Inflation and Economic Development a General Evaluation

• Published date: 01 June 1971
• Date: 01 June 1971
• Author: PANAYIOTIS C. AFXENTIOU
• DOI: http://doi.org/10.1111/j.1813-6982.1971.tb00282.x

Inflation and Economic Development a General Evaluation

By PANAYIOTIS C. AFXENTIOU

INFLATION HAS BECOME one of the most popular subjects among economists deriving its popularity from the fact that many of

its characteristics and implications are widely understood. It is a topic through which economists and laymen try constantly to

communicate with each other in a world where inflation, of a mild nature in some countries and of more alarming proportions in

others, is the rule rather than the exception. As a phenomenon with all its inherent consequences inflation has a very long history.

What is relatively new is the vigour with which the idea that inflation can contribute positively to economic development has been

put forward and sometimes enthusiastically implemented by some underdeveloped countries. The proponents of this idea are

mostly found in the underdeveloped world although advocates are not missing in developed countries.

Historical and Theoretical Influences

Four influences are descernible in the literature regarding the conscious resort to inflationary measures for purposes of economic

development. The first influence derives its power from history and from politico-economic realities, the second is primarily

connected with J. M. Keynes, the third with R. Nurkse and W. A. Lewis, and the last with J. A. Schumpeter.

Impact of History and Politico-economic Realities

Deficit financing is a relatively modern accounting term, but its implications were known to rulers, kings and emperors of earlier

times and was practised by them in periods of emergency, of war expeditions and occasionally to satisfy their personal appetites.

The form of deficit financing was, however, different from the contemporary one, consisting mainly of debasement of the metal

coins. Such debasement confers large economic power to those practising it, and it is not surprising to see underdeveloped

countries employing contemporary methods of debasement to further their economic development aspirations.

Keynes in the 1920's explained how governments use deficit financing through money printing to finance their war expenditures.

The inability of governments to raise money through taxation is replaced by inflation, which is used as a method of taxation.*(1)

The efficacy of this method is indisputable. The tax is widely spread, it cannot be evaded and costs nothing to collect. Keynes

writes:

1971 SAJE v39(2) p131

A Government . . . can by this means secure the command over real resources,-resources just as real as those obtained by taxation.

The method is condemned, but its efficacy, up to a point, must be admitted. A Government can live by this means when it can live

by no other. It is the form of taxation which the public find hard to evade and even the weakest Government can enforce, when it

can enforce nothing else.*(2)

This political necessity is also admitted by W. Arthur Lewis, who states:

Governments are driven to inflation when they think the political difficulties of raising resources in this way are less than the

political difficulties in the way of raising the same sum in taxes.*(3)

The political nature of inflation is accepted by Alvin H. Hansen, who remarks: But to the politician, with his eye on the immediate

electoral impact of his policies, the inflationary way of mobilizing capital resources is usually easier than the imposition of new

taxes. It can be made to appear the result of "natural causes", or even better, of "external circumstances over which we have no

control" such as the unreasonable tight-fistedness of the Americans, and not the consequence of any deliberate governmental

action.*(4)

Experience in underdeveloped countries shows that these countries are unable to finance their development projects through tax

revenues. They, therefore, use deficit financing to secure the necessary resources for their development efforts. These countries

admit that inflationary pressures create certain difficulties but it is feared that the attempt to slow down these pressures will slow

down the rate of capital formation. The result will be economic stagnation or at least inability to institute the cumulative process of

growth. Any substantial trimming of developmental expenditures would retard the growth of production and would thus make the

task of capital formation in the future more difficult. Many governments have come to believe that the choice lies between inflation

and underdevelopment, and they are willing to pay for the social and political frictions that inflation creates rather than to retain

their status quo and price stability.*(5)

How effective this method is for underdeveloped countries and what the repercussions are on their economies will be examined

later. At this point it suffices to say that the objective of deficit financing is to gain control over real resources which will be used

for productive purposes. The inflation consequent to this is a by-product.

Impact of J. M. Keynes

One of the messages of the General Theory is the use of deficit financing during periods of recession as a means of achieving full

employment. Deficits, according to the Keynesian underemployment static model, lead almost immediately to

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