Recent Innovations in the Theory of Inflation

Abstract

Our primary purpose in this book is to examine the cluster of doctrines and empirical propositions concerning the inflationary propensities of floating exchange rates, with a view to stitching them together into a plausible and coherent hypothesis. To do this, one needs to understand (a) the contemporary theories of inflation; and (b) the precise manner in which alternative exchange-rate regimes influence the channels of transmission and the operation of the various possible price links among countries. However, before examining the systematic interaction between domestic price level, world prices, and the exchange rate in open economies, it is desirable to review briefly the major currents in the contemporary theories of inflation. While these theories are, by and large, concerned with closed economies, they have obvious relevance for the study of worldwide inflation. Since we will have occasion to refer to some of these theoretical constructs throughout this book, it is essential to have a clear notion of their meaning and significance. The purpose of this chapter is to provide a brief sketch of the more prominent models of inflation in closed economies, without any pretence of being exhaustive.¹ The next two chapters will discuss the theoretical approaches to the study of inflation in open economies under fixed and flexible exchange rates.