Nonmonetary Aspects of Inflation

THE INEFFECTIVENESS OF EFFORTS over the last decade to respond to the frustrating problem of inflation has destroyed much of the optimism that surrounded macroeconomic policy in the 1960s. The emergence of stagflation or the simultaneous existence of high levels of unemployment and continuing inflation has been a surprise to a traditional interpretation of inflation as the consequence of excessive aggregate demand. While it has not been difficult to identify the various initiating factors responsible for individual episodes of inflation, the persistence of the problem, long after the reversal of the original initiating forces and in the face of substantial unemployment, has created a problem for both theory and policy. The traditional view of the inflation process, and thus of the appropriate remedies, interprets the economy as an aggregation of individual markets that are competitive. Within these markets, changes in individual prices and wage rates are seen primarily as the reflection of changing conditions of demand and supply. In addition, both demand and supply are believed to respond quickly to changes in the structure of relative prices. Shifts in the composition of resource use can be readily accommodated by price increases in those markets when more resources are required, if they are offset by price declines in markets with reduced demand. In such an economy inflation can be constrained by aggregate demand policies alone. The adjustment of relative prices can occur wlthin a constant average price level as long as the growth in money balances (adjusted for secular trends in velocity) does not exceed the growth in real output. In fact, inflation can be viewed as strictly a