A STUDY COMPETING SCENARIOS IN EXPLAINING CAUSES OF

37c(

A STUDY OF THE EFFECTIVENESS OF FOUR

COMPETING SCENARIOS IN EXPLAINING

THE CAUSES OF STAGFLATION

THESIS

Presented to the Graduate Council of the

North Texas State University in Partial

Fulfillment of the Requirements

For the Degree of

MASTER OF SCIENCE

by

Toni T . Hurlbut, B.S.

Denton, Texas

August, 1983

Hurlbut, Toni T., A Study of the Effectiveness of Four

Competing Scenarios In Explaining the Causes of Stagflation.

Master of Science (Interdisciplinary Studies), August, 1983,

59 pp., 10 tables, bibliography, 21 titles.

This study investigates the relationship between stag-

flation and price stability and full employment and four

economic scenarios and the economic condition.

The data used in the study were obtained from govern-

ment publications and were analyzed using hierarchical

multiple regression. The standard inferential apparatus

were employed.

Give independent variables were found to be significant

in explaining the causes of stagflation. These were:

absolute change in M1 , oil embargo of 1974, corporate pro-

fits, output per hour, and Iranian crisis of 1979.

In conclusion, the causes of economic instability do

not rest with one single theory or factor, but a combination

of several.

TABLE OF CONTENTS

PageLIST OF TABLES. .. . . . . . . . . . . . . . . iv

Chapter

I. INTRODUCTION. . . . . . . . . . . . ,, . . . . 1

Background and Significance ofthe Problem

Statement of the problemUsefulness of the StudyFour ScenariosStatement of the ]ypotheses

II. REVIEW OF RELATED LITERATURE . . . . . . . . . 16

Purposes to be Se:(ved by Reviewof Literature

Sources of Literature Review

III. PROCEDURES.....-.... . . . . . . . . . . . . 27

Research TypeModel Specificatic nMeasurement and Variables

Employed in l4he Study

IV. FINDINGS. . .-............... . . . . 34

V. SUMMARY, CONCLUSIONS, INFERENCES,AND RECOMMENDATIONS. . . . . . . . . . . . . 40

SummaryConclusionsInferencesRecommendations

APPENDIX.. . . ...... . . . ........... 47

BIBLIOGRAPHY ...-.-...-........................... 58

iii

LIST OF TABLES

I. Summary of Hypotheses. . . ..-

II. Model I. .. . .. .. ..-.-.- -

IV. Model III. . . . . . . . . -

V. Multiple Regression Analysis ofModelI. . . . . . . ... -

VI. Multiple Regression Analysis ofModel1II . . . . . . . . .6..-.

VII. Multiple Regression Analysis ofModel III... . . . . . -0 .

VIII. Preliminary Data for DependentVariables. . . . ...... .

IX. Nominal Coding of DependentVariables.. . . . . . .....

X. Adjusted Data for IndependentVariables. ..9 .* .0. - -. -

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ivgloom I'll I I IN

The present study is a report of part of the results

of a joint project worked on by Joan O'Brian and Toni

Hurlbut. Therefore, portions of both papers are identical.

V

CHAPTER I

INTRODUCTION

Background and Significance of the Problem

Economic growth is extremely important to Americans

because this is a system in which everyone wants more. The

only condition under which all can realize their wants is

one of growth. Society, however, is currently a zero-sum

game in which the economy is stagnant. Capitalism cannot

survive continued stagnation. There must be economic

growth if human potential is to be realized. The economy

must continually create enough jobs to absorb all who want

to enter the labor market; otherwise great social dis-

harmony may occur.

There is a negative relationship between the growth

of real GNP and the unemployment rate. On the average, for

every 1 percent rise in unemployment above 5 percent, 2

percent of productivity is lost. If, therefore, the

unemployment rate is at 10 percent, as it has been in the

last two years, that means that 10 percent of the potential

output is lost. In addition, the social costs of unemploy-

ment are great. These costs include higher rates of

crime, mental illness, auto accidents, child abuse, alco-

holism, and divorce.

1

2

A recession is a condition in which unemployment

exceeds 5 percent and real GNP declines for two straight

quarters. :Recessions take great tolls in the form of

wasted productive resources and the long-term costs of the

slowdown of economic growth. Once lost, the skill and

productivity of wasted production resources can never be

recovered. As previously mentioned, the social costs of

recession are immense. Men and women lose their sense of

basic worth. They are unable to support their families,

farms and homes are lost, and businesses fail. There

also is a heavy cost to the government during recessions

in the form of less incoming revenues. Consequently,

the government is less able to perform the function of

providing financial aid to those in need at a time when

help is most necessary. Political and social disharmony

is another possible result of recession because of the

unrest of those out of work who cannot find suitable

employment.

Inflation is defined as unemployment at less than 4.5

percent, real GNP increasing at least by 4 percent, and

prices increasing above 2.5 percent per year. Inflation

hurts those most who have the least control over their

incomes. In an inflationary period, the amount of money

that one has to spend stays about the same while prices

increase rapidly. Inflation pushes wage earners into

3

higher and higher tax brackets, resulting in less dis-

posable income. Those who can afford to invest in land

and goods are likely to stay ahead of price increases,

since the value of their goods and properties also become

inflated. International trade is also negatively affected

by inflation. What foreign consumer or business would

invest in inflated American goods when these can be

purchased cheaper elsewhere? If inflation hits world-

wide, a collapse of world trade could result. Finally,

uncontrolled inflation can lead to political instability,

a situation which makes a country ripe for a dictatorship.

America's economic problem became one of stagflation

in the first quarter of 1973 through the first quarter of

1975 and again in the first quarter of 1981 through the

fourth quarter of 1981. Stagflation, a combination of

both recession and inflation, contains the ills of both.

