Introduction to Finance

Administrative infl ation
is the tendency of prices, aided by union-corporation contracts, 
to rise during economic expansion and to resist declines during recessions. Prices and wages 
tend to rise during periods of boom in a competitive economy. This tendency is reinforced by 
wage contracts that provide escalator clauses to keep wages in line with prices, and by wage 
increases that are sometimes greater than increases in productivity. Second, during recessions, 
prices tend to remain stable rather than decrease. This is because major unions have long-run 
contracts calling for annual wage increases no matter what economic conditions are at the 
time. The tendency of large corporations to rely on nonprice competition (advertising, and 
style, and color changes) and to reduce output rather than cut prices also keeps prices stable. 
Furthermore, if prices do decline drastically in a fi eld, the government is likely to step in with 
programs to help take excess supplies off the market. There is little doubt that prices would 
decline in a severe and prolonged depression. Government takes action to counter resulting 
unemployment, however, before the economy reaches such a level. Thus, we no longer exper-
ience the downward price pressure of a depression.
Administrative infl ation diff ers from demand-pull infl ation that happens when demand 
exceeds the available supply of goods, either because demand is increasing faster than supply in 
the early stages of a recovery period or because demand from monetary expansion by the banking 
system or the government exceeds available supply. Traditional monetary policy is not wholly 
eff ective against administrative infl ation. If money supplies are restricted enough, prices can be 
kept in line; this will lead to long-term unemployment and slow growth. It is also diffi
cult for new 
fi rms and small, growing fi rms to get credit, since lending policies are likely to be conservative. If 
administrative infl ation resurfaces, new tools may need to be developed to eff ectively deal with it.