Inflation As Well As Income Shares
In the previous article, I noted that I am deeply unhappy amongst reduced cast inflation models. (Reduced form is jargon that only refers to mathematical models that are relatively uncomplicated to write out; however, it does non hateful that the actual solution method is simple.) Meanwhile, Lavoie's text jumps to discussing reduced cast post-Keynesian models, which I am relatively happy with. This article provides a distich to explicate what mightiness seem to last an obvious inconsistency: I sneer at conventional reduced cast inflation models (which are non only "mainstream"), but I receive got no issues amongst the post-Keynesian variants, which seem only equally opened upwards to the same sorts of criticisms that conventional inflation models face. The fundamental is how the models are used.
(Most) Prices are Set past times People
One combat of background noesis is the post-Keynesian distinction betwixt flex-price markets too administered prices.Flex-price markets are things similar fiscal too commodity markets. Prices seem to mechanically laid equally a outcome of render too demand; the fact that high speed algorithms receive got taken over trading is a sign that cost formation is inwards some feel mechanical. (However, this is non truthful of all fiscal markets; although I was never a trader, I i time got dragged into a week-long give-and-take amongst a thick-headed (or abusive) counter-party refused to bring that his cost quote was 100 dry ground points off market. It took a calendar week since nosotros were inwards unlike fourth dimension zones, too no agency was I getting upwards at 1 AM to negotiate amongst that dimwit.) For free-market oriented economists, flex-price markets are the ideal, too all cost setting is an approximation of that ideal. For post-Keynesians, flex-prices are a particular case, too volition only comport upon some portions of the CPI. (As noted inwards my previous post, I believe that if nosotros are going to model CPI inflation at all, nosotros request to decompose it.) Gasoline prices (in the developed countries that I am familiar with, at least) are a element of the CPI that is closest the flex-price ideal.
For the residuum of the CPI, most prices are administered. Human beings laid prices based on a diversity of considerations. Although lucre maximisation is presumably the ultimate objective, how that is achieved is somewhat open-ended. H5N1 practiced instance is the loss-leader, such equally the cost of Costco hot dogs, which receive got non moved since 1985 (link). Obviously, the cost of hot dogs inwards a retailer's nutrient courtroom is non going to sway the national cost level, but it illustrates how cost setting tin last arbitrary.
Since nosotros receive got to predict how humans are going to react, nosotros should non last likewise surprised that reduced cast models volition receive got limitations.*
Inflation is Always And Everywhere An Income Phenomenon
Although I am non a fan of diverse output gap formulations, I grudgingly bring that render too demand affair for the conclusion of the CPI. The number is the human chemical element -- nosotros request to larn humans to alter prices, too what they react to volition alter over time. Based on my experience, Canadians inwards 2018 mean value close prices really differently than they did inwards 1978. This dooms whatever item mathematical formulation of the output gap.In the developed countries, demand commonly matters to a greater extent than for the cycle than supply. Even amongst just-in-time inventory management, stores too warehouses are chock total of inventory. (Natural disasters upset this arrangement.) Sellers base of operations pricing on what they mean value buyers tin pay, equally good equally their ain cost of goods/services sold.
What limits what people tin pass are ii factors:
- their stock of fiscal assets (not only money!) and/or assets that tin last borrowed against;
- the gauge of their hereafter income, which feeds into how much credit they receive got available.
Income determines demand, thence income is related to cost changes due to demand changes.
Prices too Income Shares
Within modern conventional economics, at that spot is an aversion to discussing the sectionalisation of national income. (Back when economic science was "political economy," this was non the case.) Standard mainstream models assume that payoff too prices are determined past times marginal considerations, too so the ratio betwixt payoff too prices is fixed past times the shape of the production function. Conversely, post-Keynesian economic science is exclusively based on wage too lucre shares.Although I did non hash out pricing inwards the articles, I would refer the reader dorsum to my (three part) primer on the Kalecki Profit Equation (link). We volition hash out a really uncomplicated economical model, inwards which at that spot is only a trouble organisation sector too a theater sector -- amongst the theater sector decomposed into workers too capitalists.