It is defined as prices rising at above 3 percent, falling

real GNP for two straight quarters, and rising unemploy-

ment. Economists have theories as to ways to combat

recession and inflation singly, but when the two are com-

bined, the problem is more complicated. Attacking in-

flation makes recession worse and vice versa. Because

stagflation is a relatively new experience, there is also

no agreement among economists as to its causes. This

study will address four competing scenarios concerning

4

concerning stagflation and its causes. By evaluating each

scenario, the author will attempt to identify variables

which interact with elements of the economy in such a way

as to exacerbate economic instability and, in particular,

stagflation.

Statement of the Problem

Does a relationship exist between certain economic

scenarios in explaining the state of the economy in rela"-

tion to stagflation and full employment and price sta-

bility?

Usefulness of the Study

It is hoped that this study will help economists

and government leaders make more intelligent economic

decisions based upon knowledge rather than conjecture.

There are significant controversies relating to funda-

mental causes of economic instability. This study will

focus on those time periods which include price stability

and full employment, stagflation decline, and stagflation

recovery. These theories, however, can be applied to

other periods of economic instability--such as periods

of recession and inflation.

5

Theoretical Model or Postulates

Stagflation Scenarios

Conventional explanations for stagflation have proved

inadequate, since analysis of classical inflation and

classical recession primarily involves a study of aggregate

demand. Orthodox monetary and fiscal policies aimed at

correcting inflation or recession have not worked during

stagflation because the policies aimed at correcting one

stiuation exacerbate the problems of the other. Economists

have had to devise new theories as to the causes of this

economic phenomenon. These following scenarios offer

widely different views on stagflation, each representing

major problems in today's economy.

Monetarist scenario.--Monetarists believe that econ-

omic instability is caused by changes in the money supply.

They place the blame for stagflation on the monetary

policies of the Federal Reserve Board. The Fed controls

the growth of the money supply, and their inept policies,

along with the ill-advised executive branch actions, cause

economic instability. That there is a time lag between

increases or reductions in the supply of money and changes

in output and prices is an agreed-upon view of monetarists.

Traditionally, the method to combat recession has

been to increase the money supply. As the money supply

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6

increases, there is no immediate visible effect on output

and employment, since there is a six-to-nine-month lag:

before the increase in the money supply has an impact.

Instead of waiting out the time necessary before changes

become apparent, the Federal Reserve Board, seeing no

immediate change, again increases the money supply. The

economy begins to respond to the initial increase in the

money supply, and productivity and employment rise. The

economy is in a recovery phase when the second increase

in the money supply occurs. The second increase pushes

the economy into inflation through higher prices.

Now the Fed is faced with a new problem, one of rising

prices. The conventional solution to this problem of

rising prices is to start reducing the money supply. When

the Federal Reserve Board does not immediately see the

desired results of a lowered money supply, another re-

duction takes place. As before, after a six-to-nine-

months lag, the first impact of the reduced money supply

will be on output and employment rather than on prices.

So in this period there are falling output and employment

along with continuing high prices. Then a second money

reduction hits, and the economy is now in a period of

stagflation, which is high unemployment and a high price

level.

7

With each fluctuation in, the money supply, the Fed

has only compounded the problem. As always, the Federal

Reserve Board was not willing to wait patiently until the

change in the money supply has had enough time to take

effect. Instead, they invariably reverse their policies

based on an initial impact rather than on the changes that

patience and the time lag would bring. In such a situ-

ation, the economy inevitably is now on a continuing

upward spiral of higher prices and higher unemployment.

The monetarists believe this vicious process can be

remedied by dampening the inflation. To do this, a

decrease in the growth of the money supply is called for.

This decrease will produce a recession which, in turn,

will increase unemployment by up to 8 to 10 percent. The

unemployed would have to be protected by some form of

better unemployment compensation so that they will not

bear the total burden of the inflation battle. After

sixteen to twenty-four months following the decrease in

the money supply, inflation will be under control, with

prices increasing at no more than 1 to 2 percent a year.

The Fed could then slowly begin to increase the money

supply at rates not exceeding the growth capacity of the

system, about 4 percent annually (1,2).

8

Power scenario.--The second scenario, the power

scenario, places the blame for the dilemma of stagflation

on the concentration of economic power in the large cor-

porations and labor unions. According to this scenario,

stagflation is always preceded by inflation which is

caused by too much spending. However, economic power

intervenes when government tries its classical remedial

actions to slow inflation by reducing spending. What

happens typically is that large corporations raise prices

because powerful labor unions demand wage raises; this

action, of course, increases production costs. The large

corporations can pass this increase on to consumers by

increasing prices through decreasing output, even though

there is falling demand for their goods. The large

businesses can get by with this because of their monop-

olistic power over the market.

To counter the stagflation resulting from these uses

of power, advocates of the power scenario believe that

government should impose legally sanctioned wage--price

guidelines. In this way, powerful business and labor

elements would be prevented from interfering with remedial

government actions to control economic instability (l;2).

Structuralist scenario.--In the third scenario, the

structuralists emphasize unemployment as the major cause

9

of economic instability. They espouse the viewpoint that

a 4.5 percent definition of full employment is inaccurate.

They maintain instead that a 7.5 percent unemployment rate

should be defined as full employment. This statistic is

based on their belief that 3 percent of the labor force

consists of workers with marginal skills, i.e., those

workers who do not possess the skills necessary to gain

employment in an increasingly technical market and those

workers who are functionally illiterate.

The structuralists maintain that, when unemployment

reaches 7.5 percent or higher, the government mistakes

this condition for a recession and implements policies

to increase employment. As a result, output increases

only slightly, and the economy seems to be in a period

of stagflation. This is not so, say the structuralists.

