Currency Value, Inflation, and Income Distribution

An earlier post discusses the way in which Modern Monetary Theorists conceptualize the value of the currency. In this context, ‘value of the currency’ refers to the currency’s domestic value, not its exchange rate. This value is defined in MMT as whatever must be done to obtain a unit of the currency. It can be defined in terms of minimum-wage or ‘simple’ labor time. A minimum wage of $10 would imply that it takes 6 minutes of simple labor time, or its equivalent, to obtain a dollar, expressed as 6 minutes/dollar or 0.1hrs/dollar. The present post considers the connection between currency value, inflation, and distribution.

A well known macroeconomic identity shows that inflation must occur if growth in money wages, w, and the aggregate markup over wage costs, k, outstrips improvements in the average productivity of labor, APL. The relationship can be expressed in simple algebra:

P* = k* + w* – APL*

In this identity, P is the general price level. The stars in the expression indicate that the terms refer to growth rates or rates of change of the variables involved. (Usually dots rather than stars would be used.) Rising productivity makes it possible to produce more real output for given employment, putting downward pressure on prices, whereas attempts by firms or workers to boost their nominal income exert upward pressure on prices.

The same relationship can be viewed in terms of currency value. Since, in MMT, this value can be regarded as the amount of labor time required to obtain a dollar, an increase in nominal wages implies a decline in the value of the currency. The identity suggests that a decline in the value of the currency (a rise in nominal wages) will be associated with inflation unless productivity improves rapidly enough to offset both this decline in currency value and any widening of the markup.

It is also possible to relate all this to real wages and income distribution.

Suppose that money wages, and therefore the value of the currency, remain constant. What will happen to real wages and income distribution?

The effect on real wages, w/P, and income distribution will clearly depend on what happens to prices while money wages remain stable. In turn, what happens to prices will depend on what happens with the markup and productivity.

To keep things simple, assume that employment remains stable as productivity is improving, perhaps because the government conducts fiscal policy to this end. On this assumption, advances in productivity will translate into higher real income, Y, irrespective of what is happening to prices and nominal income, PY.

Under the assumption of stable money wages, w* is zero, and the identity reduces to:

P* = k* – APL*

In considering the implications of stable money wages (and currency value) for real wages and income distribution, four cases suggest themselves:

(A) If the markup increases precisely in line with productivity (k* = APL*), the price level will remain steady (P* = 0), and so too will real wages. All the real gains made possible by higher productivity will go to profits. Capitalists will have a greater share of a higher real income. Workers’ absolute living standards will remain constant, but their share in real income will decrease.

(B) If the markup is increased more rapidly than productivity (k* > APL*), there will be inflation (P* > 0) and a fall in real wages. Not only will the real gains from productivity be entirely captured by capitalists but the reduction in real wages will leave workers with a lower absolute living standard.

(C) If the markup is increased less rapidly than productivity (k* < APL*), there will be deflation (P* < 0) and an increase in real wages. Since productivity is improving, but the markup increases by less than productivity, both workers and capitalists will share in the real gains.

(D) If the markup remains constant while productivity improves (k* = 0 < APL*), both money wages and the markup will be constant as prices fall (P* < 0). Workers will enjoy an increase in real wages and share equally in the real gains made possible by productivity improvements.

Notice that all these scenarios are possible even though the value of the currency has been assumed to remain constant.

To say more, it is necessary to make behavioral assumptions about causation and specify in more detail the institutional context.

In the MMT view, a job guarantee, offering a fixed living-wage job to anyone who wanted one, would provide a nominal price anchor for the broader economy and, in conjunction with generalized fiscal policy, tend to keep inflation under control.

By restricting changes in the job-guarantee wage to those that reflect changes in productivity, the job guarantee in itself would not be inflationary. Since other employers would need to offer wages that were competitive with the job-guarantee wage, the job-guarantee wage would essentially define the economy’s minimum wage, providing a floor under other wages, and also a floor under demand during downturns.

In the broader economy, both wage demands and the markup would be subject to the influence of generalized fiscal policy. In a period of excessive demand, fiscal tightening would constrain wages by altering the ratio of job-guarantee employment to other employment. The markup would be similarly constrained by fiscal tightening because total realized profit, as demonstrated by Kalecki’s profit equation, is a function of demand.

By keeping the rate of decline in the currency’s value (or the rate of increase in money wages) approximately equal to the growth rate of productivity, inflation would tend to remain low and stable.