Gittins asserts that wage growth in the resource states is in danger of pushing inflation above the Reserve Bank's target. He then uses NAIRU (non-accelerating inflation rate of unemployment) to try and explain inflationary process. The problem here is that both Gittins and Kennedy are talking nonsense. Even more worrying is the fact that the Reserve Bank subscribes to this nonsense, leading me to doubt whether it will ever grasp the real relationship between inflation and wages.

Whenever the economy heats up, thanks to the monetary spigot, economic commentators and the Reserve gravely warn that "excessive wage" increases could threaten cuts in official interest rates. But how can this be? Micro-economics tells us that if labour costs are pushed above the value of labour's marginal product unemployment will emerge, not inflation. Now we are told that instead of rising unemployment and idle capital we will get a rising price level. It never occurs to these people that the wage pressures they call inflationary are in fact the product of inflation. In short, these wage pressures are a symptom of inflation and not a cause.

Regardless of what our economic commentators claim to the contrary, wages are not the "key to inflation", money supply is. That inflation can only be discussed in this country in terms of wage growth only serves to underline just how pathetically third rate much of our so-called economic commentary really is. These pundits do not realise that Keynes was deliberately promoting inflation as a policy for reducing the unemployment level. This was made very clear for those who bothered to look:

Thus it is fortunate that the workers, though unconsciously, are instinctively more reasonable economists than the classical school, in as much as they resist reductions of money-wages . . . whereas they do not resist reductions of real wages, which are associated with increases in aggregate employment . . . (The General Theory of Employment, Interest and Money, Macmillan, St Martin’s Press for the Royal Economic Society, 1973, Book I, p. 14. Also see p. 8).

Let me spell this out for the benefit of those giant intellects in the Treasury, the Reserve and our misbegotten media. Keynes was arguing that the state should use inflation to lower the rate of unemployment. As the Austrian School points out, this is done by reducing the cost of labour relative to the value of its marginal product. Those of us with more than a passing knowledge of the history of economic thought can point out that there was absolutely nothing new in the Keynes’ approach to mass unemployment. In his discussion of the classical school’s approach to forced savings Jacob Viner noted that one version of the doctrine recognised

that an increase in money meant an increase in production, it was argued that an increase in the quantity of money would increase the monetary volume of purchases more rapidly than it would increase prices, with the result that there would be a substantial interval during which the increase of spendable funds would be absorbed by increased employment in the production of consumers’ goods rather than by increased prices. In this form of the doctrine, the increase in money results in increased real consumption, whereas in the forced-saving form it results in increased investment, but in both forms it makes possible increased employment⁴. (Jacob Viner, Studies in the Theory of International Trade, Harper & brothers, 1937, p. 189).

Just one of the problems with Keynes’ aggregate approach is that it concealed the enormous differences between various types of workers. The Austrians understood the dangers here and knew exactly where the Keynesian approach would lead, as the following quotes show:

... even if there is unemployment, the supply of special kinds of labour or of other productive factors may be scarce. The rise in consumer purchasing power and the relative diminution in investment purchasing power will then lead, via a rise in costs, to dislocations in the capital goods industries. (Fritz Machlup, The Stock Market, Credit and Capital Formation, William Hodge and Company, Limited, 1940, p.178).

It is practically indisputable that unemployment ca n be diminished by credit expansion provided simultaneous increases in money wages are prevented, or provided at least that such increases lag behind the tempo of the credit expansion. What is open to doubt, apart from the question of whether such a wage policy is likely to be pursued, is only whether the expansion of credit which is undertaken in face of unemployment contains the seed of a reaction or not. (Ibid. p.194).

If, in the absence of monetary expansion, the union movement successfully raises labour costs above their market clear level the result will be large-scale unemployment and not inflation. To suggest otherwise is to assume that union wage rises result in a natural increase in money incomes for the whole workforce. This implies that the quantity of money will passively adjusts itself to accommodate wage increases. Absurd as this view is, the Cohen Council (Council on Prices, Productivity and Income. 1959, UK) actually supported it. But as Professor W. H. Hutt stressed:

But if certain [his italics] wages rates are pushed up, in the absence of inflation other wage rates and prices will fall, or a cumulative withholding of capacity elsewhere must follow. (The Keynesian Episode: A Reassessment, LibertyPress, 1979).

Therefore the only way a wage push could succeed without raising the unemployment rate is if the central bank expands the money supply to accommodate the new wage rates. How else could aggregate money incomes rise in such circumstances? Even Greg Sword, former ACTU senior vice-president, has some understanding of this fact. It was he who declared that any refusal by the Reserve to underwrite union wage claims by inflating the money supply would be ideologically motivated.

As the old saying goes: The proof of the pudding is in the eating. I pointed out last week that from March 1996 to December 2007 currency rose by 110 per cent, bank deposits by 178 per cent and M1 by 163 per cent (Bulletin Statistical Tables, Liabilities and Assets - Monthly - A1). For the same period the Reserve's assets rose by 163 per cent. Despite the magnitude of these figures they are registering with the economic commentariat. For this lot money really does not matter.

Recent monetary figures indicate an economic contraction. Currency peaked at 40 last December: for bank deposits and M1 the figures are 191.3 and 231.3 respectively. While currency is stuck at the December figure, bank deposits and M1 started to contract, falling to 186.7 and 226.1 in January, and then to 181.4 and 220.7 in March. These figures strongly suggest a rather severe cure for wage increases is already in the works.

Gerard Jackson is Brookesnews' economics editor

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