Indexing v. Inflation

Seeing little chance of caging runaway prices, a growing number of experts have recently been urging that nations find some way to live with them. A band of conservative economists led by the provocative Milton Friedman of the University of Chicago are vigorously touting "indexing," a system that in theory preserves the buying power of money by tying all paper values to a price indicator. For example, if prices rise 7%, so does everything else: wages, prices specified in long-term business contracts, interest rates on bonds, savings and mortgages. Even taxes are included: a person whose salary rises 7% while prices are also going up 7% incurs no greater tax liability. In theory, nobody loses, and inflationary psychology is broken: there is no reason to rush out and buy now because prices may rise tomorrow by 7%; if they do, so will wages, pensions, welfare payments and the interest on savings accounts.

Indexing in one form or another is already being widely practiced. Wages are now indexed in many European countries. Last year Canada adopted a system of hinging income tax liability to price rises. In the U.S., "escalator clauses" tying wage rates to prices are familiar, and Social Security payments now automatically escalate with the consumer price index. Last week Republican Senator James Buckley of New York introduced a bill to tie tax liability and the value of Government bonds to movements in price indexes. Most significant, wholesale indexing has been a critical factor in cooling Brazil's scorching inflation rate, which was 88% a year in 1964 when the present authoritarian military government took over. In the first three months of this year, it dropped to an annual rate of 39%.

Yet there are reasons to suspect the success of indexing, even in Brazil. For one thing, a 39% inflation rate is scarcely anything to celebrate. For another, a large part of the credit for containing inflation in Brazil must go not to indexing but to the country's stern wage-price controls. Strikes are banned, what unions exist are kept weak, and yearly wage increases are held below productivity gains. The price index is also blatantly manipulated. It is heavily weighted to living costs prevailing in the state of Guanabara (where Rio de Janeiro is located), where prices trail those in the rest of the country. Last year many prices posted by the government and used in the index were well below the prices that goods were actually selling for. Despite indexing, in the five years ending in 1970, the real purchasing power of the wages earned by Brazil's largely unskilled workers dropped 30%.

Staying Ahead. Even when efficiently administered, indexing is open to a crushing objection. By enshrining a particular rate of inflation--say, 7% --indexing actually increases the pressures for a greater rate. The union leader who knows that the price index will rise 7% and that the wages of the workers he represents will go up that much automatically may then bargain for a 10% increase; the businessman who knows that the wages of his workers and the interest he pays on his debts will go up at least 7% may try for a 10% price boost to stay ahead. Thus, if a 7% inflation rate becomes accepted, the real rate may be 9%; if 9% becomes acceptable, the real rate may go to 11%, and so on up. Perhaps the final word on indexing is that a crude form was tried in Germany in the 1920s, and factories wound up paying their workers daily so that the workers could spend the money before it lost still more value.

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