MMTed is a project run by the Centre of Full Employment and Equity
Business Office:
G15V 162 Albert Street
East Melbourne 3002 Victoria
Australia
© MMTed 2024
Contact
Phone: +61-(0)419 422 410
E-Mail: Bill.Mitchell@newcastle.edu.au
Video Transcript: (use scroll bar as required)
So I want to talk now briefly about inflation and unemployment.
Now we've got to get it straight that inflation is a continuous increase in prices, not a once off increase in prices. Now, inflation can rise in a number of ways.
And one of the important insights, if you study History, there's a lot of movements in price levels derived from administrative decisions of government. So excise duties, health insurance type pricing decisions have nothing to do with the state of the economy. And we get seduced into thinking, oh, inflation is rising. But it's really because of annual government decisions to index various prices in the economy.
But in general, economists distinguish between what they call demand pull inflation, which is excessive nominal spending in the economy - in other words, when total spending outstrips the capacity of the economy to produce real goods and services, the only way out is to push up prices.
And the other way inflation can arise is through what we call cost push inflation. And that is that there's some raw material price rise, for example, pushes up business costs.
And then there's a unholy war between labour and capital as to who's going to bear the real losses associated with that raw material price rise.
And so the traditional way of thinking about these things was in what was called the Phillips curve, which was introduced in 1958 to macroeconomics.
And this was a diagram that alleged that there was a trade off between inflation and unemployment. So that if you had lower unemployment, that would push up cost pressures through wage demands and increased spending because incomes in the economy would be higher and so inflation would rise. And so there was a big industry in government policy making as to what was the optimal trade off between the two evils, inflation and unemployment.
Well, then that framework was then taken on by the monetarists in the late 1960s and in the growing sort of neoliberal attacks on government to deny that there was a trade off and claim that there was only one unemployment rate, the so-called natural rate that would be consistent with stable inflation, and that if governments tried to drive that natural rate down using fiscal policy expansion, then all they would do would create inflation.
That was a pretty erroneous analysis, but it had great political weight and became the dominant paradigm in economic policymaking.
Now, in Modern Monetary Theory, there is no natural rate of unemployment. We believe that there's only an irreducible minimum rate of unemployment. And the way we analyse inflation is to compare two buffer stock mechanisms, which we'll talk about in a subsequent video.
And those two buffer stocks are either you use an unemployment approach to discipline inflation, which is massively costly, or you use an alternative of an employment buffer stock a job guarantee.
Now, the last thing I want to talk about here is the fear that's constantly invoked when government run deficits, and that's the Zimbabwe Weimar Republic hyperinflation fear. We're led to believe that when governments run deficits continuously that eventually you'll get hyperinflation because there'll be too much money circulating, chasing too few goods and wow.
We'll take Zimbabwe, for an example, if you understand History, Zimbabwe had hyperinflation for sure. But why did it have hyperinflation? And the historical understanding will lead you to know that Robert Mugabe wanted to reward his freedom fighters who freed the country from the colonial white rulers. And at the same time, during the colonial white regime, land equity was dramatically unequal. In other words, most of the land was owned by the whites. And what Robert Mugabe did for good reasons was a disastrous policy intervention.
He gave the white farms, which were highly productive and the food bowl of Africa - he gave them to the freedom fighters who knew nothing about farming. And as a consequence, agricultural output collapsed in Zimbabwe, modern Zimbabwe. And then to solve the food crisis, the Central Bank restricted the foreign currency that they would previously make available to manufacturers to import capital equipment and so manufacturing started to falter as well. And so when you got a collapse of production and productive capacity, we call it a supply shock and it wouldn't have mattered if the Zimbabwean government had even been running fiscal surpluses, you still would have got hyperinflation because of a dramatic contraction in the supply capacity. And so the Zimbabwe example and similarly what happened in the 1920s in Germany, those examples provide no understanding, no knowledge of what happens in a normal situation where governments running fiscal deficits and supply is growing as investment grows.
End of Transcript
Inflation is the continuous rise in the price level. Deflation is the opposite. A once-off price rise is not an inflationary episode. If the inflation rate is falling, prices are still rising but at a slower rate. Extreme cases of accelerating inflation are referred to as hyperinflation.
