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The Big Inflation Thread

Helsworth, this is mainly for you.

http://en.wikipedia.org/wiki/Price/wage_spiral
http://www.imf.org/external/pubs/ft/wp/2003/wp03164.pdf
http://www.marxists.org/archive/mattick-...n/ch02.htm

We are bout committed to an empirical economics. We understand that the money supply is endogenously determined by the market economy and that the 'velocity of money' plays an important role in inflation. Thus we reject the simplistic theories which see it as 'too much money chasing too few goods'.

As I view it, inflation occurs whenever firms decide, in large numbers, to consistently raise prices for an extended period. Firms are run by real human beings, not by 'rational' homo economicus. Thus the reasons for decisions to raise prices are diverse and such decisions are innately unpredictable. Further there is far more communication and coordination among firms than traditional economics (and dissident economics which is not explicitly leftist) admits to. The employing class has developed a very high level of class consciousness.

The dynamics involved in the real economy (as opposed to the simplistic models produced by the neoclassical school) are incredibly complex, chaotic, and largely beyond not only my understanding, but the understanding of all honest economists. Thus we must be humble.

We can of course make empirical observations and deduce some small pieces of this complex dynamic. microeconomics can be useful to a certain extent in formulating an understanding of some of the important factors behind the decisions of individual firms to raise prices.

The wage-price spiral is an empirically observed phenomenon. It is accepted that it occurs by economists across the political spectrum. Whenever the working class gains even a modicum of advantage in the class struggle we observe inflation. These observations have been made by commentators as diverse as Paul Mattick and the IMF (even if the IMF uses different terminology).

When workers gain some advantage in the class struggle (i.e. via Job Guarantee, low unemployment, Basic Income, higher minimum wage etc), they demand higher wages. In order to maintain their profit margins firms raise prices. Realizing that their real wages have not increased, workers once again demand wage increases. In this situation, firms will also be acting in concert to pressure government to reduce labours bargaining power. Inflation is in firms interest if it serves to damage a left-wing government leading to its replacement, or alternatively if inflation can be blamed on workers bargaining power and thus used to persuade the existing government to reduce this bargaining power.

Thus anyone who aims to improve labours bargaining power needs a plan to deal with the resulting inflationary pressure.


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This post was last modified: 27.02.2014 20:05 by BaktoMakhno.

27.02.2014 19:54
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Post: #2
RE: The Big Inflation Thread

Too much money ChasinG too few goods is mv. Money satisfying savings desires does not impact the CPI.
Must read! It's pretty short. The Golden Age of Keynesianism and Stagflation explained
http://forum.ars-regendi.com/the-golden-...25479.html

So what is inflation?
Note, for the sake of keeping it simple, I am only considering inflationary pressures that arise from nominal demand (spending) growth outstripping the real capacity of the economy to react to it with output responses. In other words, I am excluding inflation that may arise from supply shocks – such as a rise in an imported raw material (for example, oil). That is another issue altogether.
The reason I am excluding supply-driven inflationary impulses is because the mainstream attack on the current use fiscal policy (and monetary policy) is really about demand pressures. We are continually reading crude statements such as there is “too much money” in the system.
However, the solution to both sources of inflation is not that dissimilar although additional measures might be brought to bear to handle the case of a price hike in an imported raw material.

First we should make sure what we are talking about. Many conservative commentators think that when workers get a pay rise it is inflation. It is not. Those on the left think that when the corporate sector increase the price of a good or service it is inflation. It is not.

It is also not inflation when the exchange rate falls pushing the price of imports up a step. So a depreciation in the currency does not constitute inflation. It might stimulate inflation but is not in itself inflation.

It is also not inflation when the government increases a particular tax (say the VAT or GST) by x per cent to some new level.

So while a price rise is a necessary condition for inflation it is not a sufficient condition. Observing a price rise alone will not be sufficient to categorise the phenomena that you are observing as being an inflationary episode.

Inflation is the continuous rise in the price level. That is, the price level has to be rising each period that you observe it. So if the price level or a wage level rises by 10 per cent every month, then you have an inflationary episode. In this case, the inflation rate would be considered stable – a constant rise per period.

If the price level was rising by 10 per cent in month one, then 11 per cent in month two, then 12 per cent in month three and so on, then you have accelerating inflation. Alternatively, if the price level was rising by 10 per cent in month one, 9 per cent in month two etc then you have falling or decelerating inflation.

If the price level starts to continuously fall then we call that a deflationary episode.

Hyper-inflation is just inflation big-time!

So a price rise can become inflation but is not necessarily inflation. Many commentators and economists get this basic understanding wrong – often and continually.

