Series Id: PRS85006112
Duration: % change quarter ago, at annual rate
Measure: Unit Labor Costs
Sector: Nonfarm Business
Inflation will also move in relation to the difference between the growth rate of U and the growth rate of the economy (gQ). U follows Kalecki’s equation of profit, which broadly states that that the level of profit in the economy is a function of aggregate demand. Thus the term, (gU – gQ) represents the pressures of aggregate demand on the economy. If gU goes up and gQ is unchanged, then gP rises given everything else. However, to assume that gQ is constant is not acceptable unless the economy is at full employment, so a positive shock on aggregate demand will usually lead to a positive increase in gQ.
Thus, overall, there are two sources of inflation in this approach, a cost-push source (here summarized by the unit labor cost) and a demand-pull source (here summarized by the aggregate demand gap). Note that the money supply is absent from this equation. Money does not directly affect prices. Assuming that a drop of money from the sky leads to inflation, first, does not understand how the money supply is created (it is at least partly created to produce goods and services), second, assumes that people will automatically spend rather than hoard the addition funds obtained (people do hoard for all sorts of reasons and do derive “utility” from hoarding money), third, assumes that the economic output cannot respond to additional demand. If more people suddenly go to the store, producers usually produce more rather than raise prices. Output is not a fixed pie that involves allocation to one group at the expense of another group. The size of the pie increases and decreases with the number of people demanding pie.
A version of this theory has been used in many different models that have endogenous money, liquidity preference, demand-led theory of output and other non-mainstream characteristics. Godley’s and Lavoie’s Monetary Economics as well as Lavoie’s Foundation of Post Keynesian Economics are good books to get more modeling. Of course, modern mainstream monetary economics is rejected in those books; income effect dominates over substitution effect, production is emphasized over allocation, monetary profit affects economic decisions, etc. Be prepared for a change of perspective in which scarcity is not the starting point of economics.
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