If there is one thing, macroeconomists – especially those working at the FED – are expected to be able to make sense of, it is inflation. Thus, it might be surprising what the FED chair Jerome Powell said in June 2022 at an ECB Forum on the topic. His claim about the limits of macroeconomic knowledge, however, should not come as a surprise to someone who has followed the recent debate on Econtwitter at the turn of the year on how to understand inflation. It did not seem like there is a clear-cut consensus about the roots of inflation.

Olivier Blanchard started the debate by a twitter tread, where he argued that there is a distributional conflict between workers, firms, and taxpayers lying at the heart of inflation.

1/8. A point which is often lost in discussions of inflation and central bank policy. Inflation is fundamentally the outcome of the distributional conflict, between firms, workers, and taxpayers. It stops only when the various players are forced to accept the outcome.

— Olivier Blanchard (@ojblanchard1) December 30, 2022

Taking this Post-Keynesian perspective, opens the room for the state when it comes to the most efficient policy response to recent inflationary episodes. Leaving the task to solve a distributional conflict to the central bank alone then seems to be highly inefficient.

The New Keynesian Consensus

The basic New Keynesian Phillips Curve relates inflation to aggregate demand and inflation expectations. If the economy is close to its potential or if marginal costs of additional production rise (e.g. because of energy prices), firms use their price setting power to raise prices, which leads to inflation. In this framework, central banks are the only game in town to effectively fight inflation by raising interest rates to bring down aggregate demand (which means to bring up unemployment) and to anchor inflation expectations. The question Blanchard was asking is, if this is always the most efficient policy response as well, or if there was a less costly way.

If inflation is understood as distributional conflict between firms and workers who are trapped in a price-wage spiral^[1], dealing with inflation becomes a coordination problem. Krugman explained this idea in his New York Times column entitled “The Football Game Theory of Inflation”, where he compared the process to a football game in which everyone tries to stand up to see over everyone else, and the result is that no one can see better than they could before, but now everyone’s legs are tired. In this analogy, the central bank makes everyone sit down by making the game less interesting, reducing exhaustion at the expense of increased boredom. But what if there was a way that no one would stand up in the first place? And how to coordinate, if some stand up no matter what?

As Claudia Sahm argues in her blog, relying on monetary policy is not the only option for policy makers. Because inflation is a multidimensional problem, action at all policy levels is necessary, which opens the room for fiscal or regulatory policies.

One way would be to adopt strategic price policies of “systematically significant prices”, as proposed by Isabella Weber. In the football stadium analogy this would prevent people in the first row from standing up. A new working paper by her together with co-authors takes into account distributional considerations with an input-output model of inflation, differentiating between certain goods and sectors.