Second, it also follows that cyclical adjustments in price levels by firms from what they are currently offering at depressed levels of activity to what the price levels that are defined at their normal operating capacity levels are not inflation. When the economy is in poor shape, firms cut prices in an attempt to increase capacity utilisation by temporarily suppressing their profit margins and hence maintain market share. As demand conditions become more favourable the firms start increasing the prices they offer until they get back to those levels that offer them the desired rate of return at normal capacity utilisation.

Firms are basically quantity adjusters if they have spare capacity. They will seek to maintain market share when nominal demand grows by increasing output where possible. Should nominal demand growth (supported in part by net public spending) outstrip this capacity then firms will become price adjusters, because they can no longer expand real output.

Bottlenecks in some sub-markets may occur before other sectors are at full capacity and so price pressures might emerge just before overall full capacity is reached. So, in reality, the aggregate supply response (which tells you how much real output will be forthcoming at each price level) may not be strictly reverse-L shaped (where price is on the vertical axis and output on the horizontal axis). The extent to which the reverse-L becomes a curve at at a point approaching full capacity is an empirical matter.
Inflation occurs when there is chronic excess demand relative to the real capacity of the economy to produce.

Supply-side inflation?
Demand-pull inflation refers to the situation where prices start accelerating continuously because nominal aggregate demand growth outstrip the capacity of the economy to respond by expanding real output. Remember Gross Domestic Product (GDP) is the market value of final goods and services produced in some period.

So GDP = P.Y where P is the aggregate price level and Y is real output. Aggregate demand (expenditure) is always equal (by national accounting) to GDP or P.Y. So if there is growth in demand that cannot be met by growth in Y then P has to rise.

Keynes outlined the notion of an inflationary gap in his famous article – J.M. Keynes (1940) How to Pay for the War: A radical plan for the Chancellor of the Exchequer. London: Macmillan.

While this was in the context of war-time spending when faced by tight supply constraints (that is, an restricted ability to expand real output), the concept of the inflationary gap has been generalised to describe situations of excess demand (which I outlined above).

When there is excess capacity (supply potential) rising nominal aggregate demand growth will typically impact on real output growth first as firms fight for market share and access idle labour resources and unused capacity without facing rising input costs. As the economy nears full capacity the mix between real output growth and price rises becomes more likely to be biased toward price rises (depending on bottlenecks in specific areas of productive activity). At full capacity, GDP can only grow via inflation (that is, nominal values increase only).

Cost-push inflation (sometimes called “sellers inflation”) has a long tradition in the progressive literature (Marx, Kalecki, Lerner, Kaldor, Weintraub) although it is not exclusively a progressive theory. Milton Friedman considered that wage demands from trade unions were a major threat to inflation although he ultimately considered central bank monetary policy to be the real problem in that they accommodated these wage demands by increasing the “money supply”.

Cost-push inflation is an easy concept to understand and is generally explained in the context of “product markets” (where goods a sold) where firms have price setting power. That is, the perfectly competitive model that pervades the mainstream economics textbooks where firms have no market power and take the price set in the market, is abandoned and instead firms set prices by applying some form of profit mark-up to costs.

Kalecki is notable in that he started his analysis assuming mark-up pricing as an attempt to develop economic theory that was based on how the real world actually operated.

The notion is pretty straightforward although there are many different versions. But generally, firms are considered to have target profit rates which they render operational by the mark-up on unit costs. Unit costs are driven largely by wage costs, productivity movements and raw material prices.

Trade union bargaining power was considered an important component of the capacity of workers to realise nominal wage gains and this power was considered to be pro-cyclical – that is, when the economy is operating at “high pressure” (high levels of capacity utilisation) workers are more able to succeed in gaining money wage gains.

In these models, unemployment is seen as disciplining the capacity of workers to gain wages growth – in line with Marx’s reserve army of unemployed idea.

Workers have various motivations depending on the theory but most accept that real wages growth (increasing the capacity of the nominal or money wage to command real goods and services) is a primary aim of most wage bargaining.

So we get a “battle of the mark-ups” operating – workers try to get more real output for themselves by pushing for higher money wages and firms then resist the squeeze on their profits by passing on the rising cost – that is, increasing prices with the mark-up constant.

At that point there is no inflation – just a once-off rise in prices and no change to the distribution of national income in real terms.

However, if the economy is working at high pressure, workers may resist the attempt by capital to keep their real wage constant (or falling) and hence they may respond to the increasing prices by making further nominal wage demands. If their bargaining power is strong (which from the firm’s perspective is usually in terms of how much damage the workers can inflict via industrial action on output and hence profits) then they are likely to be successful.

