Puzzled by proposed inflation mechanisms

Question

There are some explanations for long term inflation that completely baffle me in that they seem so deeply flawed that I wonder how come they are taken seriously.

So take for example the idea of a "wage price spiral". The idea is (very roughly) that workers demand big wage increases so the companies that employ the workers have to put their prices up to maintain profitability but this then induces workers to demand even higher wages - repeat ad infinitum. The problem is that unless there is an accompanying increase in the money supply (and why would there be) then there is no way for this to continue. The rate of flow of money being used to purchase goods would be required to grow continuously. This can only be achieved through an increase in money velocity. This might happen for relatively short periods but decade after decade? This makes no sense.

I could make a similar argument about the idea that inflation expectations drive inflation. Without ever increasing velocity this cannot work.

Am I missing something?

AFAICT The only inflation theory that does not suffer from this flaw is money supply driven inflation. It's relatively easy to see how the money supply can grow indefinitely.

EDIT: I guess my criticism of the wage price spiral and inflation expectations could be invalid on several grounds:

1. I have missed something in my logic and the criticism is simply invalid.
2. Wage price spiral and inflation expectations only account for short term fluctuations and cannot (or are not intended to) explain long term inflation.... come to think of it, without a permanent rise in the money supply or a permanent increase in money velocity then the temporary rise in inflation must be followed by a fall back to the original price level.
3. Wage price spiral and inflation expectations can work in the very long term because both of them are things which actually cause the money supply to grow, thereby avoiding the need for ever increasing velocity.
4. Something else I haven't thought of.

Answer 1

Inflation Expectations

Inflation expectations affect inflation because people are not myopic and take future into consideration.

For example, if you expect that tomorrow prices will double, and you are having job interview today, you will be negotiating for your salary based on your expectations of future. If everyone expects inflation to be 3% people will start to incorporate that expectation into their economic decision making today.

Prices often follow self-fulfilling prophecies. If everyone expect crude oil to sell for \$100 a barrel tomorrow, then if price today is lower people start to hoard/buy it which pushes the price to \$100 today. People and even fully rational agents of economic models act based on their beliefs about reality and future reality, not necessarily about what the reality is.

In fact even when it comes down to fundamentals, such as money supply, real output etc., in modern economic models it does not just matter what they are today, but it matters far more what people expect them to be in the future (e.g. see discussions of this in Romer Advanced Macroeconomics, or Woodford Interest & Prices). Undergraduate textbooks often abstract from expectations as they are not always easy to model mathematically but once you get to graduate level models you will see expectations everywhere.

There are many rigorous theoretical models which show that inflation expectations matter via various mechanisms (see Friedman (1968), Phelps (1968), Mortensen (1970) and Lucas and Rapping (1969). In addition, these theories were already tested empirically so much that at this point its nearly impossible for a reasonable person to deny the evidence on effect of inflation expectations (see the seminal paper of Carlson and Parkin (1975) and studies cited therein)

Brookings has an nice explainer accessible to laymen for importance of inflation expectations you can read here.

The Wage Price Spiral

This one is bit more controversial reason than inflation expectations since it requires many assumptions on the nature of competition on both labor and goods markets and some specific market rigidities to work, but it certainly can work. The mechanism for this is as follows (Blanchard, 1986):

after an increase in aggregate demand, the process of adjustment of nominal prices and nominal wages results from attempts by workers to maintain or increase their real wage and by firms to maintain or increase their markups of prices over wages. Under continuous price and wage setting, the process of adjustment would be instantaneous; under staggering of price and wage decisions, the adjustment takes time. The more inflexible real wages and markups are to shifts in demand, the higher is the degree of price level inertia, and the longer lasting are the effects of aggregate demand on output.

There is also empirical evidence for Wage Price Spiral, which although not as overwhelming as in the case of inflation expectations, is nonetheless quite convincing (e.g. see Kandil 2007).

Answer 2

I do agree expectations play a big part of that, if theoritically wage-price spiral causes inflation.

But possibly maybe this scenario may somehow fit for wage-price spiral inflation to last in the long run,

Suppose There is a Shortage of Supply of a Key Commodity or Commodities, or fundamental essential Goods/Services for a society, that will last from the present time to the Long Run. The Prices of those Commodities or Goods/Services will increase by Large Amounts. Since the Prices of those Commodities or Goods/Services will increase, Workers will demand Higher Wages from Firms. Here we have 2 things, 1 Higher Wages, more buying power, but then Less Supply of Commodities or Goods/Services, which will increase prices, which will cause inflation, which in effect will decrease the buying power of the new wages given to the Workers.

So in this scenario, the Tip of the Cause is the Shortage of Supply of Goods, and not a manipulation of Money Supply.