BPEA | 1975 No. 2

Inflation: Its Mechanics and Welfare Costs

1975, No. 2

ECONOMISTS CONTINUE to be baffled by the mystery of inflationary recession (or stagflation) that has been experienced by industrialized countries during the 1970s. What causes inflation to churn on and on even after excess demand disappears? This whodunit is the latest in a long series that reflects the inadequacy of current theory in explaining the mechanics of how inflation proceeds once it has begun. In this paper, I shall sketch an interpretation of the persistence of inflation based on an interaction of “customer” or “career” markets, in which prices and wages do not equate supply and demand, with “auction” markets, in which prices do reliably clear markets.