[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Inflation–Unemployment
Trade-Offs
Economists focus on trade-offs: if we want more of one thing, what do we have to
give up? Can we have lower average unemployment if we are willing to accept higher
average inflation? Does keeping inflation low and stable mean that output and unemployment
will fluctuate more? Chapter 31 provided the analytical basis for addressing
these questions. Clearly, we would like to have both low (and stable) inflation
and low (and stable) unemployment. Economists’ understanding of the trade-offs
that policymakers must face has evolved over time.
THE OLD INFLATION–UNEMPLOYMENT
TRADE-OFF
Fifty years ago, most economists thought that there was a trade-off between
the average level of unemployment and the average rate of inflation. Economists
who believed that the costs of inflation were high argued for lower inflation and
a higher unemployment rate, while those who held that the benefits of low inflation
were far outweighed by the costs of high unemployment argued for
lower unemployment rates and higher inflation. Thus, disagreements about
policy largely hinged on disagreements about the relative costs of inflation and
unemployment.
Attempts in the 1960s to exploit this trade-off by reducing unemployment to
levels much lower than previously experienced led, as our analysis in Chapter 31
predicted, to higher inflation. And rather than remaining stable at its new higher
level, the inflation rate continued to increase as long as unemployment remained
below the economy’s natural rate of unemployment. The economy ended up
back at potential GDP, with the same average levels of unemployment as before
but with higher inflation rates. During the 1970s, a consensus developed that
the economy could not enjoy a sustained level of unemployment below the
natural rate.
The experience of the 1960s and 1970s convinced most policymakers that no
trade-off exists between average rates of inflation and average rates of unemployment.
As we learned in Part Six, the average level of the unemployment rate and the rate
of real economic growth are determined by such fundamentals as technological
change, population growth, labor market institutions, and the skills of the workforce.
Because these factors are unrelated to the economy’s average rate of inflation,
allowing average inflation to rise brings no long-run benefit in the form of faster
growth or lower average unemployment. The choice facing policymakers appeared
to be a simple one—the economy could operate at full employment with low inflation,
or it could operate at full employment with high inflation. Obviously, low inflation
was preferable.
728 ∂ CHAPTER 33 THE ROLE OF MACROECONOMIC POLICY