Built-in inflation is a type of
inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
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 total market value of all the final goods and services produced and rendered in a specific time period by a country or countries. GDP is often used to measure the economic performanc ...
) in the
Phillips curve model, while the other two factors lead to ''shifts'' in the
Phillips curve.
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, 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 affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rat ...
or
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 variab ...
to induce a
recession 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
Incomes policies in economics are economy-wide wage and price controls, most commonly instituted as a response to inflation, and usually seeking to establish wages and prices below free-market level.
Incomes policies have often been resorted to ...
) may also be needed in the fight against inflation.
References
{{DEFAULTSORT:Built-In Inflation
Inflation