All Commentary
Thursday, February 1, 1979

Beyond Supply and Demand: The Psychology of Inflation

Mr. Wolfe is a student at Hillsdale College In Michigan. This article constitutes his award-winning entry M the 1978 “Ludwig von Mises Memorial Essay Contest—The Political Economy of inflation: Government and Money” sponsored by the intercollegiate Studies institute.

When Alexander Solzhenitsyn declared in his Harvard commencement address that neither diplomacy nor military strength could abolish the danger posed by the Soviet Union, and that only a reinvigoration of moral and spiritual character would be effective in the struggle with Communism, he caused quite a commotion. To his critique of the West as weak and cowardly came a barrage of denunciations, from such varied sources as Mrs. Rosalynn Carter and The New York Times. The Times editors called him “obsessed” and summarized their view in this way:

At bottom, it is the argument between religious Enthusiasts, sure of their relationship to the Divine Will, and the men of the Enlightenment, trusting in the rationality of humankind.

Indeed, the editors of the Times had gone to the root of the issue. For Solzhenitsyn is a religious believer, sure that the Divine Will has revealed certain moral absolutes through the Judeo-Christian tradition, and convinced that they are being eroded—and that in the process our society is crumbling.

Though Solzhenitsyn’s remarks were directed primarily at U. S. foreign policy and the international conflict with Communism, they have profound implications for domestic issues, including the economic. The failings he pointed out—worship of material wellbeing, the placing of human “rights” over human obligations, the loss of personal responsibility, and the willingness to sacrifice for the common good—all are intimately connected with our economic problems, and particularly with the phenomenon known as inflation.

From the viewpoint of economics per se, inflation is readily defined: it is the governmental increase in the quantity of money and credit—an increase which has in this century far exceeded the growth in the production of goods and services. But what are the ultimate reasons why the government increases the money supply in this way? It is the contention of this essay that these reasons are directly related to the moral and spiritual failings which Solzhenitsyn discerns in the American people.

One of the great economists of our time who would have been sympathetic with that view is Wilhelm Roepke, a man with some kinship to Solzhenitsyn, both in his courage and beliefs. In his book, A Humane Economy, Roepke said of our age of inflation:

. . . it is the acute stage of a chronic pathological process fed by forces which are now permanently operative, and as such, it is not susceptible to any quick or lasting cure. The inflation of our time is intimately connected with some of its most obdurate ideas, forces, postulates, and institutions and can be overcome only by influencing these profound causes and conditions. It is not just a disorder of the monetary system which can be left to financial experts to redress, it is a moral disease, a disorder of society. This inflation, too, belongs to the things which can be understood and remedied only in the area beyond supply and demand.

A Spiritual Illness

Believing with Roepke that inflation is not just a disorder of the monetary system but a moral disease and ultimately a spiritual illness, we will seek here to examine this fundamental problem—to analyze the psychology of inflation. Psychology is used here in the classical sense, that of Plato and Aristotle, to mean the understanding of the order of the soul. And if, as Plato said, society is “man writ large,” then inflation will only be properly understood and possible solutions arrived at through a knowledge of man’s moral and spiritual disorders which cause him to constantly increase the quantity of money, and thus decrease its value.

The term “psychology of inflation” is usually connected with the attitudes of anticipation that cause workers to fight for wage increases large enough to cope with future increases in the cost of living, that cause management to set prices high enough to maintain profits despite increases in future costs—as well as those attitudes that cause consumers to buy more or less than they ordinarily would because of their expectations about what is happening, and what will happen, to the value of their money. But this approach to the psychology of inflation assumes a long and continuous period of inflation that will go on indefinitely in the future; it is based on inflation as a “given.” Our concern here is with the non-economic causes of inflation, and in particular the moral problems that prompt government to increase the quantity of money.

Some observers emphasize the moral problem of greedy citizens who clamor for more government services but are unwilling to pay higher taxes. Others point an accusing finger at selfish workers who want higher wages without increasing production. Still others indict unprincipled politicians who try to win elections by appearing to give the people more benefits without charging them more. To some commentators the moral problem centers around the hubris of intellectual planners who believe themselves capable of manipulating the money supply better than the “invisible hand” of the market place.

One thing is certain: inflation is the economy’s reaction to a whole range of questionable human desires and actions which place such a strain upon the economy’s resources that its money is debased. As Roepke put it:

If any man should continually sin against all the rules of reasonable living, some organ of his body will slowly but surely suffer from the accumulation of his mistakes; the economy, too, has a very sensitive organ of this kind. The organ is money; it softens and yields, and its softening is what we call inflation, a dilatation of money, as it were, a managerial disease of the economy.

It is the “sin against all the rules of reasonable living” that is, at bottom, the cause of inflation.

