Inflation & Rashomon

The 1951 Japanese film classic Rashomon presents the same
incident as seen by four different people. Each has a rather
different view of the same reality. 

My earlier posts on the definition of inflation and CPI: Good as
Gold (now on my web page "Inflation" file in the Economics
section), describe three different ideas of inflation.

I will illustrate these by describing how the "oil crisis" in the
US during the 1970's is viewed from the perspective of each of
these views. 

The CPI Theory

The "CPI Increase" theory of  Inflation. According to this view,
OPEC increased the price of oil in 1973. Between July 1973 and
July 1975, the price of crude processed by American refineries
tripled. Since the US imported about a third of the oil it
burned, there was no choice but to pass the higher price charged
on to the refined gasoline and diesel oil. This raised the price
of transportation and thus the price of practically everything in
the US market. 

Nixon made a gallant effort to save us from inflation by imposing
wage and price controls, but in spite of his efforts the Consumer 
Price Index (CPI) increased and thus caused inflation. 

The Money Supply Theory

When LBJ decided to expand the Viet Nam war and also fund the
Great Society programs without raising taxes to pay for either,
he inflated the money supply. Nixon followed suit, and this
increase in currency caused prices to rise. One of the first
price increases was in petroleum derived products because the
OPEC countries wanted to be paid more dollars since it was clear
that the dollar was  worth less. The CPI rose as a consequence of
the money supply inflation.

Nixon foolishly tried to suppress the consequences of the inflation
by imposing wage and price controls, but of course this just made
the dislocations in the economy even worse, and resulted in such 
things as long lines at filling stations.


The Value of Currency Theory.

This is similar to the Money Supply theory in some ways. The US
dollar had been valued at $20.67 per ounce of gold from the early
days of the country until the 1930's when it was devalued to $35
per ounce. Even though US citizens were prohibited from trading
in gold, there was plenty in Fort Knox, and the US guaranteed to
exchange dollars for gold at $35 per ounce to settle
international accounts.

Then in August 1971, the Nixon administration broke the link
between the dollar and gold. This devalued the dollar, so the
OPEC wanted payment for oil in the same gold units, not the same
number of devalued dollars. Thus oil became one of the first
prices to increase because of the devaluation of the dollar.

Nixon tried wage and price controls, but this did nothing to 
restore the value of the dollar.

Which story is "true"? 

                     ,,,,,,,
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                       (_)
jim blair (jeblair@facstaff.wisc.edu) For a good time call
     http://www.geocities.com/capitolhill/4834