Built-in account

Built-in inflation

Built-in inflation is an economic concept referring to a type of inflation that resulted from past events and persists in the present. It thus might be called hangover inflation.

At any one time, built-in inflation represents one of three major determinants of the current inflation rate. In Robert J. Gordon's triangle model of inflation, the current inflation rate equals the sum of demand-pull inflation, supply-shock inflation, and built-in inflation. "Demand-pull inflation" refers to the effects of falling unemployment rates (rising real gross domestic product) in the Phillips curve model, while the other two factors lead to shifts in the Phillips curve.

The built-in inflation we see now started with either persistent demand-pull or large cost-push (supply-shock) inflation in the past. It then became a "normal" aspect of the workings of the economy due to the roles of inflationary expectations and the price/wage spiral.

  • Inflationary expectations play a role because if workers and employers expect inflation to persist in the future, they will increase their (nominal) wages and prices now. (see real vs. nominal in economics.) This means that inflation happens now simply because of subjective views about what may happen in the future. Of course, following the generally-accepted theory of adaptive expectations, such inflationary expectations arise because of persistent past experience with inflation.
  • The price/wage spiral refers to the conflictual nature of the wage bargain in modern capitalism. (It is part of the conflict theory of inflation, referring to the objective side of the inflationary process.) Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages (or to attain a target real wage) by pushing for higher money (or nominal) wages. Thus, if they expect price inflation -- or have experienced price inflation in the past -- they push for higher money wages. If they are successful, this raises the costs faced by their employers. To protect the real value of their profits (or to attain a target profit rate or rate of return on investment), employers then pass the higher costs onto consumers in the form of higher prices. This encourages workers to push for higher money wages.

In the end, built-in inflation involves a vicious circle of both subjective and objective elements, so that inflation encourages inflation to persist. It means that the standard methods of fighting inflation using either monetary policy or fiscal policy to induce a recession are extremely expensive, i.e., meaning large rises in unemployment and large falls in real gross domestic product. This suggests that alternative methods such as wage and price controls (incomes policies) may be needed as complementary to recessions in the fight against inflation.

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