The Welfare State

That inflation is closely related to the emergence of the welfare state in the middle decades of this century seems almost self-evident. From the Presidency of Franklin Roosevelt and the time of the Depression (which resulted, incidentally, in large part from the Federal Reserve’s gross mismanagement of the money supply) government has expanded enormously into the realm of “social welfare” with such programs as Social Security, welfare payments, unemployment insurance, Medicare and Veterans’ payments. Though the Federal budget has mushroomed, taxes have not gone up enough to fully compensate and the result has been repeated deficit budgets. To fill the gap between what is taken in and what is paid out the federal government has created fiat money—through the printing press and credit expansion —which is inflation.

What are the root moral and spiritual causes that have been responsible for the tremendous growth of the welfare state—a government virtually obliged to spend more than it takes in?

As various scholars have pointed out, since the time of the Renaissance men have exhibited an increasing confidence in their ability to control nature and society, to produce endless progress, and to equalize economic well-being. The philosophers of the Enlightenment preached the great power of man and his rationality as a kind of ersatz religion in place of the Judeo-Christian heritage, and with the advent of modern technology it actually seemed as if man could create a heaven on earth.

At the same time, as the Industrial Revolution created a more complex economy, people could no longer observe many basic economic phenomena with their own eyes. Modern man has become increasingly cut off from a knowledge of scarcity because of the great prosperity he has enjoyed; living in a complex urban society he has lost sight of the relationship between production and consumption, effort and reward. Promoters of the welfare state have even led him to believe that government was a creator of wealth, and could bestow it on the deserving—if they insisted on getting their due.

Simultaneously, there has been a great decline in ethical instruction and character training in this century—especially in our schools. What Richard Weaver termed the “spoiled child psychology” has emerged. In his powerful little book, Ideas Have Consequences, Weaver spoke of modern man as a spoiled child.

The scientists have given him the impression that there is nothing he cannot know, and false propagandists have told him that there is nothing he cannot have. Since the prime object of the latter is to appease, he has received concessions at enough points to think that he may obtain what he wishes through complaints and demands. This is but another phase of the rule of desire.

Having been cut off from his religious faith, or having forgotten its moral implications as they apply to his responsibilities as a citizen, modern man has little or nothing to act as a curb on his appetite. In the past half century government has acted as man’s benefactor in the name of compassion and humanitarianism, assuring men that their appetites are legitimate and that government can gratify them. In reality, however, government has nothing to give some but what it takes from others.

The relatively recent character changes which have caused the growth of the welfare state, and in turn, which have been encouraged by it, have been noted in studies made by the scholarly research firm of Yankelovich, Skelly and White. As a result of interviewing hundreds of thousands of Americans over the past 30 years, these researchers have discovered three basic changes in modern attitudes which have taken place in a single generation: a loss of autonomy (dependency), focus on self (personalized morality), and the psychology of entitlement (parentalism).

The Consumer View

For centuries it was each man’s goal to become self-sufficient and self-supporting—that is, for himself and his family. Knowing that if he did not work he would die, his efforts were vigorously directed toward production. Modern man, deluded that abundance is automatic—a fact of life—and driven by his unchecked appetite, is no longer concerned with his role as producer. In fact, attitude research concerning the contemporary American’s economic perceptions shows that he views himself almost entirely as a consumer. Thus we have a citizen whose self-image focuses on his activities in getting and using money and goods, and who is no longer guided or disciplined by objective moral standards. Understandably, he feels himself entitled to the money and services that Big Brother concedes and even gladly offers him. And power-seeking politicians, eager to get elected, are correspondingly happy to promise the citizen these things—even if it means creating a socialist system with deficit budgets financed by inflation.

Inevitably the inflation gets out of hand and the intervening politician has no answer but controls. Weaver comments:

What happens finally is that socialism, whose goal is materialism, meets the condition by turning authoritarian; that is to say, it is willing to institute control by dictation in order . . . not to disappoint the consumptive soul.

In the end, then, freedom is lost. The passions of the consumptive soul will, as Burke said, forge his fetters. Another major cause of inflation is institutional interventions by government and labor unions in setting wage rates, combined with a government policy of “full employment.”

Through legislating an arbitrary minimum wage—deliberately higher than free market rates—government disemploys the least qualified job seekers, those unable to produce enough to justify that wage. Labor unions, because they have been granted monopolistic and coercive privileges by government, can force wages higher still, and in turn, oblige companies to raise their prices to levels which consumers will not pay. This would create widespread unemployment if government did not intervene by further increasing the quantity of money—to put more dollars in consumers’ pockets, and thus enable them to buy the overpriced goods. The astute labor union leader realizes that this governmental action in effect lowers the wage increases he has gained, and so he in turn puts pressure for another round of wage raises. Under the Full Employment Act government is virtually obliged to further increase the money supply—since politicians find that “jawboning” fails to hold down wages (or prices) and they are unwilling to repeal the labor legislation that prevents the market from determining wage rates.

