Inflation and A W Philips

Both Keynesian and Monetarist economists were primarily concerned with the demand side of the economy - how to stimulate demand and thereby production and concomitantly expenditure. So along came A W Philips.

Philips got the notion that a high rate of unemployment is usually accompanied by a low rate of inflation, and vice versa. (Full employment accompanied by high rate of inflation). Consequently it was thought that if you deliberately caused inflation you could wipe out or reduce unemployment. This is fallacious reasoning. It is obvious that printing money will for a short period cause high employment. You can provide money for gangs of men to make clothes pegs and then throw them away- the problem comes when you have to pay for them.

If the money was used to produce something useful and that could be sold at a profit, then although t there would indeed be a rise in the price of the wood and wire to make the pegs (because of the extra demand) but such increase would be repaid when the pegs were sold.

Furthermore, the demand for pegs, schools and airports is usually fictitious. No money is generated by their construction and therefore the loans cannot be repaid. Real inflation now starts when the money supply is again increased to repay these borrowings. So Philips is partly right - if you increase the money supply to stimulate useful production and provided it is repaid, higher employment can be achieved.

The problem is that Governments think they know better than businessmen what to produce. Business men (and women) have to repay their debts or suffer for their mistakes. Governments can simply print more money. But in the end even they become nervous at the rising inflation: the merry-go-round is abruptly stopped, the workers fired. Now unemployment increases and it is expected that inflation will come down -but it doesn’t. It does not come down because the money supply has not been curbed and debts paid out of real money.