Many economists generally agree that inflation is caused by bank credit expansion or by “money printing” by the Federal Reserve Bank.
But recently I came across a paper written by economics professor L. Randall Wray where he makes a pretty good case that in a “monetary production economy” (that is, an economy where production usually begins and ends with money), there are several alternative causes, but he also explains in more detail exactly why and how inflation can occur via bank credit expansion.
The paper explains how prices are generally set in a monetary production economy: An entrepreneur can more easily obtain loans when he has market power. Market power, without delving into details, is the ability to push up prices for goods and services.
Post Keynesians adopt an aggregate markup theory of pricing in which price is determined at the macro level as a markup over labor costs. The price of consumption goods must be high enough above wages in that sector so that some consumption goods will be left for workers in other sectors. This allows some workers to be put in the investment sector (and government and trade sectors) to produce the surplus (goods and services) that workers cannot buy.
One of the main purposes of business credit is to facilitate the capital development of the economy, that is to allow entrepreneurs to buy factors of production to improve output per worker. When business credit is extended, and new checking account money is created out of nowhere, the workers building the machinery, computers, software, etc. in question, will end up buying consumer goods as well. So the price for consumer goods needs to be sufficiently high above wages per unit in order to keep the workers producing consumer goods from consuming their own entire output, and in order to make room for workers in other sectors.
Bank loans are often extended under the assumption that the receiving entrepreneur will be able to achieve a certain price markup over labor costs, so you can see how price plays a big role in the process of obtaining business credit for capital expansion.
It is of course possible that the price increases are moderated or counterbalanced by the subsequent increase in productivity. However, capital expansion projects can also fail, so it’s not unreasonable to expect a certain tendency for prices to rise over time in a fiat monetary production economy.
But price pressure can also result from workers’ desire to raise wages:
As Ingham (2000) notes, money prices are the result of complex power struggles–both between capital and labor, and among capitalists. When labor is strong, it can push up wages; in order for individual firms to maintain markups from which profits are derived, they must raise prices in compensation. This could be called “cost-push” inflation, and would be more likely to result from decentralized wage bargaining in the presence of strong labor unions, with each individual union trying to obtain larger-than average wage increases for members and possibly generating a wage-price spiral. On the other hand, “markup” or “profits” inflation results when firms are able to raise the markup over wage costs.
The paper then explains why some refer to this type of inflation as “incomes inflation”:
Inflation caused by rising wages or rising markups is often called “incomes inflation” to indicate that it results from a struggle to increase the income of either labor or capital.
Spot Price Inflation
The paper also recognizes another type of price pressure that can be caused by entities that are monopoly price setters:
In addition to incomes inflation, overall price increases can be induced by rising “spot prices”. The best example would be an increase of energy prices such as those experienced during the mid and late 1970s, and repeated on a lesser scale in 2000. Rising energy prices of course affect the cost of production of almost all goods and even of most services. Firms will attempt to pass these along in the form of higher prices of intermediate and final goods. If energy prices are increased only once, this could cause only a one-time “price shock” resulting in a higher aggregate price level. By itself, this would not be defined as inflation, which implies continuing price increases. However, the price shock could set off a struggle by workers to maintain nominal income shares (and real–inflation adjusted–wages), which could generate a wage-price spiral if firms attempt to maintain markups.