At that point there is still no inflation. But if firms are not willing to absorb the squeeze on their real output claims then they will raise prices again and the beginnings of a wage-price spiral begins. If this process continues then you have a cost-push inflation.

The causality may come from firms pushing for a higher mark-up and trying to squeeze workers’ real wages. In this case, we might refer to the unfolding inflationary process as a price-wage spiral.

Conflict theory of inflation
There was a series of articles in Marxism Today in 1974 which advanced the notion of inflation being the result of a distributional conflict between workers and capital. One such article by Pat Devine (1974) ‘Inflation and Marxist Theory’, Marxism Today, March, 70–92 is worth reading if you can find it. As an aside, you can view an limited archive of Marxism Today since 1977 which is a very valuable resource.

Another influential book at the time was Robert Rowthorn’s 1980 book – Capitalism, Conflict and Inflation (Lawrence and Wishart).

The conflict theory derives directly from cost-push theories referred to above. Conflict theory recognises that the money supply is endogenous (as opposed to the Monetarist’s Quantity Theory of Money which assumes, wrongly, that the money supply is fixed).

In this world, firms and unions have some degree of market power (that is, they can influences prices and wage outcomes) without much correspondence to the state of the economy. They both desire some targetted real output share.

In each period, the economy produces a given real output which is shared between the groups with distributional claims. If the desired real shares of the workers and bosses is consistent with the available real output produced then there is no incompatibility and there will be no inflationary pressures.

But when the sum of the distributional claims (expressed in nominal terms – money wage demands and mark-ups) are greater than the real output available then inflation can occurs via the wage-price or price-wage spiral noted above.

The wage-price spiral might also become a wage-wage-price spiral as one section of the workforce seeks to restore relativities after another group of workers succeed in their wage demands.

That is, the conflict over available real output promotes inflation. Various dimensions can then be studied – the extent to which different wage contracts overlap and are adjusted, the rate of growth of productivity (which provides “room” for the wage demands to be accomodated without squeezing the profit margin), the state of capacity utilisation (which disciplines the capacity of the firms to pass on increasing costs), the rate of unemployment (which disciplines the capacity of workers to push for nominal wages growth).

Now here is the complication. Conflict theories of inflation note that for this distributional conflict to become a full-blown inflation the central bank has to ultimately “accommodate” the conflict. What does that mean?

If the central bank pushes up interest rates and makes credit more expensive, firms will be less able to pay the higher money wages (the conceptualisation is that firms access credit to “finance” their working capital needs in advance of realisation via sales). Production becomes more difficult and workers (in weaker bargaining positions) are laid off.

The rising unemployment, in turn, eventually discourages the workers from pursuing their on-going demand for wage increases and ultimately the inflationary process is choked off.

However, if the central bank doesn’t tighten monetary policy and the fiscal authorities do not increase taxes or cut public spending then the incompatible distributional claims will play out and inflation becomes inevitable.

Note I have not considered in any detail in this blog – the open economy interpretations of the conflict theory of inflation which have been developed by several Latin American researchers. That will be in Part 3 in this series which I will write another day.

There are also strong alignments between the conflict theory of inflation and Minksy’s financial instability notion. Both consider the dynamics are variable across the business cycle and so when economic activity is weak, both the distributional claims and the attitude of banks to lending will be benign. As the economic growth gathers pace, the claims increase and the risk-averseness of banks declines and more risky loans are made.

Pat Devine’s article (noted above) also introduced the notion that inflation was a structural construct. He argued that the increased bargaining power of workers (that accompanied the long period of full employment in the Post Second World War period) and the declining productivity in the early 1970s imparted a structural bias towards inflation which manifested in the inflation breakout in the mid-1970s which he says “ended the golden age”.

This notion implicates Keynesian-style approaches to full employment – and says the conduct of fiscal policy which squarely aimed to maintain full employment and high growth rates provided the structure for the biases to emerge. Then with the collapse of the Bretton Woods system of convertible currencies and fixed exchange rates (which provided deflationary forces to economies that had strongly domestic demand growth) these structural biases came to the fore.

Rowthorn says that the mid-1970s crisis – which marked the end of the Keynesian period and the start of the neo-liberal period – was associated with a rising inflation but also an on-going profit squeeze due to declining productivity and increasing external competition for market share. The profit squeeze led to firms reducing their rate of investment (which reduced aggregate demand growth) which combined with harsh contractions in monetary and fiscal policy created the stagflation that bedeviled the world in the second half of the 1970s.

The resolution to the “structural bias” was the policy-motivated attack on the working class bargaining power – both in the form of the persistently high unemployment and specific labour relations legislation. The subsequent redistribution of real income towards profits reduced the inflation spiral as workers were unable to pursue real wages growth and productivity growth outstripped real wages growth.

