The Problem of Stagflation

The source is an edited-volume excerpt rather than a standalone monograph: Gottfried Haberler’s chapter “The Problem of Stagflation,” reprinted from William Fellner’s AEI collection Contemporary Economic Problems (1976). Fellner is the editor; Haberler contributes the stagflation chapter; Geoffrey Moore’s employment/unemployment contribution is the only companion chapter named in the file; Burns, Friedman, Keynes, Hicks, Hayek, Houthakker, Giersch, and Knight appear as interlocutors. Haberler’s chapter moves through definition, theory, “special factors,” structural reform, and policy warning.

However, the 1974–1975 recession had a feature that made it perplexing and disturbing from the theoretical as well as from the policy point of view: it was a highly inflationary recession, a pronounced case of stagflation.

Haberler treats the 1974–1975 downturn as a break in postwar business-cycle experience: recession no longer reliably checked inflation, and recovery began from an already high inflation rate. His first conceptual move is to distinguish stagflation from the narrower inflationary recession, making the problem apply to both downturns and slack recoveries.

Stagflation can be defined as the coexistence of significant inflation and substantial general unemployment and slack over a considerable period.

The thesis follows from that definition: simultaneous inflation and unemployment are not natural features of competitive markets but signs of institutional obstruction. Downward wage rigidity, union bargaining, indexation, agricultural supports, regulation, and politically organized income claims prevent relative prices and wages from adjusting. Hence macroeconomic policy faces a dilemma, not merely a calibration problem.

The policy dilemma of stagflation is this: If macroeconomic monetary and fiscal policies try to counteract inflation, they increase unemployment; if they try to reduce unemployment they intensify inflation.

Haberler’s discussion of OPEC oil prices and other “special factors” is meant to limit, not deny, their role. A competitive economy could absorb a terms-of-trade loss through relative-price and income adjustment; rigid wages might justify only a small once-for-all rise in prices. The continuing two-digit inflation requires something deeper: real-wage resistance and wage push by organized groups.

But all special factors combined in conjunction with money wage rigidity can explain only a fraction (perhaps a fourth) of the two-digit inflation.

This is also why Haberler is only partly monetarist. Inflation requires monetary expansion, but aggregate monetary theory cannot by itself explain how nominal GNP divides between output and prices. For that, he turns to institutional microeconomics: unions, regulated industries, monopoly protections, government-mandated prices, and the erosion of money illusion after prolonged inflation.

Monetary restraint is a necessary condition for stopping an inflation but it is not a sufficient condition for an economically efficient and politically feasible anti-stagflation policy.

The reform section gives the chapter its practical edge. Haberler attacks agricultural marketing orders, import restrictions, “voluntary” export limits, Buy American rules, transport and energy regulation, union hiring restrictions, Davis-Bacon wage requirements, strike-subsidizing benefits, and minimum-wage laws. Such measures protect particular incomes while reducing output, employment, and macroeconomic flexibility.

Such structural reform is not a zero-sum game. The purpose is not a redistribution of a given pie but the enlargement of the pie.

Haberler is pessimistic about rapid reform because entrenched groups defend their privileges, so his immediate recommendation is slow expansion rather than election-year stimulus. Rapid demand expansion would, in his view, reignite inflation, force another monetary brake, or invite wage-price controls that could lead toward rationing and planning.

In my opinion it would be a great mistake to speed up the expansion in order to reduce unemployment quickly, whatever the political appeal of such a policy may be in an election year.

The chapter’s lasting relevance lies in its explanation of the 1970s breakdown of demand-management confidence: stagflation is monetary accommodation under institutionally protected claims on real income. Haberler’s polemical closing image captures his rejection of stimulus as anti-inflation policy.

To say as some do that a more rapid monetary expansion would reduce the rate of inflation because it would stimulate production and so increase aggregate supply is like saying that one can make a drunk sober by forcing whiskey down his throat to pep him up.