What does the inflationary process look like?

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Characterisations of the inflationary process

The inflationary process can be broken down into three parts:

  • the origins of inflation
  • the transmission of inflationary pressure
  • and the array of inflationary outcomes.

At the outset, it should be made clear that there is no settled and widely accepted account of the inflationary process.

There are three dominant characterisations of the process, often presented as rivals, but which are not mutually exclusive.

There are various facets to the inflationary process, and the different approaches highlight these various facets.


Inflation as the outcome of a power struggle over real resources

This characterisation emphasises the role of conflict between groups of agents (e.g. labour unions, employers’ organisations, government) in their quest for economic advantage.

Microeconomics, game theory and psychology take precedence over macroeconomics in this explanation.

In the bargaining model, the focus is on the power struggle between groups of employers and groups of employees over the factor shares of entrepreneurial income and wage income.

This holds the potential for a wage–price spiral to occur, which would also affect public sector costs.

This tempts governments to expand the money supply, with the result that the rise in the price level is validated. Thus, on this account, inflation arises in the labour market and is transmitted to the money supply and to the product markets.


Inflation as a symptom of excessive aggregate demand

Here, the emphasis is on the product markets – the markets for goods and services – where the aggregation of final demand by consumers, firms and government is liable to differ from the aggregate supply of goods and services.

Inflation is viewed as a side effect of excessive aggregate demand, which is then transmitted to the labour market.

This is a macroeconomic explanation that asserts the dependency of private consumption and investment on income and interest rates.


Inflation as a monetary phenomenon

The monetary account of inflation asserts a causal relationship running from the money supply to the price level, based on certain strong assumptions about the demand for money and the velocity of transactions (the speed with which money circulates) in the economy.

The standard case assumes that the demand for and supply of money are in balance, or equilibrium. However, if there is a monetary imbalance, then this is an additional source of disturbance to the markets for goods and assets.


Looking for a synergy between the three approaches

The search for synergy between these three approaches begins with the recognition that, in the real world, all markets are interdependent, and that each national economy is heavily influenced by its international trading relationships.

At various times each of these caricatures of the inflationary process has seemed relevant and credible.

However, none of them constitutes a general theory or description of the inflationary process.

Furthermore, changes in institutional structures:

  • for pay bargaining
  • for the ownership of large utilities
  • in the distribution between income
  • spending and wealth taxes
  • in the degrees of concentration in and regulation of the financial system.

These can all make a huge difference to the outworkings of the inflationary process.



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