Primer: Post-Keynesian Inflation Theory Basics

This article is an introduction to the post-Keynesian approach to inflation. It is largely based on Section 8.1.1 of Professor Marc Lavoie's Post-Keynesian Economics: New Foundations (link to my review). Similar to the move on stock-flow consistent models, nosotros start out amongst what is essentially an accounting identity: a declaration that is truthful past times definition. We ask to empathize the implications of the accounting identity before nosotros worry close the behavioural aspects (which are non pinned downward amongst accounting).

(The approach hither is quite distinct from conventional approaches; I discussed why post-Keynesians refuse conventional inflation theory inward an before article.)

Markup Pricing

For simplicity, this article only discusses a shut economy; that is, an economic scheme that is non opened upwardly to external trade. Section 8.1.2 of Post-Keynesian Economics discusses the opened upwardly economic scheme case.

In a monetary telephone substitution economy, pretty much all goods together with services that are exchanged based on monetary transactions are the results of approximately course of study of labour. Yes, working capital alphabetic lineament goods are typically required, but those working capital alphabetic lineament goods were the number of labour inputs. For those of us worried close resources consumption, commodity inputs are important, but those commodities do non magically seem -- human labour is required to extract them. If ane wanted to paraphrase approximately Teutonic economists, goods together with services are the number of human action.

We tin utilisation Hollywood dystopian fiction to give a proficient illustration. On Earth, nosotros do non (yet!) pay for access to oxygen; it is available to well for you lot individuals without whatever witting effort. Whereas if nosotros plough to the (presumably) fictional Mars of the Arnold Schwarzenegger version of Total Recall, oxygen was nether the command of the rather villainous entity that ruled Mars. (Admittedly, this breaks downward at the goal of the film, where oxygen was made available past times alien technology.)  So oxygen is exterior the analysis of economies on Earth, whereas it would live on of import on (pre-alien intervention) Mars.

In a capitalist society, the mass of output is past times paid labour. Although at that spot are self-employed individuals (like myself) together with worker-owned firms, they are yet a minority. The defining characteristic of workers is that they are paid a wage, which is usually fixed nominally (although employees at the overstep of the hierarchy skim off a lot of profits via bonus schemes).

If nosotros assume that all output is the number of wage labour, nosotros tin instruct far at the identity (due to Weintraub):
\[
p = \kappa \frac{w}{y},
\]
where:

• $\kappa$ is the average markup;
• $w$ is the nominal wage rate;
• $y$ is the output per worker.

For example, if $\kappa$ is 1.1, hence the selling cost output is 10% higher than the wage cost to create it. 

Rates of Change

We directly plough to the charge per unit of measurement of modify of prices -- inflation.

We announce the percent modify of a variable $x$ equally $\hat{x}$, which is defined as:

\[
\hat{x(t)} = \frac{ \frac{dx}{dt}}{x(t)},
\]
(the charge per unit of measurement of modify of $x$ divided past times $x$ itself). Needless to say, nosotros assume that the variable stays away from zero. (Unfortunately, the hats on my variables seem to live on offset when the page is rendered, which is annoying.)

If nosotros apply approximately basic calculus, nosotros tin come across that:
\[
\hat{p} = \frac{\frac{dp}{dt}}{p(t)} = \hat{w}(t) - \hat{y}(t) + \hat{\kappa}(t).
\]

Interpretation

We desire to live on able to explicate persistent inflation; for brusk periods of time, the 3 terms inward the charge per unit of measurement of modify identity tin do all sorts of things.

The declaration inward Post-Keynesian Economics is that markups cannot rising forever, equally that would imply an ever-rising turn a profit part of national income. One mightiness cynically banker's complaint that this is precisely what has been happening for the post-1980 period, but fifty-fifty so, the rising inward the cost grade was much greater than the rising inward profits over that period. Instead, nosotros ask to aspect at the showtime 2 terms: how much greater wage growth is than output per worker (${\hat w} - \hat{y}$).

The analysis hence leads to: why volition wage gains outstrip productivity? The post-Keynesian respond is that this volition plough over off if workers' bargaining seat increases relative to that of concern owners. As I noted previously, coming upwardly amongst a mathematical formulation of the notion of "workers' bargaining position" is going to live on difficult.

However, ane tin come across the attraction of this theory. By most accounts, the bargaining seat of labour has been crippled equally a number of structural changes imposed since the early on 1980s. From this standpoint, the deceleration of inflation is no accident.

