Macroeconomic Instability and Coordination
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Macroeconomic Instability and Coordination

Selected Essays of Axel Leijonhufvud

Axel Leijonhufvud

Axel Leijonhufvud has made a unique contribution to the development of macroeconomic theory. This volume draws together his insightful essays dealing with the extremes of economic instability: great depressions, high inflation and the transition from socialism to a market economy. In several of the papers, Leijonhufvud brings a neo-institutionalist perspective to the problems of coordination in economic systems.
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Chapter 7: Theories of stagflation

Axel Leijonhufvud


7. Theories of stagflation The occurrence of stagflation came as a nasty shock to a great many economists. Evidently, the economics profession has gotten so much into the habit of teaching that unemployment and inflation are alternating or alternative phenomena that their actual conjuncture seemed at first to be a riddle to which received theory might not supply an answer. A few writers of some note indeed went so far as to proclaim that stagflation proved the bankruptcy of standard theory. Well, stagflation is not a riddle. Far-fetched or ad hoc explanations are not required. Instead, theories of unemployment and theories of inflation can be combined in a variety of ways that avoid contradiction. I want to discuss a few of these. It seems easiest to start by considering different theories of unemployment. STAGFLATION I: THE CASE OF THE MISSING MARKET MECHANISM The first theory of unemployment that needs to be mentioned is based on the notion that labor markets do not have functioning market mechanisms. Wage rates are not governed by demand for and supply of labor. In particular, an excess supply of labor does not constitute a ‘market force’ that will set in motion adjustments that could result in its own elimination. Wage determination is to be explained by institutional factors, exogenous to the market. A common version of this theory has wage rates independent of the excess demand for labor at all values of employment below full employment, with inflation...

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