Inflation Variability, Real-Wage Variability and Production Inefficiency

In recent years economists have paid considerable attention to the relation between the rate of inflation and its temporal variance. consensus emerging from this discussion is that there exists a strong positive relation between the inflation rate and its temporal variance. (See for example, Okun, 1971; Gordon, 1971; Jaffe and Kleiman, 1977; and Foster, 1978.) Clearly, the increased variability of the inflation rate is likely to involve social costs that concern inefficiency in consumption and in production. Thus, in his Nobel lecture, Friedman (1977) says: The growing volatility of inflation and the growing departure of relative prices from the values that market forces alone shall set, combine to render the econoniic system less efficient (p. 470). In general, the interpretation given to production inefficiency resulting from increased variability in the inflation rate is that of a reduction in to a level lower than that occurring under price stability. For example, Levi and Makin interpret Friedman's inefficiency argument thus: From the two components of Friedman's argument we have that high inflation accompanied by ... high variability of inflation will mean a lower output (Levi and Makin, 1980, p. 1023). It is our purpose in this paper to elaborate on the concept of the production inefficiency caused by increased inflation variability (IV), where we focus on the variability in the real wage caused by inflation variability. We suggest a concept of inefficiency of production that relates average changes in the use of labour to average changes in output. Specifically, it is shown that IV alters and/or labour employment in a way that is inferior to the relation between and employment under stable prices. That, we suggest, is the crux of production inefficiency resulting from IV. This production inefficiency will emerge as a result of IV independently of whether rises or falls as a result of IV. Indeed, our analysis will illustrate that mean may increase or decrease, so that, by using alone as an index of efficiency, we may obtain the unlikely result that IV raises production efficiency. One result we derive en route is that, under plausible assumptions about the production function, labour employment may, on average, rise with IV. Notwithstanding this, we show that efficiency in production declines. This result may be used as an interpretation of the inefficiency concept as used by Friedman. Thus, Friedman says: These developments clearly lower economic efficiency. It is less clear what their effect is on recorded unemployment. . (1977, p. 466). We proceed by considering the basic model and showing the ambiguity of the effect of inflation variability on mean in Section I. In Section II, we show that IV introduces a production inefficiency defined upon the

Economics · Inefficiency · Inflation (cosmology) · Labour economics · Macroeconomics · Microeconomics · Production (economics) · Wage · Economic theories and models · Economic Theory and Policy · Monetary Policy and Economic Impact

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  Open Access•Michael Rothschild, Joseph E Stiglitz•Journal of Economic Theory•1970

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  Edward Foster•The Review of Economics and…•1978

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  Stanley Fischer•Journal of Political Economy•1977

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