FMM Working Paper

: A post-Keynesian open economy model of conflict inflation, distribution, employment, and external balance

Post-Keynesian conflict inflation models have received renewed attention in the course of the recent inflationary processes related to the recovery from the Covid-19 crisis in 2020 and the hike of energy prices in the context of the start of the Russian war on Ukraine in 2022. Although the basic principles of conflict inflation can be presented in a closed economy framework (e.g. Hein 2023, chap. 5), examining current sources and triggers of inflation requires open economy models. Post-Keynesian economics has presented several of these models (e.g. Blecker 2011, Vera 2014, Bastian and Setterfield 2020), which differ in the role assigned to the nominal and the real exchange rate (RER), on the one hand, and the stability of the wage and price Phillips curves, on the other hand. This paper first provides a systematic overview of post-Keynesian open economy conflict inflation models using the treatment of the RER and the stability of the Phillips curve as the main clustering criteria. Second, it provides a model including an unstable Phillips curve and a policy rule targeting a certain RER in response towards trade imbalances. The model distinguishes three equilibrium rates of employment: the goods market equilibrium rate of employment, the distribution claims equilibrium and hence stable inflation rate of employment, and finally the external balance equilibrium rate of employment. The interaction of these three rates drives the system. Finally, the model examines the conditions for an overall equilibrium and its stability.

Keywords: conflict inflation, open economy, exchange rate policy, post-Keynesian model