The Mirage of Steady Inflation

Abstract

DEVELOPMENTS WITHIN THE ECONOMY and the profession in recent years have generated a marked swing toward pessimism in the appraisal of the tradeoff between inflation and unemployment. During the fifties and the sixties, a 4 percent unemployment rate was generally accepted as a target for full employment. At that time, it was expected that it might be accompanied by an inflation rate of 2 or, at most, 3 percent.' In contrast, some recent readings of the Phillips curve reported in this journal suggest that, under present circumstances, a 4 percent unemployment rate means as much as 5 percent inflation for the long run, while holding the inflation rate down to 2 percent would require an unemployment rate of 51/2 percent.2 Some economists have responded to this unhappy news by espousing either "brake riding" or "gas pumping," as I have characterized these positions elsewhere.3 The brake rider would accept a higher unemployment rate. Although some brake riders have urged actions to ameliorate the adverse human and redistributive impact of unemployment, their program still involves large 1. See, for example, the estimates in Paul A. Samuelson and Robert M. Solow, "Analytical Aspects of Anti-inflation Policy," in American Economic Association, Papers and

The Links between Inflation and Inflation Uncertainty at the Longer Horizon

“…To conclude: it was demonstrated by applying modern non-linear state-space modeling to extensive empirical data that the old argument by Okun (1971) is valid. High inflation and low inflation uncertainty are largely incompatible.…”

“…Inflation-uncertainty literature: theoretical arguments A hypothesis that higher inflation is related to greater inflation uncertainty was advanced in Okun (1971) and became well-known when Milton Friedman in his Nobel lecture Friedman (1977) based a critique of Phillips curve on the hypothesis. The argument was that at the high rates of inflation macroeconomic policy would become more erratic leading to a greater volatility of the price level.…”

“…Studies using cross-country data mostly confirm the existence of the relation between the level and uncertainty of inflation (for example, see Okun (1971), Logue andWillett (1976), Foster (1978), Gale (1981), Ram (1985), Morris (1996), Fang, Miller, andYeh (2007)). In these studies simple inflation variability over some fixed period is typically used as a measure of uncertainty in a country (for example, the sample standard deviation or the mean absolute change).…”

“…From an economic policy perspective it is important that it is almost never possible to have high average inflation and low inflation uncertainty simultaneously (cf. Okun (1971)). If a policy-maker seeks to maintain low inflation uncertainty, but at the same time conducts an expansionary monetary policy then he follows an unachievable goal or "mirage" as Okun called it.…”

“…The existing literature suggests several approaches to measuring of inflation uncertainty and most of them have serious drawbacks. Cross-country studies starting from Okun (1971) use indicators which are only indirectly connected with inflation uncertainty. This raise doubts about their relevance to the problem.…”