In one of my early articles (1987) – in the Australian Economic Papers – The NAIRU, Structural Imbalance and the Macroequilibrium Unemployment Rate – I developed the notion of a macroequilibrium unemployment rate. This came from my PhD research on inflation and natural rates. It was the first Australian study of hysteresis and one of the first international studies.

The motivation was clearly that the policy orientation in the UK, the US and in Australia was and remains based on the view that inflation is the basic constraint on expansion (and fuller employment).

The popular belief is that fiscal and monetary policy can no longer attain unemployment rates common in the sixties without ever-accelerating inflation rate of unemployment. The natural rate of unemployment (NRU) which is the rate of unemployment consistent with stable inflation is considered to have risen over time.

The non-accelerating inflation rate of unemployment (NAIRU) is a less rigorous version of the NRU but concurs that a particular, cyclically stable unemployment rate coincides with stable inflation. Labour force compositional changes, government welfare payments, trade-union wage goals among other “structural” influences were all implicated in the rising estimates of the inflationary constraint.

The NAIRU achieved such rapid status among the profession as a policy-conditioning concept that I thought it warranted close scrutiny.

My basic proposition was that persistently weak aggregate demand creates a labour market, which mimics features conventionally associated with structural problems.

The specific hypothesis I examined was whether the equilibrium unemployment rate is a direct function of the actual unemployment rate and hence the business cycle. That is the hysteresis effect.

By developing an understanding of the way the labour market adjusts to swings in aggregate demand and generates hysteresis, providing a strong conceptual and empirical basis for advocating counter-stabilising fiscal policy (aggregate policy expansion in a downturn).

So while it might look like the degree of slack necessary to control inflation may have increased, the underlying cyclical labour market processes that are at work in a downturn can be exploited by appropriate demand policies to reduce the steady state unemployment rate.

In that work I outlined a conceptual unemployment rate, which is associated with price stability, in that it temporarily constrains the wage demands of the employed and balances the competing distributional claims on output.

I introduced a new term the macroequilibrium unemployment rate (the MRU) which I noted was, importantly, sensitive to the cycle due to the impact of the cyclical labour market adjustments on the ability of the employed to achieve their wage demands. In this sense, the MRU is distinguished from the conventional steady state unemployment rate, the NAIRU, which is not conceived to be cyclically variable.

What I wanted to show was that there was an interaction between the actual and MRU which would establish the presence of the hysteresis effect.

To be clear – the significance of hysteresis, if it exists, is that the unemployment rate associated with stable prices, at any point in time should not be conceived of as a rigid non-inflationary constraint on expansionary macro policy.

The equilibrium rate itself can be reduced by policies, which reduce the actual unemployment rate. That is why I chose to use the term MRU, as the non-inflationary unemployment rate, as distinct from the NAIRU, to highlight the hysteresis mechanism.

The idea is that structural imbalance increases in a recession due to the cyclical labour market adjustments commonly observed in downturns, and decreases at higher levels of demand as the adjustments are reserved. Structural imbalance refers to the inability of the actual unemployed to present themselves as an effective excess supply.

The non-wage labour market adjustment that accompany a low-pressure economy, which could lead to hysteresis, are well documented. Training opportunities are provided with entry-level jobs and so the (average) skill of the labour force declines as vacancies fall. New entrants are denied relevant skills (and socialisation associated with stable work patterns) and redundant workers face skill obsolescence. Both groups need jobs in order to update and/or acquire relevant skills. Skill (experience) upgrading also occurs through mobility, which is restricted during a downturn.

So why would there be some unemployment rate that is consistent with stable inflation. Remember this is a non Job Guarantee world. The introduction of a JG would change things considerably (more favourably).

There is an extensive literature that links the concept of structural imbalance to wage and price inflation. A non-inflationary unemployment rate can be defined which is sensitive to the cycle.

My work at the time was contributing to the view that inflation was the product of incompatible distributional claims on available income. So when nominal aggregate demand is growing too quickly, something has to give in real terms for that spending growth to be compatible with the real capacity of the economy to absorb the spending.

Unemployment can temporarily balance the conflicting demands of labour and capital by disciplining the aspirations of labour so that they are compatible with the profitability requirements of capital. That was Kalecki’s argument which I considered in the blog – Michal Kalecki – The Political Aspects of Full Employment.

A lull in the wage-price spiral could thus be termed a macroequilibrium state in the limited sense that inflation is stable. The implied unemployment rate under this concept of inflation is termed in this paper the MRU and has no connotations of voluntary maximising individual behaviour which underpins the NAIRU concept that is at the core of mainstream macroeconomics.