They believe that the problem is either inflation or

recession. To remedy this misnamed condition of stag-

flation, structuralists call for a redefining of the

unemployment statistic, decreased government spending,

and the creation of government jobs for those who lack

marketable skills (1;2).

Micro scenario.--The fourth scenario, the micro or

supply side scenario, advocates the explanation that

stagflation is caused, in part, by real shortages in

10

supply (output). These shortages occur in areas of out-

put which are essential and have multiplier impacts on

costs of producing other basic goods and services. An

example would be the belief that one cause of stagflation

is the reduction in petroleum supplies by OPEC, the

oil producing monopoly. Petroleum is an essential resource

since it is involved in the production of so many other

necessary goods and services. Another contributing factor

to stagflation, according to the micro scenario, is

excessive government regulation. Examples are the

Environmental Protection Agency, the Occupational Safety

and Health Administration, and the Department of Energy.

Advocates of the micro scenario also believe that import

restrictions and tariffs increase inefficiency in domestic

industries and thereby restrict aggregate supply. The

belief that excessive rates of taxation reduce incentives

and, thus, supply is another contention of the proponents

of the micro scenario. They believe the appropriate

policies to combat stagflation are the following: removal

of government regulation, encouragement of free trade,

decontrol of gasoline and natural gas prices to encourage

domestic production, and selective tax cuts to build

incentives and encourage output (.1;2).

11

Statement of the Hypotheses

The hypotheses are summarized in the table which

follows. The signs in the table are the hypothesized

signs of the model regression coefficients.

Under price stability and full employment (Y1),

there will be an absolute positive change in M1 (X1 )

which will move the economy away from stability because

at full employment an increase in M1 would be inflationary.

An increase in absolute change in the labor force (X2)

would be helpful in keeping the economy stable because

employment of workers is needed if there is to be con-

tinued gorwth in GNP. A positive absolute change in

corporate profits (X3) would also be positive in keeping

the economy stable because these profits are needed for

future growth in the corporations and, consequently, the

economy. A positive change or increase in output per

hour (X4) would contribute to keeping the economy stable

and growing. A positive change in compensation per hour

(X5 ) would move the economy away from stability because

an increase in hourly wages would take away from corporate

profits and would also be inflationary (drive up prices

as corporations tried to make up losses from extra wages

per hour). Both X6 --Oil Embargo, and X7 _--Iranian Crisis,

would have a negative effect on a stable economy. They

would create rising prices, less corporate profits, and

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higher unemployment since businesses could not continue

to operate under oil shortages and prohibitive oil prices.

Consequently, stagflation would ensue.

Under Stagflation I (Y2) it is not clear what an

increase in Ml would mean. Since stagflation is a com-

bination of recession and inflation, the result of an

added money supply is questionable. This added money

would benefit a recession and exacerbate an inflation.

An increase in X2 --change in labor force, at a time when

companies were not at full production would only drive

stagflation higher, since added workers who cannot be

fully utilized would compound the problem. A positive

increase in corporate profits (X 3 ) during stagflation

would, according to the power scenario, indicate an

unadjusted rise in prices; this would push stagflation

higher. According to the micro scenario, it could mean

more money for investment and new machinery and, conse-

quently, be a healthy step toward stability and away from

stagflation.

A positive change in output per hour (X4) would help

to move the economy back to stability and away from stag-

flation. An increase in compensation per hour (X5)

would be inflationary and, consequently, contribute to

continued stagflation. Both the oil embargo (X6) and

14

the Iranian Crisis (X7 ) would be destabilizing factors

and therefore help to continue stagflation.

The same holds true for stagflation I and for stag-

flation II.

CHAPTER BIBLIOGRAPHY

1. Abernathy, L. M., William A. Luker, and Sue White,"Instability; Ups and Downs of a Market Economy,"It. Works, North Texas State University, Denton,Texas, 1975.

2. Luker, William A. and Geneva Wimberly, Hard Choices,Manchaca, Texas, Sterling Swift, 1981.

15

---------- 7- 7-

CHAPTER II

REVIEW OF RELATED LITERATURE

Purposes to Be Served by Review of Literature

This study replicates one by Richard J. Covington,

"A Study of Three Competing Scenarios on the Causes of

Stagflation." In his study Covington concluded:

First, since the variables were successful inclassifying different phases of the economy,they are significant factors in the behaviorof the economy. Second, since these variablesrepresent scenarios suggesting problems inthe United States economy and since theyconform to these scenarios, then they suggesta need for ameliorative actions with respectto each. Third, because of the prominence ofthe variables representing the power andstructural scenarios during Stagflation I andII, the most powerful explanation of stagfla-tion as a result of the -study would includeelements of both the power and structuralscenarios (1, p. 29).

The Covington study, a multiple discriminate analysis,

"was designed to determine if variables representing the

three scenarios vary significantly during different phases

of the economy" (I, p. 29).

Covington divided the years from 1966 through 1977

into different phases, using the following criteria vari-

ables based on quarterly data:

16

AIN0144011WAN-44M AKMWA

17

1. average rates of unemployment

2. changes in the consumer price index

3. real gross national product

These phases or periods were as follows:

1. Full employment and price stability and pricestability--first quarter, 1966, through fourthquarter, 1967-

2. Classical inflation--first quarter, 1986, throughfourth quarter, 1979

3. Classical recession--first quarter, 1970, throughfourth quarter, 1970

4. Classical recession recovery--first quarter,1971, through fourth quarter, 1972

5. Stagflation I--first quarter, 1973, throughfirst quarter, 1975

6. Stagflation II--second quarter, 1975, through

fourth quarter, 1977

Covington selected the variable Ml, changes in the

supply of money, to represent the monetarists' scenario.

