A general theory of conflict inflation

This paper develops a novel conflict inflation model to unify the analysis of stable and explosive inflation dynamics, addressing a central theoretical divide in the literature. After providing explicit foundations for wage and price setting behaviour, it is shown that inflation expectations interact multiplicatively with the aspiration gaps of workers and firms rather than add linearly to them as in previous models. As aspiration gaps grow and inflation rises, the conflicting claims of workers and firms accelerate rather than rise steadily. This is reflected in nonlinear wage and price inflation curves whose vertical asymptotes reflect what we call the barrier wages of workers and firms-the critical values of the real wage at which workers and firms are able to resist any further increases in their aspiration gap by matching any rate of inflation. Stable inflationary-distributional outcomes follow only when the barrier wage of workers remains below that of firms. Runaway exchange rate depreciation caused by a balance-of-payments crisis is shown to lead to the collision of barrier wages and thus hyperinflation within the model in a way that is fully consistent with some stylised facts of hyperinflation. The model thus explains how explosive inflation may take hold, what the limits to stable distributional outcomes are, and how a stable inflation regime may evolve into an unstable one, all while maintaining the parsimony of the simple linear conflict inflation models.