Wage demands are thus inversely related to the actual number of unemployed who are potential substitutes for those currently employed.

Increasing structural imbalance (via cyclical non-wage labour market adjustment) drives a wedge between potential and actual excess labour supply, and to some degree, insulates the wage demands of the employed from the cycle. The more rapid the cyclical adjustment, the higher is the unemployment rate associated with price stability.

Stimulating job growth can decrease the wedge because the unemployed develop new and relevant skills and experience. These upgrading effects provide an opportunity for real growth to occur as the cycle reduces the MRU.

Why will firms employ those without skills? An important reason is that hiring standards drop as the upturn begins. Rather than disturb wage structures firms offer entry-level jobs as training positions.

It is difficult to associate wage demands (in excess of current money wages) with the workforce. While the increased training opportunities increase the threat to those who were insulated in the recession this is offset to some degree by the reduced probability of becoming unemployed.

The subsequent empirical work I did and which has since been built on by others has blown the NAIRU concept out of the water. Please read my blog – The dreaded NAIRU is still about! – for more discussion on this point.

At the time, and since, a lot of progressives have objected to the idea that there is some steady-state unemployment rate that disciplines inflation. They claim is sounds like a NAIRU and is a concession to the mainstream paradigm.

Rowthorn clearly understood that at some level of unemployment – which emerges when the government tightens its policy settings – inflation stabilises. This sounds like a NAIRU.

In my 1987 article I wrote:

Quote:
Inflation results from incompatible distributional claims on available income, unemployment can temporarily balance the conflicting demands of labour and capital by disciplining the aspirations of labour so that they are compatible with the profitability requirements of capital … The wage-price spiral lull could be termed a macroequilibrium state in the limited sense that inflation is stable. The implied unemployment rate under this concept of inflation is termed in this paper the MRU and has no connotations of voluntary maximising individual behaviour which underpins the NAIRU concept …


That is a crucial distinction – it is no surprise in a capitalist system that if you create enough unemployment you will suppress wage demands given that workers, by definition, have to work to live.

But you can underpin this notion of equilibrium without recourse to the individualistic and optimising behaviour assumed by the mainstream.

Raw material price rises
Raw material shocks can also trigger of a cost-push inflation. They can be imported or domestically-sourced. I will devote a special blog to imported raw material shocks in the future.

But the essence is that an imported resource price shock amounts to a loss of real income for the nation in question. This can have significant distributional implications (as the OPEC oil price shocks in the 1970s had). How the government handles such a shock is critical.

The dynamic is that the imported resources reduces the real income that is available for distribution domestically. Something has to give. The loss has to be shared or borne by one of the claimants or another. If the workers resist the lower real wages or if bosses do not accept that some squeeze on their profit margin is inevitable then a wage-price/price-wage spiral can emerge.

The government can employ a number of strategies when faced with this dynamic. It can maintain the existing nominal demand growth which would be very likely to reinforce the spiral.

Alternatively, it can use a combination of strategies to discipline the inflation process including the tightening of fiscal and monetary policy to create unemployment (the NAIRU strategy); the development of consensual incomes policies and/or the imposition of wage-price guidelines (without consensus).

Progressives argued that the best way to deal with such the likelihood is via an incomes policy saying that the NAIRU strategy is very costly in terms of real output losses.

They consider incomes policies can be developed with mediate the claims on the real income available to render them compatible over time. I will write a separate blog about incomes policies as I did a lot of work on them in the late 1980s and into the 1990s.

I also wrote some papers in the 1980s on having wage-price rules driven by productivity growth in certain sectors (for example, in the so-called Scandinavian Model (SM) of inflation.

This model, originally developed for fixed exchange rates, dichotomises the economy into a competitive sector (C-sector) and a sheltered sector (S-sector). The C-sector produces products, which are traded on world markets, and its prices follow the general movements in world prices. The C-sector serves as the leader in wage settlements. The S-sector does not trade its goods externally.

Under fixed exchange rates, the C-sector maintains price competitiveness if the growth in money wages in its sector is equal to the rate of change in its labour productivity (assumed to be superior to S-sector productivity) plus the growth in prices of foreign goods. Price inflation in the C-sector is equal to the foreign inflation rate if the above rule is applied. The wage norm established in the C-sector spills over into wages growth throughout the economy.

The S-sector inflation rate thus equals the wage norm less its own productivity growth rate. Hence, aggregate price inflation is equal to the world inflation rate plus the difference between the productivity growth rates in the C- and S-sectors weighted by the S-sector share in total output. The domestic inflation rate can be higher than the rate of growth in foreign prices without damaging competitiveness, as long as the rate of C-sector inflation is less than or equal to the world inflation rate.

