Inflation: Its Mechanics and Welfare Costs

Abstract

Inflation: It s Mechanics and Welfare Costs ECONOMISTS CONTINUE to be baffled by the mystery of inflationary recession (or stagflation) that has been experienced by industrialized countries during the 1970s.What causes inflation to churn on and on even after excess demand disappears?This whodunit is the latest in a long series that reflects the inadequacy of current theory in explaining the mechanics of how inflation proceeds once it has begun.In this paper, I shall sketch an interpretation of the persistence of inflation based on an interaction of "customer" or "career" markets, in which prices and wages do not equate supply and demand, with "auction" markets, in which prices do reliably clear markets.Changing Styles in Inflation Theory The suggested interpretation developed in this paper builds on past theoretical literature, which I shall briefly review as a foundation for the subsequent analysis.VINTAGE KEYNESIANISM Vintage Keynesianism of the World War II period offered a comparativestatic view of price-level equilibrium, given an "inflationary gap" and a Note: I am indebted to Nancy Delaney for her assistance in the research, and to Edward Gramlich and several participants in the Brookings panel for constructive criticism.

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