Hourly compensation in the private business sector, output

per hour of all persons in the private business sector,

and corporate profits after taxes were the variables

representing the power scenario. The structuralists'

scenario was represented by the variables unemployment

rates of black teenagers and changes in the size of the

civilian labor force.

Although the primary purpose of this study is to

replicate Covington's research, it focuses on the following

periods:

18

1. Full employment and price stability--firstquarter, 1966, through fourth quarter, 1967

2. Stagflation I (decline)--first quarter, 1973,through first quarter, 1973, and first quarter,1981, through fourth quarter, 1981

3. Stagflation III (recovery)--second quarter,1973, through fourth quarter, 1980

This study used Covington's variables with the

exception of black, teenage unemployment rate, since

the total unemployment rate was used as a criteria vari-

able in determining the periods. Two additional variables

were added: the oil embargo of 1974 and the Iranian

crisis which occured during the fourth quarter, 1979.

Next a five-year period from 1978 through 1982 was added.

Finally, a different regression analysis, a step wise

regression was used to test the study's hypothesis.

It is hoped that by these additions to and repli-

cation of Covington's study will add to the body of know-

ledge needed in order that necessary amelioriative measures

can be taken which will help to stabilize the economy.

Sources of Literature Review

The scenarios previously described are supported by

different schools of economic thought. The monetarists

believe fluctuations in the growth of the money supply

lead to inflation and/or recession. The nation's leading

conservative economist, Milton Friedman, is perhaps the

19

most prolific of the monetarists. In Free to Choose:

A Personal Statement, Friedman says,

Five simple truths embody what we know aboutinflation.

1. Inflation is a monetary phenomenon arisingfrom a more rapid increase in the quantityof money than in output.

2. In today's world government determines,orcan determine--the quantity of money.

3. There is only one cure for inflation: aslower rate of increase in the quantity ofmoney.

4. It takes time--measured in years, not months-for inflation to develop; it takes time forinflation to be cured.

5. Unpleasant side effects of the cure areunavoidable (3, p. 282).

He further states,

The cure for inflation is simple to state buthard to implement. Just as an excessive in-crease in the quantity of money is the one andonly important cause of inflation, so a reduc-tion in the rate of monetary growth is the oneand only cure for inflation. . . . Governmentmust increase the quantity of money less rapidly.The problem is to have the political will to takethe measures necessary. Once the inflationarydisease is in an advanced state, the cure takesa long time and has painful side effects (3, p. 270).

In his book Dollars and Deficits, Friedman reiterates

the importance of monetary policy. He states that "infla-

tion is always and everywhere a monetary phenomenon,

produced in the first instance by an unduly rapid growth

in the quantity of money . . ." (2, p. 18). He asserts

20

that "the Fed' s erratic policy reflects also its failure

to allow for the delay between its actions and their

effect on the economy" (2, p. 167). He concludes that

"the Fed will continue to step too hard on the brake

until the recessionary effects are clear and unmistakable

and then will step too hard on the accelerator" (2, p. 167).

Another spokesman for the monetarists, Beryl Sprinkle,

in his book Money and Markets writes that "various studies

have demonstrated that changes in money are associated

with changes in the economy in a causal manner" (12, p. 278).

Sprinkle seems to agree with Friedman on the causes of

inflation when he writes, "excessive money growth, in the

view of the monetarist, has accounted for all known sizable

inflations, domestic and foreign, modern and ancient"

(12, p. 278). Sprinkle lays the blame for inflation on

the Fed when he states, "the supply of the monetary base,

then, is substantially under the complete control of the

Federal Reserve" (12, p. 67). Sprinkle suggests reme-

diation when he says, "stable monetary growth in line with

output potential raises the welcome possibility of less

inflation and lower interest rates along with stable

economic growth and better corporate performance" (12, p. 280).

Therefore, the monetarists agree that the basic problem

with the economy is the erratic growth of the money supply,

time lags, and the policies of the Fed.

21

The power scenario views stagflation as the result

of the misuse of power in the hands of the large labor

unions and monopolistic corporations. In his book

Economics and the Public Purpose, John Kenneth Galbraith

speaks of the power of unions, "where unions do exist,

producers do not control prices. . . . wage increases

do shove up prices; an industry-wide wage increase

forces the employers, in effect, to agree on a price

increase" (4, p. 130). In another statement he speaks

of producers: "if producers have the power to raise

prices in response to wage claims and if the increase

depends on the amount of the claim, the firm is no

longer subordinate to the market" (4, p. 184). Galbraith's

solution to power in the hands of big business and labor

in his book Money, Whence It Came, Where It Went is

"direct wage and price control where there is market

power is inevitable. . . . Market power of strong

corporations and strong unions can create an inflationary

dynamic of its own" (5, p. 372).. Robert Lekachman also

advocates controls as a means to combat inflation and

recession when he says, "I also believe that permanent

controls over large enterprises, professional charges,

and major unions would, if equitably administered, keep

inflation be ow dangerous levels and avert recession"

(7, pp. 120-1 21).

22

Abba Lerner, author of Flation, advocates the idea

that "we would have to remove the power of the trade

unions to prevent wages from falling in spite of unemploy-

ment" (8, p. 21).

According to Richard Covington, proponents of the

power scenario seem to agree that there has been "a break-

down in the competitive market with wages and prices no

longer responsive to supply and demand" (1, p. 10).