Inflexible Wage Demands

Above and beyond these “institutional” interventions by government and labor unions, there is still another artificial pressure that tends to push wages above market rates: each person’s exaggerated idea of his own worth, combined with the pervasive notion that wages may go up—but never go down. To many an American employee, the idea that his wage might reasonably go down, even if he has become less productive or market conditions affecting his employability have changed, is almost unthinkable. To some extent this reveals unawareness of how the market operates. It also indicates that people now have a viable alternative to working: collecting unemployment insurance. And it suggests that the concept of sacrifice and self-discipline in adjusting one’s living standard to the circumstances of life has largely been lost.

What produces this array of pressures—from minimum wage legislation, monopolistic unions and unenlightened public opinion? A combination of economic misconceptions, short-sighted workers, the political power of unions, and a kind of maudlin sympathy on the part of many bystanders who may not personally benefit from artificially high wages but urge them out of a love for “humanity” in the abstract. And all these pressures are permitted to operate because government officials, under the influence of Keynesian ideas, hope to secretly lower real wages through inflation to prevent widespread unemployment.

Another category of moral and psychological problems is implicit in the philosophy and policy behind government manipulation of the money supply—a modern day incarnation of the Renaissance conceit that man, through his rational powers, can control nature, society and even the economy, and that unless man steps in, everything will fall apart. Adopting a policy of intervention, government planners have aimed at “stimulating” the economy through fiscal expansion and have attempted a “fine tuning” of the economy in the name of “economic balance.”

Fine-Tuning the Economy

All this has been undertaken in the belief that the market place, if left alone, is unable to bring stability and growth and is susceptible to the “boom and bust” cycle. As if the economy were an ill patient, whose body could not regulate itself, government’s “doctors” have sought to stimulate or heat up a “cold” economy by fiscal expansion and cool down an “overheated” economy by fiscal contraction, thus creating the boom and bust cycle for which capitalism is blamed. The results have been uncontrolled double-digit inflation and recession. The fine tuners have discovered that instead of “balance,” they have only that curious combination of stagnation and inflation known as “stagflation.”

Those who believe they can centrally plan and control the economy have made us all victims of their vanity: they are, in effect, setting themselves up as little gods over the economy—and the population. They attempt to balance an economy which they have upset by their interventions, and only manage to add further to the problem. As F. A. Hayek has pointed out, market prices are uniquely capable of assimilating all the millions of bits of information that allow business to operate smoothly. The interventionists possess very limited information and are essentially tinkering with an economy they know not how to control or to improve. These policies betray an acute lack of belief in true and enduring principles of economics—principles which have the sanction of morality and common sense.

Though government directly intervened to stimulate the economy, and Keynesian economists are responsible for giving government’s actions an appearance of intellectual sanction, both business and organized labor must share some of the responsibility. Union leaders will urge inflationary measures to keep their overpriced members employed, and businessmen may join them because a stimulated economy puts more dollars in consumers’ pockets and can mean larger sales and higher profits in the short term. Both the union and the business leader suffer from unawareness or rejection of Henry Hazlitt’s basic lesson: an economic policy must be evaluated for its effects on the whole population in the long term rather than on a limited sector in the short term. This holds true for all those who clamor for special interest legislation, welfare, and so on. The desire for immediate gratification instead of looking to what is best for everyone over a period of time has been a major cause of inflation—governmental increase in the quantity of money and credit.

Redeemable in Gold

And it is here that the very question of the integrity or inviolability of money comes in—and with it the question of the gold standard. For centuries, even in the most turbulent times, money was regarded as inviolable; the notion that money could be created by fiat was put on the same level as forgery and fraud.

The gold standard has traditionally been the method by which the value of money has been anchored to something more stable and constant than the whims of governments. Making paper money redeemable in gold disciplines the politician and obliges him to severely limit the increase in the money supply. Our rejection of the gold standard, while intellectually rationalized, was really a turning away from the responsibilities and norms which this standard requires. Every society has norms by which it must live if it is not to degenerate into mere anarchy. Roepke concludes:

It is not enough that these should be laid down in constitutions; they must be so firmly lodged in the hearts and minds of men that they can withstand all onslaughts. One of the most important of these norms is the inviolability of money. Today its very foundations are shaken, and this is one of the gravest danger signals for our society and state.

A return to the gold standard will only be feasible when the enduring moral values affirmed by Solzhenitsyn and others live in the hearts and minds of the American people.

Problems are comparatively easy to state—answers come a lot harder. The first step toward overcoming the failings which constitute the psychology of inflation is summed up by the Greek dictum: “know thyself.”

Am I guilty of any of the “sins” that contribute to inflation? When Americans can ask and honestly answer that question, and begin to correct their faults, they will have taken a step toward the psychology of freedom and the morality of sound money.