Sunday, December 6, 2020

The most important difference between cost-push and demand-pull inflation

I'm not a fan of "diagrams" in economics, but sometimes...

This is a screen capture of slide 36 from a SlideShare presentation by videoaakash15. You can click the image to visit the presentation. Fifteen, nice work on the diagrams.

Slide 36 shows two diagrams: demand-pull inflation, and cost-push inflation. Each diagram is defined by two heavy black lines, one horizontal, one vertical, that meet near a "0". The two lines are like two sides of a box that contains stuff we're not going to talk about. Again, I'm no fan of diagrams.

In the two diagrams above, the heavy black vertical is labeled "Price level, P". In every econ diagram I've ever seen, the vertical shows the price level. Dunno why. Prices go "up", I guess.

And sure enough, between the heavy black vertical and the "Price level" label there is an arrow pointing up, suggesting a move from P0 to P1 ... a move from Price level 0 to Price level 1. 

And that's how they show prices going up on a diagram of inflation.

Notice that both heavy black verticals show the same information: "Price level" label, arrow pointing up, P0 (price before going up) and P1 (price after going up).

It's a little different for the heavy black horizontals for the two diagrams. Each horizontal has a label that says "Aggregate output (income), Y". And each has an arrow. But the arrows don't point in the same direction. The arrows point in two different directions because the diagrams are for two different kinds of inflation. It is this difference, the difference in what happens to "Aggregate output (income)" for the two different kinds of inflation, that makes it important to know about the two different kinds of inflation.

For the diagram on the left, the arrow points away from the "0" that is near where the two lines meet. As aggregate output goes from Y0 to Y1 it moves away from zero and toward a larger number. This kind of inflation, demand-pull inflation, makes aggregate output and income bigger.

For the diagram on the right the arrow points toward the "0". As aggregate output moves from Y0 to Y1 it moves toward zero. Aggregate output and income get smaller. Cost-push inflation makes output and income smaller.

To be more precise: Under demand-pull inflation, output and income tend to grow faster. Under cost-push inflation, they tend to grow slower.

Demand-pull is good for growth. Cost-push is not. This is the most important difference between them. The difference, by the way, arises not from any Arthurian fantasy, but from economists' diagrams of inflation.


The Arthurian said...

Me: "Demand-pull is good for growth. Cost-push is not."

Frederic S. Mishkin in The Causes of Inflation:
"Both types of inflation are associated with high rates of money growth so they cannot be distinguished on this basis. However, as Figures 3 and 4 indicate, demand-pull inflation will be associated with periods when output is above the natural rate level, while cost-push inflation is associated with periods when output is below the natural rate level."

The Arthurian said...

I see that Mishkin simply associates a type of inflation with a level of growth, while I almost make it sound as if you could use different types of inflation to speed up or slow down the economy. It should be obvious that is not what I mean. But if the economy sucks and you have inflation, it's a pretty good bet that the inflation is cost-push. And if the economy is booming and you have inflation, my guess would be it is demand-pull.

Following what I quoted above from Mishkin, he says:
"It would then be quite easy to distinguish which type of inflation is occurring-if we knew what the value of the natural rate of unemployment or output is. Unfortunately, the economics profession has not been able to ascertain the value of the natural rate of unemployment or output with a high degree of confidence."
Yeah... but you don't need to know the exact value of the natural rate unless you are extremely fussy. I think people can tell the difference between "the economy is booming" and "the economy sucks" with their eyes closed.

And look at this shit. The next thing Mishkin says is:
"In any case, the distinction between demand-pull and cost-push inflation is not important. Whether it is the government or workers and firms that initiates the inflation is irrelevant;"

Oh my god! I don't buy that at all.
And then after the semicolon, Mishkin finishes his sentence:
"... is irrelevant; the ultimate source of either type of inflation is the commitment of the government to a high employment target."

Not what I was expecting!

The Arthurian said...

New link for the Mishkin PDF at the KC Fed:

The Arthurian said...

Closely related, a post of mine from five years back:
How to tell cost-push from demand-pull