In equilibrium, nominal labour costs in the C-sector will grow at a rate equal to the room (the sum of the growth in world prices and the C-sector productivity). Where non-wage costs are positive (taxes, social security and other benefits extracted from the employers), nominal wages would have to grow at a lower rate. The long-run tendency is for nominal wages to absorb the room provided. However in the short-run, labour costs can diverge from the permitted growth path. This disequilibrium must emanate from domestic factors.

The main features of the SM can be summarised as follows:

The domestic currency price of C-sector output is exogenously determined by world market prices and the exchange rate.
The surplus available for distribution between profits and wages in the C-sector is thus determined by the world inflation rate, the exchange rate and the productivity performance of industries in the C-sector.
The wage outcome in the C-sector is spread to the S-sector industries either by design (solidarity) or through competition.
The price of output in the S-sector is determined (usually by a mark-up) by the unit labour costs in that sector. The wage outcome in the C-sector and the productivity performance in the S-sector determine unit labour costs.
An incomes policy would establish wage guidelines which would set national wages growth according to trends in world prices (adjusted for exchange rate changes) and productivity in the C-sector. This would help to maintain a stable level of profits in the C-sector.

Whether this was an equilibrium level depends on the distribution of factor shares prevailing at the time the guidelines were first applied.

Clearly, the outcomes could be different from those suggested by the model if a short-run adjustment in factor shares was required. Once a normal share of profits was achieved the guidelines could be enforced to maintain this distribution.

A major criticism of the SM as a general theory of inflation is that it ignores the demand side. Uncoordinated collective bargaining and/or significant growth in non-wage components of labour costs may push costs above the permitted path. Where domestic pressures create divergences from the equilibrium path of nominal wage and costs there is some rationale for pursuing a consensus based incomes policy.

An incomes policy, by minimising domestic cost fluctuations faced by the exposed sector, could reduce the possibility of a C-sector profit squeeze, help maintain C-sector competitiveness, and avoid employment losses. Significant contributions to the general cost level and hence prices can originate from the actions by government. Payroll taxation, various government charges and the like may in fact be more detrimental to the exposed sector than increased wage demands from the labour market.

Although the SM was originally developed for fixed exchange rates, it can accommodate flexible exchange rates. Exchange rate movements can compensate for world price changes and local price rises. The domestic price level can be completely insulated from the world inflation rate if the exchange rate continuously appreciates (at a rate equal to the sum of the world inflation rate and C-sector productivity growth).

Similarly, if local price rises occur, a stable domestic inflation rate can still be maintained if a corresponding decrease in C-sector prices occur. An appreciating exchange rate discounts the foreign price in domestic currency terms.

What about terms of trade changes? Terms of trade changes, which in the SM justify wage rises, also (in practice) stimulate sympathetic exchange rate changes. This combination locks the economy into an uncompetitive bind because of the relative fixity of nominal wages. Unless the exchange rate depreciates far enough to offset both the price fall and the wage rise, profitability in the C-sector will be squeezed.

It was considered appropriate to ameliorate this problem through an incomes policy. Such a policy could be designed to prevent the destabilising wage movements, which respond to terms of trade improvements. In other words, wage bargaining, consistent with the mechanisms defined by the SM may be detrimental to both the domestic inflation target and the competitiveness of the C-sector, and may need to be supplemented by a formal incomes policy to restore or retain consistency.

I remind all progressives of what Rowthorn (a Marxist economist) noted:

Quote:
…trade unions cannot afford to be too successful …

Which means in a capitalist system which is driven by the rate of profit, workers can create unemployment by being too successful in their wage demands.

Modern Monetary Theory policy considerations
As I explained in Part 1 of this series – Modern monetary theory and inflation – Part 1 – a cost-push inflation requires certain aggregate demand conditions to continue for its fuel. In this regard, the concept of a supply-side inflation blurs with the demand-pull inflation although their originating forces might be quite different.

An imported raw material shock just means that real income is lower and will not cause inflation unless it triggers an on-going distributional conflict. That conflict needs “oxygen” in the form of on-going economic activity in sectors where the spiral is robust.

The preferred approach is to use employment buffer stocks in conjunction with fiscal policy adjustments to allow the available real income to be rendered compatible with the existing claims.

Modern Monetary Theory rejects the NAIRU approach (the current orthodoxy) – that is, the use of unemployment buffer stocks – where inflation is controlled using tight monetary and fiscal policy, which leads to a buffer stock of unemployment. This is a very costly and unreliable target for policy makers to pursue as a means for inflation proofing.