There are various approaches to studying inflation. Economists distinguish demand pull from cost push inflation, although the demarcation between the two types of inflation is not as clear cut as one might think. Further, they are both related to the notion that inflation arises out of conflict between labour and capital over the distribution of national income (conflict theory).
Conflict theory situates the problem of inflation as being intrinsic to the power relations between workers and capital (class conflict), which are mediated by government within a capitalist system. It brings together social, political, and economic considerations in a generalised view of the inflation cycle. This mediation by government varies over the course of history but in more recent times has been biased towards protecting the interests of capital, particularly financial capital, at the expense of workers’ real wage aspirations.
The nature of the power relations between workers and capital is integral to understanding all inflationary processes.
Business firms have price setting power and set prices by applying a mark-up to costs in order to achieve target profit rates that satisfy their shareholders or owners. Unit costs are driven by wage costs, productivity movements and raw material prices. Shifts in any of these determinants can generate cost increases, which price setting firms may pass on by raising prices.
On the other hand, the bargaining strength of workers will depend on their capacity to mobilise effectively, which is typically through trade union action. The shift to more casualised, precarious employment over the last several decades along with reduced rates of unionisation in many developed economies has reduced the bargaining power of the union movement. In many instances this has been reinforced by anti-union legislation.
In each period, the economy produces a given nominal income (GDP) which is then divided between the distributional claimants - wages, profits, rents, interest, taxes and so on.
If the desired output shares of the workers and firms are consistent with the available GDP, then there is no incompatibility and there will be no inflationary pressures arising from this source. However, if the distributional claims are incompatible, then the aggrieved group(s) would seek redress by seeking wage increases (labour) and/or impose price increases (firms).
When the economy is strong, the capacity of workers to realise wage gains rises and vice-versa. In boom times, firms also fear protracted strikes that will damage them at a time when profits are high.
To protect their market share in these circumstances, they are more likely to concede to the workers’ demands, knowing that they can in turn use their price setting power to defend their profits by increasing prices (that is, restore the previous mark-up).
This can be described as a battle of the mark-ups.
When the income aspirations of each is greater than GDP and neither bargaining party is prepared to concede to the other by ceasing to pursue higher nominal income demands then inflation will result.
The role of government is also implicated. While it is the distributional conflict which initiates the inflationary spiral, government policy has to be compliant for the nascent inflation to persist.
If governments tighten macroeconomic policy settings by cutting spending and/or raising taxes or the central bank pushes up interest rates, then the resulting unemployment will impose costs on workers and eventually force then to moderate the wage demands. Similarly, the cuts in spending hurt sales and reduce the willingness of firms to push up prices.
Thus, what might emerge as a 'cost push' pressure, which sparks the distributional conflict, requires certain demand (spending) conditions to be present for an inflationary spiral to emerge.
Higher raw material price shocks can also trigger cost push inflation. These cost shocks may be imported (for example, an oil-dependent nation might face higher energy prices if world oil prices rise) or domestically sourced (for example, a nation may experience a drought which increases the costs of food crops and impacts on all food processing industries).
Demand pull inflation occurs when prices start accelerating continuously because total spending growth outstrips the capacity of the economy to respond by expanding real output. Once full employment was reached, then nominal demand growth beyond that level would be inflationary.
As noted above, higher levels of activity, can also promote cost-push pressures by increasing the bargaining power of workers and making it easier for firms to pass on the higher costs as higher prices.
This notion also led to the notion of a trade-off between inflation and unemployment (the so-called Phillips curve) because as total spending rises, unemployment falls and then price pressures rise.
In the video we learned that movements in the price level that are reported regularly by national statistical agencies and capture headlines are often driven by administrative decisions of government or other authorities. While many commentators await with baited breath for these statistical updates and tell their audiences when there is an uptick in the reported inflation rate, that the economy is close to overheating and deficits have to be cut, they rarely tell us the impact of these policy decisions, which have nothing much to do with the state of the economy.
See if you can find evidence that shows the impact of these administrative decisions on movements in reported inflation rates.
Look for excise and other tax changes, agreements to allow health cost increases, agreements to allow energy price rises, and more.
MMTed is a project run by the Centre of Full Employment and Equity
Business Office:
G15V 162 Albert Street
East Melbourne 3002 Victoria
Australia
© MMTed 2024
Contact
Phone: +61-(0)419 422 410
E-Mail: Bill.Mitchell@newcastle.edu.au