Unemployment and Inflation – Part 13

I am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text during 2013 (to be ready in draft form for second semester teaching). Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.

This is the continuation of the Chapter on unemployment and inflation – the series so far is:

• Unemployment and inflation – Part 1
• Unemployment and inflation – Part 2
• Unemployment and inflation – Part 3
• Unemployment and inflation – Part 4
• Unemployment and inflation – Part 5
• Unemployment and Inflation – Part 6
• Unemployment and Inflation – Part 7
• Unemployment and Inflation – Part 8
• Unemployment and Inflation – Part 9
• Unemployment and Inflation – Part 10
• Unemployment and Inflation – Part 11
• Unemployment and Inflation – Part 12

I am now continuing …. Note this Chapter may be split into several at the editorial stage. For now I am just treating it as a continuous and logical (sequential) flow. The sequence is a mix of history and evolution of related ideas.

Chapter 12 – Unemployment and Inflation

MATERIAL HERE NOT REPEATED

12.X The Conflict Theory of Inflation

The Conflict Theory of Inflation beds the analytical approach in the power relations within the capitalist system. It brings together social, political and economic considerations into a generalised view of the inflation cycle.

The conflict theory derives directly from cost-push theories referred to above. Conflict theory recognises that the money supply is endogenous, which is in contradistinction to the Monetarist’s Quantity Theory of Money that erroneously considers that the money supply is exogenously controlled by the central bank.

The conflict theory assumes that firms and trade unions have some degree of market power (that is, they can influences prices and wage outcomes) without much correspondence to the state of the economy. They are assumed to both desire some targetted real output share and use their capacity to influence nominal prices and wages to extract that real share.

In each period, the economy produces a given real output (real GDP), which is shared between the groups with distributional claims in the form of wages, profits, taxes etc. In the following discussion, we assume away the other claimants and concentrate only on the split between wages and profits. Later, we will introduce a change in an exogenous claimant in the form of a rise in a significant raw material price.

If the desired real output shares of the workers and firms is consistent with the available real output produced then there is no incompatibility and there will be no inflationary pressures. The available real output is distributed each period in the form of wages and profits, which satisfy the respective claimants.

The problem arises when the sum of the distributional claims (expressed in nominal terms – money wage demands and mark-ups) are greater than the real output available. In those circumstances, inflation can occur via the wage-price or price-wage spiral mechanisms noted above.

[CONTINUED FROM HERE]

The wage-price spiral might also become a wage-wage-price spiral as one section of the workforce seeks to restore relativities after another group of workers succeed in their nominal wage demands.

The role of government is also implicated. While it is the distributional conflict over available real output which initiates the inflationary spiral, government policy has to be compliant for the nascent inflation to persist.

Business firms will typically access credit (for example, overdrafts) to “finance” their working capital needs in advance of realisation via sales. In an inflationary spiral, as workers seek higher nominal wages, firms will judge whether the costs of industrial action in the form of lost output and sales are higher than the costs of accessing credit to fund the higher wages bill. Typically, the latter option will be cheaper.

If credit conditions become tighter and loans become more expensive then firms will be less able to pay the higher money wages demanded by workers. The impact of the higher interest rates may thus lead to a squeeze on real wages with the consequent negative impact on consumption spending. Firms will also be less willing to invest in new projects given the cost of funds is higher.

As a consequence, if monetary policy become tighter there will be some point where real production growth declines and the workers who are in weaker bargaining positions are laid off. The rising unemployment, in turn, eventually discourages the workers from pursuing their on-going demand for wage increases and ultimately the inflationary process is choked off.

The Conflict Theory of Inflation thus hypothesises a trade-off between inflation and unemployment.

The alternative policy stance is for the central bank to accommodate the inflationary struggle by leaving its monetary policy settings (interest rates) unchanged. This accommodation would also likely see the fiscal authorities maintaining existing tax rates and spending growth.

From an operational perspective, the commercial banks would be extending loans and, in the process, creating deposits in the accounts of its business clients. The central bank would then ensure that there were sufficient reserves in the banking system to maintain stability in the payments system. The nominal wage-price spiral would thus fuel the demand for more loans with little disciplining forces.

There are also strong alignments between the conflict theory of inflation and Hyman Minksy’s financial instability notion. Both theories consider that behavioural dynamics are variable across the business cycle. When economic activity is strong, the risk-averseness of banks declines and they become more willing to extend credit to marginal borrowers. Equally, firms will be more willing to pass on nominal wage demands because it becomes harder to find labour and the costs of an industrial dispute in terms of lost sales and profits is high. Workers also have more bargaining power due to the buoyant conditions.

At low levels of economic activity, the rising unemployment and falling sales militates against wage demands and profit push. It also is associated with higher loan delinquency rates and banks become more conservative in their lending practices.

