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The prime effect of inflation

What has been the biggest impact of rapid inflation on the United States economy? It is the huge increase in the labor force, says Hendrik S. Houthakker, a Harvard University economist. With rising prices squeezing the incomes of their husbands, many wives found jobs to maintain the living standards of their families.

Dr. Houthakker admits that the women's liberation movement facilitated this growth in two-income families. So did the rising tide of divorces and separations. However, his several years of work on a forthcoming book on the costs of inflation have indicated that the prime motivation for the trend was economic, not sociological.

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Other findings of this former member of President Nixon's Council of Economic Advisers:

* The damaging effect of inflation is widespread. No special segment of society has been especially hard hit by rising prices.

For instance, it is often held that older people are special victims of inflation. But Dr. Houthakker notes that social-security and other government pensions of older people are indexed to protect their real purchasing power. Private pensions are sometimes partly adjusted for inflation. Moveover, people in this age group tend to own their own homes or other real estate.

hese have gone up in value with inflation. So, although older individuals may suffer severely from inflation, as a whole the group has done no worse than other elements of society.

"The impact of inflation on the distribution of income seems to be very insignificant," he added in an interview here. If anything, it may have hurt the rich more than the poor.

* Corporate accounting practices are not adjusted to the realities of inflation. "They are quite archaic," Dr. Houthakker says.

The Securities and Exchange Commission (SEC) has for two years required major corporations to publish their earnings statements according to both historical costs and replacement costs. The historical-costs accounts, based on what plant and equipment cost to purchase, are generally presented in corporate annual reports. The newer replacement-cost accounts, based on what it would cost to buy new plant and equipment today, are stowed in the so-called 10K reports. These are sent to the SEC, but not usually to stockholders.

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Dr. Houthakker compared the results of the two bookkeeping systems for 50 major companies for two years. He found that the replacement-cost accounts showed much poorer performance than the historical-cost accounts which corporations emphasize.

Some companies, which talk of even increasing profits under the historical-cost system, show losses on the replacement-cost basis. The problems of Chrysler, for instance, could be clearly seen in the replacement-cost accounts well before becoming visible in the historical-cost accounts in its annual reports.

"Corporations on the whole have been very reluctant to give any publicity to these replacement accounts," Dr. Houthakker said. "A large majority of them prefaced these 10K statements with lengthy statements that they are meaningless and that stockholders should pay no attention to them. Clearly managements are worried by what impression these accounts will make on shareholders."

Dr. Houthakker believes the replacement-cost accounts, though perhaps not the last word, are an improvement over the historical-cost accounts in presenting an accurate picture of a company's financial position. "They should have more prominence by being included in annual reports."

* Inflation distorts corporate taxes.

Dr. Houthakker argues that instead of playing down their replacement-cost accounts, corporations should use that information as the basis for pushing depreciation reform.

"They are paying taxes and dividends on nonexistent earnings," he said. In other words, inflation under historical-cost accounting exaggerates earnings.

In fact, he maintains that many corporations have been paying "unduly high dividends." They have, in effect, been paying their dividends out of unrealized capital gains rather than current income. That means the companies are being run down, as those paid-out capital gains are not available for replacing plant and equipment.

So what's to be done about inflation?

Dr. Houthakker urges that the nation's central banker, the Federal Reserve System, maintain a narrow range of growth in the money supply -- say a 5 percent rate in the measures known as M1A or M1B.

He predicts that if it does, the inflation rate will drop to around 6 percent by the end of next year; real growth in the output of goods and services will have resumed; and the prime interest rate offered by commercial banks to their most creditworthy customers will have declined to 7 or 8 percent or even lower.

"There would be more confidence in the economy then," he said.

It's a relatively rosy forecast, compared with the gloom offered today by many economists.

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