Unemployment as the main cause of economic instability

is the primary emphasis of the structuralists. In Labor

Theory Richard Pearlman asserts that "structuralists do

claim . . . as full employment is approached . . . the

economy strengthens, structural employment appears, and

reduction in these structural elements is associated with

inflation" (11, o. 189). Discussing the structuralists

in Hard Choices, the Lukers state that the structuralists

"believe that the 4.5 percent definition for full employ-

ment has been inaccurately specified. They maintain

that full employment is, in reality, a condition where

about 7.5 percent of the work force is unemployed"

(9, p. 218). This is based on the structuralists'

belief that workers with marginal skills make up 3

percent of the unemployed (9). Marshall and Goodwin

in their book, Cooperatives and Rural Poverty in the

South, discuss the movement of unemployed blacks from

23

the rural south into the labor market and cite the "poor

match between the qualifications of displaced farm labor

and the requirements of the South's growth industries"

(10, p. 11). So it seems, according to the structuralists,

only a redefining of the labor statistic, taking into

account the marginal unemployed, will bring about a more

stable, less inflationary economy.

Lester Thurow supports the fourth scenario, the

micro or supply-side scenario, when states in his book

The Zero-Sum Society that

Nowhere is the nature of our fundamental dilemmamore clearly illustrated than in energy. Highprices, shortages, and supply disruptions areserious. They threaten future growth in ourstandard of living and are the main drivingforce behind an accelerating rate of inflation.. . . Our inability to solve the energy problemcontributes to making the inflation problemmuch worse, since energy is used in the productionand distribution of almost everything. Risingenergy prices cause price increases in othergoods and services. Wage earners attempt tokeep up with prices by demanding large wage in-creases. This leads to even greater inflation(13, pp. 24, 41).

Thurow addresses the contribution of excessive government

regulations to inflation when he states,

Deregulation could force prices down in truckingand many other industries. . . . There are ahost of government programs designed to raiseprices that could be abandoned. . . . Abandoningany or all of these programs would substantiallyreduce the rate of inflation (13, p. 69).

H

24

In his book The Way the World Works, Jude Wanniski

writes of the reduction of incentives under progressive

taxation, and he states that taxes of the progressive

ad valorem nature have led to "simultaneous inflation

and contraction--'stagflation'" (14, p. 115). George

Gilder in his book Wealth and Poverty states that

"there is no question that such marginal tax rates.

have a substantial negative impact on taxable economic

activity, work, effort, and productivity" (6, p. 187).

Gilder advocates an end to governmental confiscatory

tax practices.

Again spokesman for each school of economic thought

hold forth their views as the most relevant and meaningful

answers to the problems of economic instability in the

country today.


1. Covington, Richard J., "A Study of Three CompetingScenarios on the Causes of Stagflation, " un-published problem in lieu of thesis, Depart-ment of Applied Economics, North Texas StateUniversity, Denton, Texas, 1980.

2. Friedman, Milton, Dollars and Deficits, EnglewoodCliffs, New Jersey, Prentice-Hall, Inc.,1968.

3. and Rose, Free to Choose, NewYork, Harcourt Brace Jovanovich, 1980.

4. Galbraith, John Kenneth, Economics and the PublicPurpose, Boston, Houghton Mifflin Company,1973.

5. , Money, Whence It Came,

Where It Went, New York, Bantom, 1975.

6. Gilder, George, Wealth and Poverty, New York, BasicBooks, Inc., 1981.

7. Lekachman, Robert, Inflation, New York, Random House,1973.

8. Lerner, Abba P., Flation, Baltimore, Penguin Books,Inc., 1973.

9. Luker, William A., and Geneva Wimberly, HardChoices, Manchaca, Texas, Sterling Swift,1981.

10. Marshall, Ray and Leonard Godwin, Cooperatives andRural Poverty in the South, Baltimore, TheJohns Hopkins Press, 1971.

11. Pearlman, Richard, Labor Theory, New York, JohnWiley and Sons, Inc., 1969.

12. Sprinkel, Beryl W., Money and Markets: A Monetarists'View, Homewood, Illinois, Richard D. Irwin,Inc., 1971

26

13. Thurow, Lester C. , The Zero-Sum Society, New York,Penguin Books, 1981.

14. Wanniski, Jude, The Way the World Works, New York,Simon and Schuster, 1978.

CHAPTER III

PROCEDURES

Research Type

The research for this study's data was of an associ-

ational explanatory type. It involved a nonexperimental

test of the structural hypotheses.

The three models are specified as follows:

TABLE II

MODEL I

Dependent Variable Y = Full Employment and Price StabilityNominal I = Full Employment andPrice Stability, 0 = Non Full Employ-ment and Price Stability

Independent Type ofVariables Measurement

Absolute change in M . . . . . . . .. . .. Cardinal

X2 Absolute change in total labor force . . . Cardinal

X3 Absolute change in corporate profits . . . Cardinal

X4 % change in output per hour. . . . . . . . Cardinal

X5 % change in compensation per hour. . . . . Cardinal

X6 Oil embargo... . . . Nominal l=Post embargo0=Pre embargo

X7 Iranian crisis . . . . . . . . . . Nominal l=Post crisis0=Pre crisis

= f(X1 , X2 3 ; X4 ; X5 6 7

27

28

TABLE III

MODEL II

Dependent Variable Y2 = Stagflation I (decline)Nominal I = Stagflation I,0 = Non Stagflation I


X Absolute change in.... . . . . . . . . . . Cardinal

X2 Absolute change in total labor force . . . Cardinal

X3 Absolute change in corporate profits . . . Cardinal

X4 % change in output per hour. . . . . . . . Cardinal

X5 % change in compensation per hour. . . . . Cardinal

X6 Oil embargo. . . . . . . . . . . . Nominal l=Post embargo0=Pre embargo

X7 Iranian crisis . . . . . . . . . . Nominal l=Post crisis0=Pre crisis

Y2 = f(X ; X2 ; X3 ; X4 ; X5 ; X6 ; X7 )

