You Say Potato, I Say Potahto; You Say Tomato, I Say Tomahto; You Say Distribution, I Say Expectation

Once again, the estimable Olivier Blanchard is weighing in on the question of inflation, expressing fears about an impending wage-price spiral that cannot be controlled by conventional monetary policy unless the monetary authority is prepared to impose sufficiently tight monetary conditions that would entail substantially higher unemployment than we have experienced since the aftermath of the 2008 financial crisis and Little Depression (aka Great Recession). Several months ago, Blanchard, supporting Larry Summers’s warnings that rising inflation was not likely to be transitory and instead would likely remain high and possibly increase over time, I tried to explain why his fears of high and rising inflation were likely exaggerated. Unpersuaded, he now returns to provide a deeper explanation of his belief that, unless the deep systemic forces that cause inflation are addressed politically rather than left, by default, to be handled by the monetary authority, inflation will remain a persistent and vexing problem.

I’m sorry to say that Professor Blanchard starts off with a massive overstatement. While I don’t discount the possibility — even the reality — that inflation may sometimes be triggered by the attempt of a particular sector of the economy to increase the relative price of the goods or services that it provides, thereby increasing its share of total income at the expense of other sectors, I seriously question whether this is a typical, or even frequent, source of inflation. For example, oil-price increases in the 1970s and wage increases in France after the May 1968 student uprisings did trigger substantial inflation. Inflation served as a method of (1) mitigating ing adverse macroeconomic effects on output and employment and (2) diluting the size of the resulting wealth transfer from other sectors.

Blanchard continues:

2/8. 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.


Again, I’m sorry to say that I find this remark incomprehensible. Blanchard says “the source of the conflict may be too hot an economy,” and in the very next breath says that in the labor market (as if it made sense to view the labor market, accounting for more than half the nominal income of the economy, as a single homogeneous market with stable supply and demand curves), “workers may be in a strong position to bargain for higher wages given prices,” while in the goods market firms may be in a strong position to bargain for higher prices relative to wages. What kind of bargaining position is Blanchard talking about? Is it real, reflecting underlying economic conditions, or is it nominal, reflecting macroeconomic conditions. He doesn’t seem to know. And if he does know, he’s not saying. But he began by saying that the source of the conflict “may be too hot an economy,” suggesting that the source of the conflict is macroeconomic, not a conflict over shares. So I’m confused. We can only follow him a bit further to see what he may be thinking.

3/8. 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.

Now Blanchard seems to be attributing the conflict to an exogenous — and unexmplained — increase in commodity prices. One sector presumably enjoys an improvement in its bargaining position relative to the rest of the economy, thereby being enabled to increase its share of total income. Rather than consider the appropriate response to such an exercise of raw market power, Blanchard simply assumes that, but doesn’t explain how, this increase in share triggers a vicious cycle of compensating increases in the prices and wages of other sectors, rather than a one-off distributional change to reflect a new balance of economic power. This is a complicated story with interesting macroeconomic implications, but Blanchard doesn’t bother to do more than assert that the disturbance sets in motion an ongoing, possibly unlimited, cycle of price and wage increases.

4/8. 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.

5/8. 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…)

These two statements from the thread are largely innocuous and contribute little or nothing to an understanding of the cause or causes of inflation or of the policies that might mitigate inflation or its effect,

6/8. 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’s not clear to me what constitutes “acceptance” of the outcome. Under any circumstance, the players will presumably still seek to choose and execute what, given the situation in which they find themselves, they regard as an optimal plan. Whether the players can execute the plan that they choose will depend on the plans chosen by other players and on the policies adopted by the central bank and other policy makers. If policy makers adopt a consistent set of policies that are feasible and are aligned with the outcomes expected by the players, then the players will likely succeed in implementing what they regard as optimal plans. If the policies that are followed are not consistent and not feasible, then those policies will not be aligned with the outcomes expected by the players. In the latter case, matters will likely get worse not better.

7/8. 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.

I can’t help but observe the vagueness associated with the pronoun “it” and its unidentified antecedent. The outcome of a complex economic process cannot be achieved by a negotiation between workers,firms and the state. Things don’t work that way. Whatever negotiation Professor Blanchard is dreaming about, no negotiation can possibly determine the details of an outcome. What is possible is some agreement on policy goals or targets for inflation and some feasible set of policies aimed at achieving, or coming close to, a target rate of inflation. The key variable over which policy makers have some control is total aggregate demand for the economy measured either as a rate of nominal spending and nominal income over a year or as a rate of growth in spending and income compared to the previous year. Since inflation is itself a rate of change, presumaby the relevant target should be a rate of change in total nominal spending and nominal income. Thus, the appropriate target for policy makers to aim for is the yearly rate of growth in total nominal spending and total nominal income.

Given some reasonable expectation about the rate of technical progress (labor productivity) and the rate of increase in the labor force, a target rate of inflation implies a target rate of increase in total nominal spending and total nominal income. Given expectations about the increase in labor productivity, there is an implied rate of increase in nominal wages that is broadly consistent with the inflation target. But that average rate of increase in nominal wages can hardly be expected to be uniform for all industries and all firms and all workers, and it would be folly, on purely technical reasons, to attempt to enforce such a target in average nominal wage growth. And for legal and political reasons, it would be an even greater folly to try to do so.

Besides announcing the underlying basis for the targeted rate of nominal income growth, and encouraging workers and firms to take those targets seriously when negotiating wage contracts and setting prices, while recognizing that deviations from those targets are often reasonable and appropriate in the light of the specific circumstances in which particular firms and industries and labor unions are operating, policy makers have no constructive role to play in the setting of prices or wages for individual firms industries or labor contracts. But providing useful benchmarks for private agents to use as a basis for forming their own expectations about the future to guide their planning for the future is entirely appropriate and useful.

I should acknowledge that, as I have done previously, that the approach to policy making summarized here is based on the analysis developed by Ralph Hawtrey over the course of more than a half century as both a monetary theorist and a policy advisor, and, especially, as Hawtrey explained over a half-century ago in his final book, Incomes and Money.

8/8. 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.

Insofar as policymakers can show that they are coming reasonably close to meeting their announced targets, they will encourage private actors to take those announced targets seriously when forming their own expectations and when negotiating with counterparties on the terms of their economic relationships. The least painful solutions are those in which economic agents align their expectations with the policy targets announced — and achieved — by policy makers.

Originally tweeted by Olivier Blanchard (@ojblanchard1) on December 30, 2022.

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1 Response to “You Say Potato, I Say Potahto; You Say Tomato, I Say Tomahto; You Say Distribution, I Say Expectation”



  1. 1 Dangerous Metaphors | Uneasy Money Trackback on January 5, 2023 at 7:32 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner

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