Here is a thread that we saw on Olivier Blanchard‘s Twitter account and that we wanted to share on our pages (with his agreement). It deals with conflicts of distribution and stabilization of inflation. A very enlightening thread to go further in understanding the mechanisms of inflation.
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.
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.
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.
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.
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…)
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.
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.
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.
Olivier Blanchard, 2022.12.31
We also invite you to read Paul Krugman’s reaction to this thread (https://twitter.com/paulkrugman/status/1609536858039652353?s=20&t=r5LUcJAvvEtI3x0DY1KwZg) as well as Olivier Blanchard’s reflections on this other thread: https://twitter.com/ojblanchard1/status/1609283037568679938?s=20&t=r5LUcJAvvEtI3x0DY1KwZg
About Olivier Blanchard
Olivier Blanchard is Robert Solow Professor Emeritus of Economics at MIT and Fred Bergsten Senior Fellow at the Peterson Institute of International Economics. He was Chief Economist of the International Monetary Fund from 2008 to 2015.
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