This was an associational research project, with

the basic design being a time series analysis using the

independent variables measured quarterly over the time

period from the second quarter, 1966, through the

fourth quarter, 1982. The independent variables that

were measured are as follows:

1. The absolute change in M

2. The absolute change in the total labor force,including armed forces

29

TABLE IV

MODEL III

Dependent Variable Y3= Stagflation II (recovery)Nominal 1 = Stagflation II,0 = Non Stagflation II


X1 Absolute change in .1 . . . . . . . . . . . . Cardinal

X2 Absolute change in total labor force . . . . Cardinal

X3 Absolute change in corporate profits . . . . Cardinal

X4 % change in output per hour. . . . . . . . . Cardinal

X5 % change in compensation per hour . . . . . Cardinal

X6 Oil embargo. . . . . . . . . . . . .Nominal l=Post embargo60=Pre embargo

X7 Iranian crisis . . . . . . . . . . .Nominal l=Post crisisPre crisis

3= f(X1; X2 ; X3 ; X4 ; X5 ; X6 ; X7 )

3. The absolute change in corporate profitsbefore taxes

4. The percentage change in output per hourall employees

5. The percentage change in compensation perhour

6. The oil embargo of 1974

7. The Iranian crisis of 1979

Since this analysis was designed to determine the

effect that certain criteria variables, representing ithe

four scenarios (previously described), had on specified

b . :e. __

30

periods of the economy, the first step was to collect

data whereby the economy could be classified as being

in one of the three phases--full employment and price

stability, stagflation I, or stagflation II. The three

criteria variables employed in this classification, using

quarterly data obtained from Economic Indicators, were

average rates of unemployment, changes in the consumer

price index, and changes in the real gross national

product. From an examination of these variables, the

following time periods were derived:

1. Full employment and price stability--secondquarter, 1966, through fourth quarter, 1967.

2. Stagflation I--first quarter, 1973, throughfirst quarter, 1975, and first quarter, 1981,through fourth quarter, 1981,

3. Stagflation II--second quarter, 1975, throughfourth quarter, 1980.

Stagflation I and stagflation II have the same

characteristics, except that stagflation I was character-

ized by a falling or negative real GNP, whereas stag-

flation II was characterized by a rising real GNP.

Next, variables were selected to represent each of

the four scenarios. M1 , the money supply, was selected

to represent the monetarists' scenario, since that

scenario is based on the belief that changes in the rate

of growth of the money supply causes economic instability.

31

The power scenario is predicated on the theory that big

business and labor unions cause economic instability

through their misuse of power. Therefore, changes in

hourly compensation, changes in output per hour for all

employees in the private business sector, and absolute

changes in corporate profits before taxes were chosen

to represent that scenario.

Since the structuralists' scenario is tied to

questions pertaining to the classification or compu-

tation of the unemployment statistic and the labor force,

change in the size of the total labor force was the vari-

able selected to represent this scenario. The micro or

supply-side scenario relates to real shortages in the

supply of basic goods in areas of output which are

essential to the economy; therefore, the last two varia-

bles selected were the oil embargo of 1974 and the Iran-

ian crisis of 1979. The statistics on these seven

variables were obtained from Economic Indicators, Statis-

tical Abstract of the United States, and Monthly Labor

Review.

The raw data were converted from absolute values

to absolute change per quarter for M1 , the size of the

labor force, and corporate profits. Output per hour

and compensation per hour were converted to percent

32

change. The oil embargo of 1974 and the Iranian crisis

of 1979 were nominally coded. The data were analyzed

using hierarchical multiple regression in the form of:

Y=A +BX + B X . . . + B X + E. The standard1 P1 22 nn

inferential apparatus was employed.


1. Economic Indicators, Washington, Government PrintingOffice, 1966-1983.

2. Elf Stepwise Regression, Alexandria, Virginia, TheWinchendon Group, 1983.

3. Monthly Labor Review, Washington, Government PrintingOffice, 1966-1983.

4. Statistical Abstract of the United States, Washington,Government Printing Office, 1966-1983.

33

-u Ifcks ~_ .. ik;i4 kj4wa.., .. :ya:. . + . r. ., ' :.. is^-i.":. , ,,, .1: ..

CHAPTER IV

FINDINGS

The data were analyzed using hierarchical multiple

regression in the form of: Y = A + B X + B2X22 .

+ B X + E. The standard inferential apparatus wasn n

employed.

Table V is an analysis of Model I. The dependent

variable in Model I was price stability and full employ--

ment. The F ratio for the overall model was 1.71, and

the degrees of freedom were 8 and 67, with P C.05. The

multiple R was .169.

The overall model was significant at the .05 level.

The individual variables which were significant were the

absolute change in M1 and the oil embargo of 1974. There

is a negative relationship between Ml and price stability

and full employment; therefore hypothesis 1, Model I

(see page 12) was sustained. There is also a negative

relationship between the oil embargo of 1974 and price

stability and full employment; therefore hypothesis 6,

Model I (see page 12), also was sustained. The other

Model I hypotheses were rejected.

34

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Table III is an analysis of Model II. The dependent

variable in Model II was stagflation I. The F ratio for

the overall model was 1.717, and the degrees of freedom

2were 8 and 67 with P(.05. The multiple R was .169.

The overall model was significant at the .05 level.

The individual variables which were significant were

corporate profits and output per hour. There is a nega-

tive relationship between corporate profits and stag-

flation I. The hypothesized relationship was indeter-

minant. There is also a negative relationship between

output per hour and stagflation I; therefore hypothesis

4, Model II (see page 12) was sustained. The other Model

II hypotheses were rejected.