Employment buffer stocks rests on the government exploiting its fiscal power that is embodied in a fiat-currency issuing national government to introduce full employment based on an employment buffer stock approach. The Job Guarantee (JG) model which is central to MMT is an example of an employment buffer stock policy approach.

Under a Job Guarantee, the inflation anchor is provided in the form of a fixed wage (price) employment guarantee.

Full employment requires that there are enough jobs created in the economy to absorb the available labour supply. Focusing on some politically acceptable (though perhaps high) unemployment rate is incompatible with sustained full employment.

In MMT, a superior use of the labour slack necessary to generate price stability is to implement an employment program for the otherwise unemployed as an activity floor in the real sector, which both anchors the general price level to the price of employed labour of this (currently unemployed) buffer and can produce useful output with positive supply side effects.

The employment buffer stock approach (the JG) exploits the imperfect competition introduced by fiat (flexible exchange rate) currency which provides the issuing government with pricing power and frees it of nominal financial constraints.

The JG approach represents a break in paradigm from both traditional Keynesian policies and the NAIRU-buffer stock approach. The difference is a shift from what can be categorised as spending on a quantity rule to spending on a price rule.

I noted interest in this concept today among the comments and I will write more about it in due course. But the point is that under a spending rule (which is the current policy approach), the government budgets a quantity of dollars to be spent at prevailing market prices.

In contrast, under a price rule (the JG option) the government offers a fixed wage to anyone willing and able to work, and thereby lets market forces determine the total quantity of government spending. This is what I call spending based on a price rule.

How does the government decide that net public spending is just right? Answer: the JG is an automatic stabiliser. The last worker that comes into the JG office to accept a wage tells you the limits of the program and the size of the budget commitment.

This becomes more complicated when there are other programs being offered. But given the automatic stabiliser nature of the JG, the government at least knows exactly how much it has to outlay each period to maintain (loose) full employment. What is does in addition to this depends on its policy ambitions and the degree of excess capacity in the non-JG sectors of the economy.

Many economists who are sympathetic to the goals of full employment are sceptical of the JG approach because they fear it will make inflation impossible to control.

However, if the government is buying a resource with zero market bid (the JG workers) and moving resources from the inflating sectors to the fixed price sector then inflation control is possible – no matter the origin.

Some people have argued that the JG could be offered in conjunction with an incomes policy if the implied JG-pool that is required to resolve the inflation spiral is too large.

This is entirely possible if you can devise an effective incomes policy. It is unnecessary for inflation control once the JG is in place but could reduce the size of the shift in resources between the private economy and the JG pool should that be considered problematic.

Conclusion
My main concern about the rising prices at present that are of supply-side origin relate to the FAO issues raised at the outset. The number (and proportion) of people in hunger will rise and that should be a government policy priority.

It certainly will not be a priority as long as governments continue headlong into fiscal austerity.

Further, under current policy approaches based on the NAIRU, if the central banks use demand-side policies to deal with a supply-side motivated problem the costs will be very high. The only way that demand-side policies should be used to effect when there is a supply-side motivated inflation is when there is an employment buffer stock system in place.

Source: http://bilbo.economicoutlook.net/blog/?p=13035

PS: Bill Mitchell is absolutely brilliant, but he's writing style I find it to be really horrible; so bear with it.


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This post was last modified: 01.03.2014 19:36 by Helsworth.

27.02.2014 20:30
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BaktoMakhno
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Post: #3
RE: The Big Inflation Thread

Ok, I will read this guys stuff in time. Still pretty busy atm.

For now two quick points, the 'conflict theory of inflation' he talks about is a radically simplified, sanitized and frankly whitewashed account of class struggle.

It is +not+ all about the money. I would argue that conflict over wages forms a relatively minor part of it. Michael Kalecki would do the same. Class Struggle, like war and pretty much all conflict boils down to fear. Remember that word. Fear. Capital wants labour scared, this is considerably more important than getting higher profits.

What comprises successful management and productive organisational culture cannot be expressed in the pseudo-mathematical jargon of which economists are so fond. Fear is a great motivator. Nothing breaks the spirit and makes people malleable like fear. Fear is what enables management to beat labour into the shape it desires, whatever that may be. In economics speak it is what enables management to externalize costs onto the staff.

This means increased productivity at the expense of 'job satisfaction' and workplace camaraderie. It is paid for buy the staff through increased stress which often results in mental health problems (in the UK the number 1 cause of mental health problems is work stress). Management is constantly experimenting to see how far they can push before people push back. The stronger labours bargaining power the sooner this happens.

If management becomes less able to externalize costs onto the staff and productivity goes down then either output will drop or they will have to hire more staff. Thus if profits are to be maintained prices must rise. This happens without any explicit demands or consciously organised struggle from labour.

