M.A. FINAL ECON: Gordon's Triangle

From M.A. FINAL ECONOMICS by Sehba Hussain and edited by Professor Shakoor Khan:

2.6.3 Gordon's triangle model
Robert J. Gordon of Northwestern University has analysed the Phillips curve to produce what he calls the triangle model, in which the actual inflation rate is determined by the sum of
1. demand pull or short-term Phillips curve inflation,
2. cost push or supply shocks, and
3. built-in inflation.
The last reflects inflationary expectations and the price/wage spiral.

(That's word-for-word the same as the haicuan blog Notes.)

Caught my eye because they say inflation is "the sum of" the three components. Leads me to think that if I was smart enough I could calculate inflation from money growth and stuff like that. And maybe that Robert Gordon has already figured out the calculation, so I don't have to be that smart.

I have to point out that economists brusquely dismiss the concept of cost-push inflation, but are highly focused on "supply shocks" as an explanation of almost everything. You know: oil as a supply shock, causing inflation in the 1970s. But tsk-tsk, don't call it "cost-push" inflation.

And yet item 2 in the triangle model description above says "cost push or supply shocks" as if these are two different names for the same phenomenon! (Note that in item 1, "demand pull" and "short-term Phillips curve inflation" are clearly offered as two different names for the same phenomenon.)

There's more on Gordon's Triangle elsewhere in the FINAL ECON paper:

2.3 KEYNESIAN VIEW
Keynesian economic theory proposes that changes in money supply do not directly affect prices, and that visible inflation is the result of pressures in the economy expressing themselves in prices. The supply of money is a major, but not the only, cause of inflation.

There are three major types of inflation, as part of what Robert J. Gordon calls the "triangle model":
Demand-pull inflation is caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favourable market conditions will stimulate investment and expansion.

Cost-push inflation, also called "supply shock inflation," is caused by a drop in aggregate supply (potential output). This may be due to natural disasters, or increased prices of inputs. For example, a sudden decrease in the supply of oil, leading to increased oil prices, can cause cost-push inflation. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.

Built-in inflation is induced by adaptive expectations, and is often linked to the "price/wage spiral". It involves workers trying to keep their wages up with prices (above the rate of inflation), and firms passing these higher labor costs on to their customers as higher prices, leading to a 'vicious circle'. Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Demand-pull theory states that the rate of inflation accelerates whenever aggregate demand is increased beyond the ability of the economy to produce (its potential output). Hence, any factor that increases aggregate demand can cause inflation. However, in the long run, aggregate demand can be held above productive capacity only by increasing the quantity of money in circulation faster than the real growth rate of the economy. Another (although much less common) cause can be a rapid decline in the demand for money, as happened in Europe during the Black Death...

(That's not quite word-for-word from Wikipedia.)


At IDEAS: A Consistent Characterization of a Near-Century of Price Behavior, by Robert J. Gordon, 1980. From the abstract:

This paper develops a single econometric equation that can explain most of the variation in the aggregate U.S. rate of inflation during the period between 1892·and 1978.

No shit. And this:

The formation of price expectations changed completely after 1950 from regressive expectations appropriate under a gold standard to extrapolative inertia-dominated expectations appropriate under a fiat money standard and postwar long-period wage contracts.

Interesting, and it sounds right. It has occurred to me that when prices were tied to gold, there wasn't much that could be done to boost the quantity of money. But when money's connection to gold became tenuous, it became possible to increase the Q of M. So I think we should expect to see the thing that Robert Gordon points out here.

Related, from the text:

The EPC [Expectational Phillips Curve] explanation, which in its most general form relates price change to expected inflation and the level of detrended output, obscures the fact that price change has been much more closely related to the contemporaneous rate of change of detrended output.

And:

... while the formation of inflation expectations has shifted in the postwar years,
the cyclical impact of detrended output changes has not.

And on page 4:

... under a gold standard we might find the price level jumping up and down around a stable or slowly moving trend ... But under the postwar fiat-money standard, few increases in the price level have been reversed.

//

Here's a place to start:

Over the near-century of annual data studied here, a change in output has shown a remarkably consistent tendency to be associated in annual data with a simultaneous change in the price level of about one-half as much. Stated another way, nominal GNP changes have been divided consistently, with two-thirds taking the form of output change and the remaining one-third the form of price change.

If true, that's a pretty interesting rule of thumb; could be as useful as Okun's law. But I've heard of Okun's and I haven't heard of Gordon's law, so maybe Gordon's law didn't hold up. I guess I'll take a look at the data.

Yeah, but not today.