Built-in inflation

Built-in inflation is a type of

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

that results from past events and persists in the present. Built-in inflation is 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, cost-push inflation, and built-in inflation. "Demand-pull inflation" refers to the effects of falling unemployment rates (rising real

gross domestic product Gross domestic product (GDP) is a monetary measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjective nature this measure is of ...

) in the

Phillips curve The Phillips curve is an economic model, named after William Phillips hypothesizing a correlation between reduction in unemployment and increased rates of wage rises within an economy. While Phillips himself did not state a linked relationship ...

model, while the other two factors lead to ''shifts'' in the

. The built-in inflation originates from either persistent demand-pull or large cost-push (supply-shock) inflation in the past. It then becomes a "normal" aspect of the economy, via 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. Following the generally accepted theory of

adaptive expectations In economics, adaptive expectations is a hypothesized process by which people form their expectations about what will happen in the future based on what has happened in the past. For example, if people want to create an expectation of the inflati ...

, such inflationary expectations arise because of persistent past experience with inflation. *The price/wage spiral is the adversarial nature of bargaining about wages in modern capitalism. It is part of the conflict theory of inflation. Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages from falling in response to inflation (or to attain a target real wage) by pushing for higher money (nominal) wages. Thus, if they expect price inflation – or have experienced price inflation in the past – they push for higher nominal 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 on to consumers in the form of higher prices. This encourages workers to push for higher nominal wages because these price rises raise their cost of living; so the inflationary cycle reinforces itself. 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

monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to control either the interest rate payable for federal funds, very short-term borrowing (borrowing by banks from each other to meet their short-term needs) or the money s ...

fiscal policy In economics and political science, fiscal policy is the use of government revenue collection ( taxes or tax cuts) and expenditure to influence a country's economy. The use of government revenue expenditures to influence macroeconomic variabl ...

to induce a

recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various ...

are extremely expensive, i.e. they can cause 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 also be needed in the fight against inflation. {{DEFAULTSORT:Built-In Inflation Inflation