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In an interview on Paris television at the end of June, French president Nicolas Sarkozy attacked the European Central Bank for raising interest rates and restraining monetary growth to rein in price inflation. The inflation currently plaguing the world, Sarkozy said, was due to an explosion in global commodity prices.
The French president’s words have a familiar ring. In the 1950s and 1960s, it was a common practice to say that price inflation could be caused by either “demand-pull” or “cost-push.” While this terminology has not yet come back into use, the ideas behind it are clearly influencing policy debates over inflation. Forty years ago, the concern was that powerful trade unions had the ability to force businesses into accepting excessive wage demands through the threat or use of the strike weapon. The resulting higher money wages received by union members pushed up the costs of production, which the affected businesses then passed on to consumers by raising the prices of their products. Over time, these union-induced higher costs would percolate through the economy, pushing up one set of prices after another, until finally the overall level of prices was raised. Hence, general price inflation had its “cause” in rising costs on the supply-side of the economy. This “cost-push” inflation was distinguished from “demand-pull” inflation, which resulted from increases in the supply of money and credit. An expanded quantity of money and credit placed greater purchasing power in the hands of the public, which then could be spent on goods and services offered on the market. An increased quantity of dollars chasing after a relatively fixed quantity of available goods resulted in an upwards pressure on prices in general. A number of economists argued at the time that cost-push could not bring about a sustained price inflation unless it was backed up by a demand-pull increase in the money supply. If the amount of money in the economy was more or less fixed in amount, excessive wage demands might merely result in greater unemployment. What employers can afford to pay workers is dependent on what consumers are willing to pay for the products those workers help to produce. If the consumers are unwilling or unable to pay more for the product when its price is raised, then the employer will be left with unsold inventory. Over time production will be cut back and unless workers are willing to accept cuts in their money wages, some of them will now be priced out of the market and find themselves unemployed. If consumers want to keep buying more or less the same amount of a particular product even after its price has gone up, then they must decrease their spending on other things since the given number of dollars in your pocket can only go so far. The following simple example can make this clear. Suppose, as in the table below, the total national income in the society is $1,000. And suppose there are three goods for which consumers as a group can spend their combined $1,000 of income. And further suppose that these consumers spend $500 on commodity “A” ($10 per unit times 50 units); $400 on commodity “B” ($20 per unit times 20 units); and $100 on commodity “C” ($5 per unit times 20 units), for total spending of that $1,000. 
If, now, a union were to successfully push up money wages in the manufacture of commodity “C” the employers might try to pass on their higher costs of production to the consumer by raising the price of this commodity to, say, $6 per unit. If consumers wanted to keep buying those same 20 units of commodity “C,” it would now cost them $120 instead of $100. With that constraint of $1,000 on total spending, it is clear that the extra $20 spent on commodity “C” must mean $20 less spending on either commodity “A” or “B” or a little bit less of both. The money demand for “A” and/or “B” must decrease by the same amount by which the money demand for “C” has increased. With lower demand for one or both of “A” and “B” their prices will tend to go down. The higher price and greater spending on commodity “C” is balanced by lower prices and less spending in this example on commodities “A” and “B.” Thus, there cannot result a general rise in prices, and hence no overall price inflation. If the workers making commodities “A” and “B” were unwilling to accept a cut in their money wages in the face of decreased spending and lower prices for their products, then some of them will potentially face being let go and unemployed. On the other hand, if with the rise in the price of commodity “C” consumers had not been willing to keep buying the same quantity of 20 units when the price went up to $6 a unit, then less of the product would be sold and production would be decreased. All that some of the union workers making “C” will have done is price themselves out of the market and cause their own unemployment. Only if the Federal Reserve (America’s central bank) increased the supply of money by $20 or more, in our example, could consumers afford to buy the same amount of commodity “C” at its higher price and still have enough money to keep buying other goods in the same amounts at the same or higher prices at the same time. Therefore, unless the monetary authority “validated” the higher wages through the demand-pull of an expanding money supply, no general price inflation can come about through any cost-push. A sustained and prolonged price inflation, therefore, is impossible without a sustained and prolonged increase in the supply of money and credit. How this relates to the current relationship between rising commodity prices and worsening inflation in the United States and around the world will be discussed in part II of this article.
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