Money Mischief_ Episodes in Monetary History - Milton Friedman [85]
There is one exception with regard to escalator clauses. They are a desirable permanent measure in the federal government sector. Social Security and other retirement benefits and many other items of government spending are now automatically adjusted for inflation. However, there are two glaring and inexcusable gaps: some tax items, such as capital gains and interest payments, and government borrowing. Adjusting the personal and corporate tax structure for inflation—so that a 10 percent price rise would raise taxes in dollars by 10 percent and not, as it does now, by something between 10 and 15 percent on the average—would eliminate the imposition of higher taxes without their having been voted on. It would end such "taxation without representation." By so doing, it would reduce the government's revenue from inflation and hence its incentive to inflate.
The case for inflation-proofing government borrowing is equally strong. The U.S. government itself produced the inflation that made the purchase of long-term government bonds such a poor investment in recent decades. Fairness and honesty toward citizens on the part of their government require the introduction of escalator clauses into long-term government borrowing.
Price and wage controls are sometimes proposed as a cure for inflation. Recently, as it has become clear that such controls are not a cure, they have been urged as a device for mitigating the side effects of a cure. It is claimed that they would serve this function by persuading the public that the government was serious in attacking inflation; that in turn would lower the anticipations of future inflation that are built into long-term contracts.
Price and wage controls are counterproductive for this purpose. They distort the price structure, reducing the efficiency with which the system works. The resulting lower output adds to the adverse side effects of a cure for inflation, rather than reducing them. Price and wage controls waste labor, both because of the distortions in the price structure and because of the immense amount of labor that goes into constructing, enforcing, and evading the controls. These effects are the same whether controls are compulsory or are labeled voluntary.
In practice, price and wage controls have almost always been used as a substitute for monetary and fiscal restraint, rather than as a complement to them. This experience has led participants in the market to regard the imposition of price and wage controls as a signal that inflation is heading up, not down. It has therefore led to the raising of inflationary expectations rather than their lowering.
Price and wage controls often seem to be effective for a brief period right after they are imposed. Quoted prices, the prices that enter into index numbers, are kept down because there are so many indirect ways of raising prices and wages—lowering the quality of items produced, eliminating services, promoting workers, and so on. But then, as the easy ways of avoiding the controls are exhausted, distortions accumulate, the pressures suppressed by the controls reach the boiling point, the adverse effects get worse and worse, and the whole program breaks down. The end result is more inflation, not less. In light of the experience of forty centuries, only the short time perspective of politicians and voters can explain the repeated re-sort to price and wage controls (Schuettinger and Butler 1979).
Institutional Reform to Promote Price Stability
The repeated ups and downs in the price level have