes in the consumer price index. The bonuses would fluctuate automatically according to the fixed formula. Therefore, political pressures and special interest groups would not be able to interfere with the necessary corrective procedures.
Fourth, the fluctuations in direct cash bonuses would be clearly and simply related to consumer prices. The public would have no difficulty in understanding the relationship and, hence, would accept cuts in bonuses when necessary, as well as enjoy increases when possible.
Fifth, fluctuations in individual bonuses would be quite small, probably less than one dollar per week. Hence, no severe hardships would be experienced when cuts in bonuses were required to prevent inflation.
Sixth, there would be no need for creating make-work or marginally useful government jobs that develop into bureaucratic self-perpetuating empires.
An interesting feature of the Demand Regulation Policy would be that these direct cash bonuses would not represent budget deficits, nor would they even be government expenditures. Quite to the contrary, they would be taxable income. Thus, the government would actually realize increased tax revenue as a result of DRP bonuses.
Where then does the money come from? It comes from the government printing presses. Why does this not destroy the value of the dollar? Because the money is being printed exactly as fast as real wealth (i.e., net increase in goods and services) is created by industry. The value of the dollar is maintained exactly fixed because money is created and distributed at a rate calculated to maintain prices constant.
The real "backing" for money is not gold, but the goods and services that money will buy. Gold itself would be worthless unless it could be exchanged for goods and services. Thus, money created by the Demand Regulation Policy would be perfectly "good" so long as it would always buy the same amount of goods and services. This would be guaranteed since the DRP would maintain the price index constant.
Administration of the DRP
It is proposed that the administration of the Demand Regulation Policy be independent from that of the National Mutual Fund. The National Mutual Fund would be (and should be) a politically sensitive organization. The DRP, on the other hand, should be isolated from immediate political pressures. The Internal Revenue Service might be a suitable body for administering the DRP. The IRS already has the mechanism for withholding taxes from biweekly paychecks. The withholding of mandatory savings bonds could be easily added. Furthermore, the IRS is suitably nonpolitical. The DRP withholding and bonus equations would be formulated by expert economists and then passed into law by the Congress of the United States, similar to the way in which tax legislation is currently handled. Any changes in the DRP formula would require an Act of Congress. The implementation of the actual withholdings or bonuses would be purely administrative operations not subject to political judgements. This is exactly the type of operation that the Internal Revenue Service is skilled in handling.
The DRP and NMF Working Together
It is commonly believed among economists that investment must come from savings and, hence, investment is dependent upon, if not strictly equivalent to, deferred consumption. It is, of course, true that the amount of investment must be matched by an equivalent amount of savings in order to prevent inflation. That is why the Demand Regulation Policy is suggested as a means for increasing savings sufficiently to compensate for the inflationary impact of financing NMF in-vestments through newly created money. However, the NMF does not get its investment capital from DRP savings. Quite the reverse, the DRP saves what the NMF invests. Thus, the NMF and the DRP reverse the classical dependence of in-vestment on savings. They instead make savings dependent on investment.
This is not an insignificant distinction for it implies that investment is now an independent variable that can be set to whatever rate is judged to be socially desirable. Savings becomes a dependent variable to be adjusted so as to prevent inflation. This is enormously important, for it implies that whenever excess productive potential exists within an economy, both investment and savings can be increased without any deferral or reduction of present consumption. New money can be created by the central bank at an arbitrary rate and invested through an agency such as the NMF. Savings are then withheld at an equivalent rate by the DRP. None of the money previously in circulation is removed, and hence there is no reduction in the existing level of consumption. The net effect is simply to employ previously idle resources in exchange for promissory notes represented by DRP savings bonds. These, of course, have no effect on demand until after a time period during which the investments pay back in terms of increased real wealth.
The classical economist may argue that this violates the free market. Classically, the capital market sets interest rates that make savings attractive and that is what provides the capital for investment. But historically, this mechanism has proven itself disastrously inadequate time and time again. Lack of investment spending is what let this country waste its enormous productive capacities for ten years during the Great Depression, and it was not until the Government, for military reasons, began to invest in defense plants that the Depression was ended. It is the lack of investment spending today that makes us unable to use what we clearly have to produce what we so desperately need. In the United States and the world today there exist overwhelming needs of every description, and yet a large percentage of our potential productive capacity sits idle.
Certainly in the present United States economy, there is enormous unused capacity. Capital equipment is typically operated only 40 hours per week, and rarely more than 80 hours per week. There are over 7 million persons actively seeking work and many millions more who would gladly work overtime if the opportunities were available. Furthermore, there are endless productivity producing technological innovations literally awaiting investment capital to bring them to fruition. The United States economy is operating nowhere near its full capacity today, and probably never has except for a few years during World War II.
Making investment independent of the propensity to save (i.e., making it possible for investment to be increased without deferring present consumption) is a revolution in economic thought. It frees the industrial system from the artificial constraints of the classical capital markets and makes it possible for production to be increased up to the maximum rate physically and technologically possible.
Working together, the NMF and the DRP would enable society to invest freely in whatever enterprises were deemed to be both profitable and socially beneficial. Production could be expanded or reduced to whatever rates the people, through their elected officials, decided were desirable. There would no longer be any need for shortages or surpluses. Working together, the NMF and the DRP could release modern technology to fulfill its potential for benefiting mankind.