Let us assume that nosotros are inwards fixed steady state, amongst no investment. In steady state, the stock of theater fiscal assets is constant, thence theater saving is zero. (I assume that neither element of the theater sector is cyberspace borrowing to the other, equally that would do an unsustainable increment of gross liabilities within the theater sector, fifty-fifty though cyberspace liabilities would last zero.) If trouble organisation sector revenue is $100, it is matched by:
- $x paid to workers equally wages;
- $(100-x) paid equally dividends to capitalists.
One may Federal Reserve annotation that the grade of x is non fixed; all nosotros tin say is that it presumably bounded past times $0 < x < $100.
We straight off plow to prices. Let us assume that at that spot are 100 workers, too they tin create 100 units of goods inwards an accounting period. If nominal revenue is $100, so the cost per practiced is $1. If the profits are $20, the implication is that payoff are $80, too so the wage is $0.80 per unit of measurement of good; each worker tin purchase 0.80 units. The remaining xx units are purchased past times the possessor of the theater amongst the $20 inwards dividends.
- If payoff ascent to $0.90 per menstruum too nosotros transition to steady state, nosotros run into that workers volition purchase xc units, too past times implication, only 10 units are left to last bought past times dividends. Wages rising faster than selling prices reduces profits.
- If the selling cost is raised to $1.10 per unit, amongst payoff unchanged, workers tin only purchase 72.73 (rounded) units; the remaining 27.27 units are purchased via dividends.
In other words, the ratio of aggregate wage rates too aggregate prices are related to the distribution of national income. I discussed this inwards i of my showtime articles (link).
What many people mean value of equally inflation -- a proportional ascent inwards both wage rates too CPI -- is viewed a somewhat particular case. equally It for certain happens inwards an economic scheme amongst widespread indexation, but i mightiness debate how much it matters. We for certain saw a shift inwards wage shares during the inflation/dis-inflation cycle inwards the USA (above).
Back to Reduced Form Models
Post-Keynesian inflation models are to a greater extent than oftentimes than non built to a greater extent than or less the wage/profit portion split; workers desire raises, too firms heighten selling prices to save lucre margins.In my view, these models are largely descriptive; generating predictions amongst them is evidently difficult. How tin nosotros mensurate the concept of "worker bargaining strength?" We tin come upwards up amongst a host of qualitative measures, but it is going to last really hard to job them to predict average wage changes within 10 dry ground points.
If i is forced to come upwards up a mathematical inflation model, i is largely stuck inwards the province of affairs of trying to extrapolate the electrical current economical environs forward. We know that things similar "worker bargaining strength" is the existent variable driving prices, nosotros only receive got to rely on other variables equally proxies to the concept. To what extent other reduced cast models are non worthless, they are acting equally useful proxies for what nosotros would similar to have. However, past times performance is no indicator of hereafter results, too if nosotros desire to do things similar long-term inflation forecasts for actuarial purposes, nosotros request a ameliorate handgrip on what changes to expect out for.
Concluding Remarks
I promise to give-up the ghost along amongst a summary of Marc Lavoie's description of post-Keynesian models inwards an upcoming article.Footnote:
* This is non to say that nosotros cannot model some aspects of human behaviour. In the plain where I used to last an academic -- command systems theory -- at that spot were perfectly adequate models of airplane pilot reaction time. These models had to last used, equally a airplane that resonates at the incorrect frequency volition autumn prey to pilot-induced oscillations. What happens is that the natural reactions of the airplane pilot volition destabilise an otherwise stable plane. In fellowship to halt the airplane from bucking, they request to allow larn of the flying stick, which is non what pilots commonly desire to do inwards a crisis.
(c) Brian Romanchuk 2018
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