How Different is This?

If nosotros stick to simply the accounting identity that I described inward this article, ane could reasonably debate that this is non that much unlike than conventional theories close inflation. The same accounting identity appears, since it is evidently true.

The departure is stark if nosotros aspect at political economic scheme considerations: a viewpoint that has largely been whitewashed from polite economical conversation. If nosotros stick to the mathematical formulation used inward mainstream macro, prices are purely the number of marginal productivity; the concept of a grapple for income shares disappears past times definition. (One may banker's complaint that non all mainstream economists solely purchase that story, fifty-fifty if they are otherwise theoretically orthodox.)

From a practical consideration, key bankers are obsessed amongst labour marketplace statistics. Is the unemployment charge per unit of measurement below the dreaded NAIRU? Although the output gap -- equally defined past times actual gross domestic product versus "potential" -- is allegedly to a greater extent than useful than the "NAIRU gap," ane may banker's complaint that it has barely come upwardly up inward conversation this bicycle (other than beingness invoked past times charge per unit of measurement doves). In previous cycles, the output gap was to a greater extent than pop inward marketplace analysis. No thing what mainstream economic science allegedly says close the drivers of inflation, wage inflation is what matters inward practice.

However, ane may banker's complaint the absence of the notion of the key banking concern determining the cost level, or the diminished purpose of expectations. Since administered prices are laid past times human beings equally a markup over costs (a signal I noted inward an before article), their expectations close their futurity costs evidently matters. For this reason, nosotros should non live on surprised that at that spot is human relationship betwixt inflation expectations together with realised inflation. However, it is unclear how far nosotros tin run amongst that concept.

If ane demands a reduced monastic tell inflation model, nosotros ask to fountain to Section 8.4 of Post-Keynesian Economics -- the conflicting claims model. However, despite my preparation equally an applied mathematician, I am deeply skeptical close such reduced-form models. I convey less objections to the post-Keynesian version. The argue is that the models comprise approximately fairly arbitrary variables, such equally targets for existent wages. Why would workers' target for their existent reward change? Although ane mightiness live on able to do approximately historical analysis, it seems straightforward that such variables are a component subdivision of the political economic scheme environment. We tin examine plumbing equipment a model to historical data, but whatever extrapolation of past times trends is evidently contingent on the environs non changing. This is non a characteristic of mainstream macro, which allegedly capture universal truths close the economy.

If nosotros homecoming to my complaints close cost index aggregation (detailed inward my before article), nosotros come across that the simplified post-Keynesian models are also hitting past times them. (Within the post-Keynsian literature, at that spot is a lot of detailed empirical move on inflation, which would live on compatible amongst the cost grade aggregation critique.) Although the aggregate accounting identity is truthful past times definition, it is the number of lumping together real unlike cost measures. Influenza A virus subtype H5N1 proficient instance is the runaway cost inflation inward American academy tuition: it is sure non the number of paying trouble professors also much. We would ask to endeavour to apply the concepts to the components of the domestic cost construction where the cost is best explained past times a markup over trouble employee wages; other parts of the CPI volition march to unlike drummers.

From a policy standpoint, nosotros come across why the authorities needs to live on concerned close wage growth inward the context of inflation control. Real output per worker is laid past times the "technology" of the production process; it is unclear how much nosotros tin increment that over fourth dimension (although every political political party tends to hope that this is what their programme volition deliver). Although the authorities should live on neutral amongst regards to the distribution of income betwixt labour together with capital, it does seem somewhat implausible to worry close an ever-increasing grade of profits amongst a fixed grade of wages. By the procedure of elimination, this agency that policy makers ask to ensure that wage growth cannot indefinitely outstrip productivity growth (which is assumed to live on exterior the command of policy). This logic explains why I would only live on concerned close a homecoming of a 1970s style inflation inward the context of changes inward the political environment.

Concluding Remarks

From the perspective of my potential volume on the concern cycle, I dubiety that I volition instruct much farther downward the rabbit hole of inflation theory than this. From the perspective of orthodox mainstream macro, such a decoupling of inflation from the concern bicycle is insane: the conclusion of prices is the whole key to the concern cycle. However, the testify of such a persuasion is sketchy at best, together with hence I would prefer to motility inflation analysis to a after report.

(It may live on that I volition eventually bind my reports into a unmarried large book, but I would rather proceed my reports at a manageable size.)

(c) Brian Romanchuk 2018