Table IV is an analysis of Model III. The dependent

variable in Model III was stagflation II. The F ratio

for the overall model was 11.813, and the degrees of

freedom were 8 and 67 with P .05. The multiple R

was .584. The overall model was significant at the .05

level.

The individual variables which were significant were

corporate profits, the oil embargo of 1974, and the Iranian

crisis of 1979. There is a positive relationship between

corporate profits and stagflation II. The hypothesized

relationship was indeterminant. There is a positive

relationship between the oil embargo of 1974 and stagflation

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39

II; therefore hypothesis 6, Model III, was sustained.

There is a negative relationship between the Iranian crisis

of 1979 and stagflation II. Since a positive relation-

ship was hypothesized for this situation, this hypothesis

was not sustained. The other Model III hypotheses were

rejected.

CHAPTER V

SUMMARY, CONCLUSIONS, INFERENCES,

AND RECOMMENDATIONS

Summary

Two variables were significant in Model I (price

stability and full employment): the absolute change in

Ml and the oil embargo of 1974. Two variables were signi-

ficant in Model II (stagflation I): corporate profits

and output per hour. Three variables were significant in

Model III (stagflation II): corp rate profits, oil

embargo of 1974, and the Iranian risis of 1979.

Conclusi ns

Model

The fact that M had a negat

price stability and full employme:

the monetarists' theory that an a]

contributes to economic instabili

micro scenario view that shortage

to economic instability gains cre

cance of the negative relationshi

and full employment and the oil e:

40

lye relationship with

it in Model I supportsabsolute change in M

by. The supply side or

s in supply contribute

fence from the signifi-

p between price stability

nbargo of 1974 in Model I.

41

Model II

The negative relationship between the absolute change

in corporate profits and stagflation I in Model II does

not support the power scenario's theories, but it could

support the micro theories in that the economy would be

moving away from stagflation toward economic stability as

more money is available for new machinery and research

and development. However, the negative relationship

between changes in output per hour and stagflation I in

Model II could support the power scenario's contention

that the economic power in the hands of large corporations

and labor unions can contribute to economic instability.

Model III

The positive relationship between corporate profits

and stagflation II in Model III also contributes to the

power scenario's theory.

The micro or supply side scenario again gains credi-

bility from the positive relationship between stagflation

II and the oil embargo of 1974 in Model III. The fact

that there is a negative relationship between the Iranian

crisis of 1979 and stagflation II in Model III does not

support the micro theory, however.

Five variables representing three scenarios were

found to be significant. These variables are as follows:

, .. : :

42

1. Ml--X

(Monetarists' Scenario)

2. Corporate Profits--X3(Power Scenario)

3. Output Per Hour--X4(Power Scenario)

4. Oil Embargo--X6

(Micro Scenario)

5. Iranian Crisis--X(Micro Scenario)

These five variables are significant factors in the

behavior of the economy. M1 was significant during

periods of full employment and price stability, while the

remaining four variables were significant during stagfla-

tion I and stagflation II. This would tend to support the

theory that the most powerful explanation of stagflation

includes elements of both the power and the micro scenarios.

The fact that five variables from three scenarios were

significant leads to the conclusion that, given the limits

of measurement, a combination of these three scenarios

have to be in some way synthesized to produce a more

general theory to explain economic instability,

Inferences

M1 is significant only during periods of full employ-

ment and price stability, not during periods of stagflation

I and stagflation II. This could be caused by the fact

43

that, in an unstable economy, changes in the money supply

do not contribute so much to further instability. However,

when the economy is stable, more money pumped into the

system throws off the balance and sends the economy into

stagflation.

The structuralist scenario's contention that incor-

rectly defined unemployment is a cause of economic insta-

bility was not supported by any of the findings. Even

though it is true that the unemployment statistic needs

to be redefined, the redefinition may not contribute

greatly one way or another to economic instability.

Recommendations

Five variables from three scenarios were significant.

This suggests that the causes of economic instability do

not rest with one single theory or factor, but a com-

bination of several. One implication of this study is

that monetary and fiscal policies are not effective in

combating stagflation but, instead, only lead to economic

instability during an economically healthy period.

Since an interruption in the supply of a major

resource, such as oil, to the economy does contribute

to stagflation, more thought by the government could be

given to taking measures to help prevent future shortages

from occurring.

44

Corporate profits proved significant in both periods

of stagflation. Further research could be aimed at deter-

mining exactly what the economic significance is and what

ameliorative measures could be taken to prevent further

unhealthy effects of big business and labor unions.

In short, one of the most important problems facing

economists and those in positions of power is recognizing

what the real problems are in the economy and deciding how

best to combat these problems.

Suggestions for Further Research

The following recommendations for further research

using the same data are suggested.

The first recommendation is to factor analyze the

three variables which were used to create the states of

the economy--real gross national product, consumer price

index, and the unemployment rate--to produce one or two

general variables that would describe the performance of

the economy. Then a regression with the same set of

independent variables, used in this study, should be

run against the newly created orthogonal dependent

variables.

The data with which this study were concerned were

time series, and therefore, subject to confounding of

45

autocorrelation. Another approach would be to whiten

the series using Box-Jenkins techniques and produce the

same regression (1, 2) .

In this study the dependent variables are nominal

(1,0). A series of nonlinear transformations of the

independent variables might improve the power of the

models.

