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A Strategic Theory of Inflation

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  • Mordecai Kurz

Abstract

A strategic mechanism of price adjustment is introduced to explain inflations in the U.S. during 1909-1974. The mechanism follows from our theory that when the profit rate is above a normal-target rate, competitive forces operate to lower prices while if the profit rate is below the target a correlated strategy among firms operates to generate a rise in prices as a strategy to improve profitability. The notion of "correlated strategy" is adopted from game theory. The mechanism may operate in harmony or against demand and the net effect is what we call the "basic inflation." Contrary to a-priori notions of positive association between inflation rates and profit rates, our theory proposes a critical test of a negative association between these variables. Such a relationship is in fact empirically established. The analysis shows that large and persistent inflationary pressures are generated by low profitability and during 1971-1977 those accounted for some 20%-50% of total inflation. These pressures would be present even if no increase in cost occurs. This suggests that an important cause of the 1970's inflation is the low profit rate in the private sector and any public policy against inflation will fail if it does not aim at the same time to raise the profit rate on private capital.

Suggested Citation

  • Mordecai Kurz, 1979. "A Strategic Theory of Inflation," NBER Working Papers 0379, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0379
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    References listed on IDEAS

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    1. Gordon, Robert J., 1976. "Recent developments in the theory of inflation and unemployment," Journal of Monetary Economics, Elsevier, pages 185-219.
    2. Robert J. Gordon, 1975. "The Impact of Aggregate Demand on Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(3), pages 613-670.
    3. Milton Friedman, 1971. "A Theoretical Framework for Monetary Analysis," NBER Books, National Bureau of Economic Research, Inc, number frie71-1, January.
    4. Friedman, Milton, 1971. "A Monetary Theory of Nominal Income," Journal of Political Economy, University of Chicago Press, vol. 79(2), pages 323-337, March-Apr.
    5. O. C. Ashenfelter & G. E. Johnson & J. H. Pencavel, 1972. "Trade Unions and the Rate of Change of Money Wages in United States Manufacturing Industry," Review of Economic Studies, Oxford University Press, vol. 39(1), pages 27-54.
    6. Fair, Ray C, 1970. "The Estimation of Simultaneous Equation Models with Lagged Endogenous Variables and First Order Serially Correlated Errors," Econometrica, Econometric Society, vol. 38(3), pages 507-516, May.
    7. Gerard-Varet, L. A. & Moulin, H., 1978. "Correlation and duopoly," Journal of Economic Theory, Elsevier, vol. 19(1), pages 123-149, October.
    8. Daniel Creamer & Martin Bernstein, 1956. "Personal Income During Business Cycles," NBER Books, National Bureau of Economic Research, Inc, number crea56-1, January.
    9. Franco Modigliani, 1958. "New Developments on the Oligopoly Front," Journal of Political Economy, University of Chicago Press, vol. 66, pages 215-215.
    10. Daniel Creamer & Martin Bernstein, 1956. "Introduction to "Personal Income During Business Cycles"," NBER Chapters,in: Personal Income During Business Cycles, pages 1-5 National Bureau of Economic Research, Inc.
    11. Azariadis, Costas, 1975. "Implicit Contracts and Underemployment Equilibria," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1183-1202, December.
    12. Sims, Christopher A, 1972. "Money, Income, and Causality," American Economic Review, American Economic Association, vol. 62(4), pages 540-552, September.
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    Cited by:

    1. Julio J. Rotemberg & Garth Saloner, 1984. "A Supergame-Theoretic Model of Business Cycles and Price Wars During Booms," Working papers 349, Massachusetts Institute of Technology (MIT), Department of Economics.

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