1/8. A point which is often lost in discussions of inflation and central bank policy. Inflation is fundamentally the outcome of the distributional conflict, between firms, workers, and taxpayers. It stops only when the various players are forced to accept the outcome.
2/8. The source of the conflict may be too hot an economy: In the labor market, workers may be in a stronger position to bargain for higher wages given prices. But, in the goods market, firms may also be in a stronger position to increase prices given wages. And, on, it goes.
3/8. The source of the conflict may be in too high prices of commodities, such as energy. Firms want to increase prices given wages, to reflect the higher cost of intermediate inputs. Workers want to resist the decrease in the real wage, and ask for higher wages. And on it goes.
4/8. The state can play various roles. Through fiscal policy, it can slow down the economy and eliminate the overheating. It can subsidize the cost of energy, limiting the decrease in the real wage and the pressure on nominal wages.
5/8. It can finance the subsidies by increasing taxes on some current taxpayers, say exceptional profit taxes, or through deficits and eventual taxes on future taxpayers (who have little say in the process...)
6/8. But, in the end, forcing the players to accept the outcome, and thus stabilizing inflation, is typically left to the central bank. By slowing down the economy, it can force firms to accept lower prices given wages, and workers to accept lower wages given prices.
7/8. It is a highly inefficient way to deal with distributional conflicts. One can/should dream of a negotiation between workers, firms, and the state, in which the outcome is achieved without triggering inflation and requiring a painful slowdown.
8/8. But, unfortunately, this requires more trust than can be hoped for and just does not happen. Still, this way of thinking inflation shows what the problem is, and how to think of the least painful solution.


A very good point from Olivier, but the replies make it clear that many people don't get it. Maybe an old analogy can help clarify 1/
I think this came from Martin Baily in the 70s. Anyway, one way to think about inflation is that it's like a sports event where everyone stands up to get a better view of the action — which is collectively self-defeating 2/
Controlling inflation by inducing a recession is like stopping the action on the field until everyone sits down again. It works, but at a cost 3/
Much better if we could get collective agreement by everyone to sit down without stopping the game. That's hard to achieve, but not always impossible 4/
The more or less painless 1985 Bruno disinflation in Israel was pretty much exactly that: all the major parties agreed to stop trying to leapfrog each other, and inflation came down right away 5/
FWIW, the 1968 Phelps paper that simultaneously and independently introduced the natural rate hypothesis — and I think much better than Friedman's — worked pretty much that way: 6/
Staggered wage-setting, and in a hot labor market everyone trying to get ahead of everyone else — with inflation possibly getting entrenched if everyone expected it to persist 7/
And of course all of this extremely relevant if we're trying to figure out how hard disinflation will be in the near future 8/


1. Answering John Cochrane: no contradiction: Higher aggregate demand leads everybody to want to increase their price relative to others. This is a distributional conflict in which everybody wants more, leading to increasing and increasing prices, i.e. inflation.

2. But there are other sources, which have to do with one player wanting to increase its price relative to others (OPEC?), even if aggregate demand is not too high. In which case, there is again a distributional conflict, which leads to inflation




Continuing this discussion. Again, Olivier is tapping into an important point often missed in monetary/macroeconomics: in the end, it all comes down to individual motives and decisions 1/
A business that raises its prices doesn't do so because the Fed has increased the money supply. The chain of events that leads to that price rise may have started with the Fed, but the firm is responding to its own market conditions 2/
There was a similar debate over the balance of payments back in the 1980s. The trade balance must equal the difference between savings and investment, and some argued that this made exchange rates and competitiveness irrelevant 3/
But exporters and importers don't care about accounting identities. They care about costs and opportunities; something that affects these, like the real exchange rate, must shift to make the identities hold 4/
The late John Williamson mocked the contrary view as the "doctrine of immaculate transfer". There's a similar doctrine of immaculate inflation, which has nominal demand driving inflation without somehow affecting the incentives of workers and firms 5/
It's precisely because inflation isn't immaculate that we worry about things like supply shocks and wage-price spirals — and why estimating the cost of disinflation is so hard 6/


I'm cross-posting everything on Mastodon. So far it's a very inadequate substitute for this site, mainly because not enough people there. But getting better by the day; it will be time-consuming and awkward to replace Twitter, but we will do as needs Musk




And I found the reference — not Martin Baily but a comment by Bill Nordhaus on a 1976 paper by Baily 1/
Paper here 2/ https://jstor.org/stable/2534370#metadata_info_tab_contents
Ungated version 3/

*1:cf. ここ

*2:ungated版の該当のコメント:An incomes policy is like an attempt to get everybody at a football game to sit down at an exciting moment-when the situation is overheated, so to speak: if everybody sits down people can see better and will be a lot more comfortable. The elegance of Baily's scheme is that inflation is reduced by making everyone sit down-not just one's least favorite steel company or labor union.