_ , ,


1. Cook, Thomas D. and Donald T. Campbell, Quasi-Experi-mentation, Dallas, Texas, Houghton MifflinCo., 1979.

2. Ostrom, Charles W., Jr., Time Series Analysis, BeverlyHills, California, Sage PUblications, 1976.

46

APPENDIX

-ilfiill''W14"WillDI-FMW ri-t-4:MW itTrfA'Lellil "PN1111?'IP11'f4-"%Tiefreiveirrealgely Milp.1rfttil*W11&'rF10Iririger-olWkrIl-33i Irfr|It'fnriffilitilthRI-ig1Pil"Ttlilli-flF411|MW3|TF11F"girillllHirftff'PflF1|l#4195filrTilifflP'Nillilil-EllidfiertN1411tiriliflindillh1rfi106Tiltlifil-itli!.ilinilf'l'illeifrirennillilin:In11'Irsifr'rrrnIIIK1Fil'I ri" Tsal1InsFrir!11Psi-rPIII.1sumir9ni'sisWgtIllingm)IIIliggII:F1t-r1I"irftFIntililKem1TE4rmillirralti gir-g:fTroris2E91a eral.4%rir Ei:rtrm11strie:m

TABLE VIII

PRELIMINARY DATA FOR DEPENDENT VARIABLES

Year Quarter GNP Unemployment Rate CPI

1966 1 640.5 3.8 112.0

2 643.5 3.9 112.9

3 649.9 3.7 114.1

4 657.2 3.7 114.7

1967 1 660.7 3.7 115.0

2 664.7 3.9 116.0

3 672.0 4.1 117.1

4 679.6 3.7 118.2

1968 1 692.7 3.7 119.5

2 703.4 3.7 120.9

3 712.3 3.6 122.2

4 718.4 3.3 123.7

1969 1 723.1 3.4 125.6

2 726.7 3.4 127.6

3 730.6 3.8 129.3

4 729.8 3.5 131.3

1970 1 723.3 4.4 114.5

2 724.4 4.8 116.3

3 727.4 5.4 117.5

4 720.3 6.2 119.1

1971 1 729.7 6.0 119.8

2 735.8 5.8 121.53 740.7 6.0 122.2

4 751.3 6.0 123.1

1972 1234

766.5783.9796.1811.6

5.95.55.55.1

124.0125.0126.2127.3

48

49

TABLE VIII--Continued


1973 1 829.3 5.0 129.82 834.3 4.8 132.43 841.6 4.7 135.54 844.6 4.8 138.5

1974 1 830.5 5.1 143.12 827.1 5.2 146.93 823.1 5.8 151.74 804.0 7.2 155.4

1975 1 1,158.6 8.5 157.82 1,168.1 8.7 160.63 1,201.5 8.6 163.64 1,215.9 8.3 166.3

1976 1 1,246.3 7.5 167.52 1,126.0 7.6 170.13 1,272.2 7.8 172.64 1,279.9 7.8 174.3

1977 1 1,311.0 7.4 178.22 1,330.7 7.1 181.83 1,347.4 6.8 184.0

4 1,360.7 6.4 186.1

1978 1 1,354.2 6.2 189.82 1,382.6 5.8 195.33 1,391.4 5.9 199.34 1,413.0 5.9 202.9

1979 1 1,430.6 5.7 209.12 1,422.3 5.7 216.63 1,433.3 5.8 233.44 1,440.7 5.9 229.9

1980 1234

1,501.91,463.31,471.91,486.5

6.27.77.57.5

239.8247.6251.7258.4

50

TABLE VIII--Continued


1981 1 1,516.4 7.3 265.1

2 1,510.4 7.4 271.3

3 1,515.8 7.6 279.3

4 1,497.6 8.8 281.5

1982 1 1,470.7 8.9 283.1

2 1,478.4 9.4 290.6

3 1,481.1 10.1 293.3

4 1,471.7 10.7 292.4

Irenlig utmesismignis.

TABLE IX

NOMINAL CODING OF DEPENDENT VARIABLES

Y1YY

Full Employ- 2 3ment and Price Stag- Stag-

Year Quarter Stability flation I flation II

1966 2 1 0 0

3 1 0 0

4 1 0 0

1967 1 1 0 02 1 0 03 1 0 04 1 0 0

1968 1 0 0 02 0 0 03 0 0 04 0 0 0

1969 1 0 0 02 0 0 0

3 0 0 0

4 0 0 0

1970 1 0 0 0

2 0 0 03 0 0 04 0 0 0

1971 1 0 0 02 0 0 03 0 0 04 0 0 0

1972 I234

0000

0000

000

51

t x awa=.+w - _ _ _

52

TABLE IX--Continued

YlYl Y3

Full Employ- 2 3went and Price Stag- Stag-

Year Quarter Stability flation I flation II

1973 1 0 1 02 0 1 0

:3 0 1 04 0 1 0

1974 1 0 1 02 0 1 03 0 1 04 0 1 0

1975 1 0 1 02 0 0 1

3 0 0 14 0 0 1

1976 1 0 0.12 0 0 1

3 0 0 14 0 0 1

1977 1 0 0 12 0 0 13 0 0 1

4 0 0 1

1978 1 0 0 12 0 0 1

3 0 0 14 0 0 1

1979 1 0 0 1

2 0 0 13 0 0 1

4 0 0 1

1980 1234

0000

0000

I1I1

F+a.. w

53

TABLE IX--Continued

Full Employ- 1 3ment and Price Stag- Stag-

Year Quarter Stability flation I elation II

1981 l 0 0 02 0 0 03 0 0 0

4 0 0 0

1982 1 0 0 02 0 0 03 0 0 04 0 0 0

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Money,Whencet.Came, Where ItWent, New York, Bantom, 1975.

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Thurow, Lester C., The Zero-Sum Society, New York, Penguin

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Covington, Richard J., "A Study of Three Competing Scenarios

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North Texas State University, Denton, Texas 1980.