Conflict Theory of Inflation and Inflationary Biases

There was a series of articles in the journal Marxism Today in 1974 which advanced the notion of inflation being the result of a distributional conflict between workers and capital.

[As an aside, you can view an limited archive of Marxism Today since 1977 which is a very valuable resource]

The article by – introduced the notion that inflation was a structural construct. He said the (Devine, 1974: 80):

The phenomenon in need of explanation is not inflation in the abstract but inflation in the world of state monopoly capitalism in the period since the second world war. Two questions arise. First, throughout this period inflation has been chronic in all the major capitalist countries; why has it replaced depression as the principle “economic” problem confronting the capitalist system as a whole? Second, within this overall framework, why has the rate of inflation varied between countries and at different times?

He argued that the increased bargaining power of workers (that accompanied the long period of full employment in the Post Second World War period) and the declining productivity in the early 1970s imparted a structural bias towards inflation which manifested in the inflation breakout in the mid-1970s which he says “ended the golden age”.

[REFERENCE: Pat Devine (1974) ‘Inflation and Marxist Theory’, Marxism Today, March, 79-92]

In this context, the “relatively full employment” has meant that (Devine, 1974: 80):

… money wages (earnings) have risen continuously, although at varying rates, for a prolonged period unprecedented in the history of capitalism. This has had far reaching effects on the functioning of the capitalist system. Faced with rising money wages, capitalists have sought to contain the increase in real wages and fend off pressure on profits by increasing prices.

On the industry side, large, oligopolistic firms with price-setting power competed against each other in non-price forms (for example, product quality, etc). The firms, however, were interdependent because market share was sensitive to their pricing strategies. When a firm was faced with nominal wage demands, the management knew that its rivals would be similarly pressured and their competitive positions would not depend on the absolute price level. Rather, a firm could lose market share if they increased prices, while other firms maintained lower prices.

But in an environment where the firms considered that the government would continue to ensure that effective demand was sufficient to maintain full employment there was no reason to assume that rising prices would damage their sales.

As a result, firms had little incentive to resist the wage demands of their workers and strong incentives to protect their market share and profits by passing on the demands in the form of higher prices.

This structural depiction of inflation – embedded in the class dynamics of capital and labour, both of which had increasing capacity to set prices and defend their real shares of production – implicates Keynesian-style approaches to full employment.

There was also an international component to the structural theory. It was argued that the Bretton Woods system imparted deflationary forces on economies that were experiencing strong domestic demand growth. As national income rose and imports increased, central banks were obliged to tighten monetary policy to maintain the agreed exchange rate parity and the constraints on monetary growth acted to choke off incompatible nominal claims on the available real income.

However, when the Bretton Woods system of convertible currencies and fixed exchange rates collapsed in 1971 the structural biases towards inflation came to the fore.

Devine (1974: 86) argued that:

… floating exchange rates have been used as an additional weapon available to the state. Given domestic inflation, floating rates provide a degree of flexibility in dealing with the resultant pressure on the external payments position. However, if a float is to be effective in stabilising a payments imbalance it is likely to involve lower real incomes at home. If a reduction in real wages (or their rate of growth) is not acquiesced in there will then be additional pressure for higher money wages and if this cannot be contained the rate of inflation will increase and their will be further depreciation.

The structuralist view also noted that the mid-1970s crisis – which marked the end of the Keynesian period – was not only marked by rising inflation but also by an on-going profit squeeze due to declining productivity and increasing external competition for market share. The profit squeeze led to firms reducing their rate of investment (which reduced aggregate demand growth) which combined with harsh contractions in monetary and fiscal policy created the stagflation that bedevilled the world in the second half of the 1970s.

The resolution to the “structural bias” proposed by economists depended on their ideological persuasion. On the one hand, those who identified themselves as Keynesians proposed incomes policies as a way of mediating the distributional struggle and rendering nominal income claims compatible with real output.

On the other hand, the emerging Monetarists considered the problem to be an abuse of market power by the trade unions and this motivated demands for policy makers to legislate to reduce the bargaining power of workers. The rising unemployment was also not opposed by capital because it was seen as a vehicle for undermining the capacity of the trade unions to make wage demands.

[NOTE: A SMALL DISCUSSION ON INCOMES POLICIES WILL BE HERE – NEXT WEEK]

From the mid-1970s, the combined weight of persistently high unemployment and increased policy attacks on trade unions in many advanced nations reduced the inflation spiral as workers were unable to pursue real wages growth and productivity growth outstripped real wages growth. As a result, there was a substantial redistribution of real income towards profits during this period.

The rise of Thatcherism in the UK exemplified this increasing dominance of the Monetarist view in the 1980s.

Raw material price rises

[NEXT WEEK – WE CONTINUE]

Conclusion

I plan to finish this discussion off next week and move on to discussions about Twin-Deficits etc.

Saturday Quiz

The Saturday Quiz will be back again tomorrow.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.