Inflation as a Cause of Economic Stagnation: A Dual Model

  • John Cornwall


One of the main arguments of this paper is that under existing institutions in the developed capitalist economies, inflation of the type experienced in the late 1960s and early 1970s leads to prolonged periods of high unemployment and low to zero rates of growth of productivity, i.e., economic stagnation. Furthermore, it is argued that without radical changes in certain key institutions, the current economic breakdown will continue indefinitely and will spread worldwide.


Unemployment Rate Inflation Rate Real Wage Aggregate Demand Full Employment 
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  1. 1.
    These two rates of unemployment are only identical under very special, highly unrealistic assumptions, e.g., perfect competition and continuous and instantaneous market clearing.Google Scholar
  2. 2.
    The sources of an inflationary bias are found in J. Cornwall, The Conditions for Economic Recovery: A Post-Keynesian Analysis, Basil Blackwell, London and M. E. Sharpe, Armonk, New York, 1983, Chapters 6, 11 and 12.Google Scholar
  3. 3.
    Kalecki in formulating his ’political theory of the business cycle’ outlines a scenario similar to that just described. However, it is the desire to keep labour in line through periodic bouts of unemployment that largely provides the motive for restrictive AD policies. See M. Kalecki, ’Political Aspects of Full Employment’ in Selected Essays on tlte Dyrramics of the Capitalist Economy, 1933–70, Cambridge, 1977.Google Scholar
  4. 4.
    Japan and Switzerland are possible exceptions.Google Scholar
  5. 5.
    See A. Thirlwall and M. Hussain, ’The Balance of Payments Con-straint, Capital Flows and Growth Rate Differences between Develop-ing Countries’, Oxford Economic Pnpeis, November, 1982 for reasons why borrowing to cover deficits cannot be done on anything other than a short-term basis. A possible exception to this might be the United States.Google Scholar
  6. 6.
    See especially E. Phelps Brown, A Century of Pay, Macmillan, London, 1968; E. Phelps Brown, ’The Analysis of Wage Movements under Full Employment’, Scottish Journal of Economics, November, 1971; and T. Scitovsky, ’Market Power and Inflation’, Economica, August, 1978.Google Scholar
  7. 7.
    See Cornwall, op. cit., chapter 9.Google Scholar
  8. 8.
    The alternative is for the authorities to introduce expansionary FE policies and to ignore the effects on inflation. Among the OECD countries only Iceland has tried this and only for a limited period of time in the 1980s.Google Scholar
  9. 9.
    See various issues of OECD Economic Outlook, Paris.Google Scholar
  10. 10.
    See E. Phelps Brown, A Century of Pay, Macmillan, London, 1968.Google Scholar
  11. 11.
    For an early statement of the credibility hypothesis see W. Fellner, ’The Valid Core of the Rationality Hypothesis in the Theory of Expectations’, Journal of Money Credit and Banking, November, 1980. An argument for sharp, severe doses of restriction is found in John You, ’Is Tax-Based Incomes Policy an Answer?, Canadian Public Policy, Winter, 1982.Google Scholar
  12. 12.
    One way of interpreting the credibility hypothesis is that the fear of unemployment, actual and possible, has been made so strong through past restrictive AD policies that workers (and management) will internalise the costs of their wage (and price) setting behaviour during the boom. High wage demands (and high price markups) will be avoided according to this doctrine out of fear that the authorities will repeat or intensify their policies. As a result wage and price settle-ments will become co-ordinated with the national goals of overall wage and price stability. This is nothing more than a voluntary incomes policy based on fear.Google Scholar
  13. 13.
    See, however, the studies by C. Barber and J. McCallum, Controlling Inflation: Learning from Experieitce in Canada, Europe and Japan, Canadian Institute for Economic Policy, Ottawa, 1982 and; C. Crouch ’The Conditions for Trade Union Wage Restraint’, in L. Lindberg and C. Maier (eds.), The Politics of Inflntion and Economic Stagnation, The Brookings Institute, Washington, 1985.Google Scholar
  14. 14.
    In contrast, it has just been argued that restrictive AD policies induce output effects largely until unemployment rates become very high. Current policies in most countries are thus examples of an inefficient application of instruments to targets at best.Google Scholar
  15. 15.
    See A. Maizels, Growth and Trade, Cambridge, 1970, Chapter 3.Google Scholar
  16. 16.
    Austria and Sweden attempted to maintain FE following the second oil shock and have been successful until recently. Even in these two countries, unemployment rates are now rising.Google Scholar
  17. 17.
    See M. Stewart, Controlling the Economic Future, Wheatsheaf, 1983, Chapters 5 and 6.Google Scholar
  18. 18.
    Inflation rates began to accelerate in mid-1985 in the United Kingdom following a modest recovery in output and no recovery in the unemployment picture.Google Scholar
  19. 19.
    If all the corporatist economies would reflate simultaneously, the effects would also be beneficial worldwide. However, because of their inflationary bias, the pluralist economies would still be forced to restrict AD. As a result worldwide recovery would not be anywhere near complete.Google Scholar
  20. 20.
    The OPEC countries restrict their imports because of an inability to absorb an amount equal to their exports. The resulting surplus has a depressing influence on world trade.Google Scholar
  21. 21.
    The so-called Carter boom of the second half of the 1970s was also only marginally successful in reducing unemployment rates.Google Scholar
  22. 22.
    See, for example, J. Williamson, ’Is there an External Constraint?’ National Institute Economic Review, August, 1984.Google Scholar
  23. 23.
    Together Canada, the United Kingdom and the United States purchased 28% of the exports of the remaining industrial countries in 1981. If Germany is included, the figure rises to 52%. See IMF Direction of Trade Statistics, 1981, Washington.Google Scholar
  24. 24.
    See F. Scharpf, ’Economic and Institutional Constraints of Full Employment Strategies: Sweden, Austria and West Germany (1973— 1982)’, IIM/Labour Market Policy, Wissenschaftszentrum, Berlin.Google Scholar
  25. 25.
    This lip service to a policy of non-intervention is not to be confused with actual behaviour and practice of these governments.Google Scholar
  26. 26.
    See H. Wallich and S. Weintraub, ’A Tax-Based Incomes Policy’, Journal of Economic Issues, June, 1971 for one of the earliest studies.Google Scholar
  27. 27.
    See F. Cripps, ’Causes of Growth and Recession in World Trade’, Economic Policy Review, March, 1978. Cripps advocates discriininat-ing against those OPEC countries that run a trade surplus. This notion can be generalised to discriminating against any country that restricts imports to something less than their FE levels for reasons other than potential payments problems at FE.Google Scholar

Copyright information

© J. A. Kregel 1989

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  • John Cornwall

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