Aggregate Demand, Conflict, and Capacity in the Inflationary Process

The dominant view relating to unemployment and inflation is that inflation will be constant at a level of unemployment (the nonaccelerating inflation rate of unemployment, NAIRU) determined on the supply side of the economy (and in the labor market in particular). Further, the economy will tend to converge to (or oscillate around) that level of unemployment. Moreover, demand variables or economic policy changes are thought to have no influence whatsoever on NAIRU. An alternative perspective on inflation would indicate that there would be no automatic forces leading to a level of aggregate demand consistent with constant inflation. Inflationary pressures would arise from, inter alia, a role of conflict over income shares, and from cost elements, with the price of raw materials, especially oil, being the most important. Insofar as there are supply-side factors impinging on the inflationary process, these would arise from the level of productive capacity (relative to aggregate demand) and from conflict over income shares. This paper focuses on the arguments and the evidence that supply-side constraints should be viewed as arising from capacity constraints, rather than from the operation of the labor market.