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

Chapter 37
INFLATION AND
UNEMPLOYMENT
∂
During the 1970s, the most pressing macroeconomic policy issue facing industrialized
economies was inflation. Despite repeated attempts to reduce
it, inflation remained stubbornly high throughout the decade. Figure 37.1
shows the inflation rates for the United States, Japan, and western Europe. All display
roughly similar patterns. Inflation had remained relatively low during the 1960s,
but it jumped to much higher levels in the following decade.
To understand how governments might control inflation, we need to understand
what causes inflation. How do we explain why some countries have higher rates of
inflation than others? What are the costs of reducing inflation? Why do the United
States and most other industrialized economies have lower inflation rates today
than they did twenty-five years ago? And why do some countries continue to suffer
from high rates of inflation?
We have already learned about the costs of inflation in Chapter 23. Many of these
costs are associated with variability in inflation rates. Countries that experience high
average inflation also experience greater inflation variability than do countries with low
average inflation. It is this unpredictibility that can impose large costs on the economy.
When inflation turns out to be higher than anticipated, lenders lose as the dollars
they receive are worth less than the dollars they lent; borrowers gain since the dollars
they repay are worth less than the dollars they borrowed. Conversely, if inflation
turns out to be lower than anticipated, borrowers lose and lenders gain. The possibility
of these unanticipated gains and losses increases uncertainty and the general level
of risk in the economy. We also learned in Chapter 23 that inflation imposes further
costs on the economy as individuals devote resources to trying to avoid its costs.
If inflation disrupts the economy, why don’t governments simply get rid of it? The
answer is that normally, inflation can be reduced only at a cost—only if the unemployment
rate is allowed to increase temporarily. This chapter looks at that short-run
trade-off. Most economists believe that in the long run, there is no trade-off—the
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