Long term unemployment, which makes people unemployable through a vicious circle, so ultimately they aren't really competing for jobs is part of the plan. That's a nasty situation to be in. Scary. People are going to be much more worried about losing their jobs if that's a possibility for them. I haven't the time to find them now, but I have read Bank of England minutes which are very candid about this. The same goes for all the other nasties that come with unemployment. In the eyes of the employing class these are great. The unemployed must suffer so the employed fear joining them. Being on the Job Guarantee wouldn't be nearly as bad as being unemployed - you are right it carries a whole host of positives. Capital is against the Job Guarantee for exactly the reasons you give in favour of it. And without simultaneous policies to control inflation the JG would be inflationary for the very same reasons.

My second point, when discussing economics I prefer not to use jargon wherever possible. Words have power, the language we use deeply influences our thoughts and beliefs to an extent we are rarely consciously aware of. Economics-speak is heavily bound up with rightist ideology and is ingeniously constructed to narrow our focus elide human and subjective factors.

I will read through the guy you've quoted (especially his stuff on Kalecki) when I am less busy.


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"There is no conversation more boring than one where Globaltom speaks" - Triniterias

This post was last modified: 03.03.2014 18:35 by BaktoMakhno.

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Post: #4
RE: The Big Inflation Thread

Bakto, you have to understand that Mitchell is NOT a politician. He's not advocating one ideology above the other. The man's an economist and he's providing an economist's insight using the jargon of his profession.
As for inflation itself, Mitchell clearly states that so many people misunderstand the meaning of the term - including the mainstream econ-blokes.
Just like Dean Baker, John T. Harvey, Warren Mosler, and others - Bill Mitchell clearly outlines that the issue of unemployment is a lot more important that the phenomenon of inflation itself. The neoliberals and the austrians would disagree heavily with this. The neoliberals would invoke the NAIRU, while the austrians would invoke the free market god which cannot be studied or conceived by mathematics or by such a thing called "the economy".
So compared to these so-called schools, MMTers and Postkeynesians are dramatically more revolutionary and progressive in their jargon than anyone else.
As for the marxians, they failed long ago to actually incorporate the use and purpose of tax-driven money in their analysis and policy prescriptions. Imagine how people would have received 19th century social democracy (marxist parties), if their leaders would have explained to them that a freefloating nonconvertible fiat regime would empower the government to do away with unemployment, exploitation, social injustice, improve standard of living, and grant the country in question independence from foreign creditors.
Imagine what would have happened if people came to understand that the reason for unemployment was political - that the government's proper role was to tax less than it spends in order to cover the desire of households to net save - thus achieving full employment.


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This post was last modified: 03.03.2014 18:54 by Helsworth.

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Post: #5
RE: The Big Inflation Thread

I understand. In pure economics jargon, here is my point:

The ability of firms to externalize costs onto employees is a factor Bill ignores. The more firms are able to externalize costs onto workers the lower their costs and the higher their output. The ability of firms to do this is determined by the level of disutility incurred by an employee who loses his job. A lower level of disutility for those who lose their jobs makes firms less able to externalize costs onto employees. This results in higher costs which firms offset by raising prices. Thus reducing the level of disutility incurred by those who lose their jobs on a large scale is likely to be inflationary. Bill does not take account of this.

All the best economists (Steve Keen in particular) recognize how the jargon of the economics profession functions to obscure reality. They make their reservations clear and point out what is being elided. I agree that postkeynesians are the best of the economics profession. I have spent a lot of time reading them and would urge others to do the same. But if their use of demonstrably flawed conceptual frameworks does not come with warnings we should read critically and carefully. There are many economic phenomenon which simply cannot be properly understood purely through economics and its jargon - political factors are too important and too deeply intertwined.

Marxian economics failed because it refused to reject the Labour Theory of Value. I completely agree with you on people needing to be educated about the true reasons for unemployment being political. When I lived in an area with an organised socialist group we used to picket the jobcentre (where unemployed people go to get their benefits) and give out leaflets explaining this. My idea.


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This post was last modified: 03.03.2014 19:41 by BaktoMakhno.

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Post: #6
RE: The Big Inflation Thread

BaktoMakhno Wrote:
The ability of firms to externalize costs onto employees is a factor Bill ignores.


Bill Mitchell Wrote:
Note I have not considered in any detail in this blog – the open economy interpretations of the conflict theory of inflation which have been developed by several Latin American researchers. That will be in Part 3 in this series which I will write another day.

See part 3 here: http://bilbo.economicoutlook.net/blog/?p=22737


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This post was last modified: 03.03.2014 19:46 by Helsworth.

03.03.2014 19:45
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