Conflict inflation: an open economy approach

Abstract

PurposeThis paper seeks to draw together the various essential elements of the conflict inflation approach within the context of an open economy and to highlight the importance of global external factors in explaining inflation.Design/methodology/approachA theoretical framework is proposed based on a model with a few simple building‐blocks. A supply side relationship that determines the trade‐off between a stable distribution of income and the external balance is first derived. As a second step the model combines the supply side relationship with James Meade's analysis of the relation between internal and external balance.FindingsThe study first shows, in the context of an small open economy, relevant trade‐offs among three crucial macroeconomics targets – external balance, internal balance, and workers/firms' aspiration balance. It then disentangles the adjustment mechanism that explains how an adverse balance of payments shocks may lead eventually to the breakdown of the conflicting claims equilibrium and inflation. Finally, it provides analytical reasons for believing that the focus of globalization (sustained and higher world demand and strong global competitiveness) is the main cause of global disinflation.Research limitations/implicationsThe present study provides a starting‐point for further theoretical developments within the conflict inflation approach and requires empirical testing.Originality/valueThe open economy conflict inflation framework could prove to be useful in improving the understanding of the relationship between global external forces and domestic inflation.