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

An important implication of this conclusion is a consensus belief about macroeconomic
policy: governments should not try to use macroeconomic policies to maintain
the unemployment rate below the natural rate or output above potential.
Expansionary policies will temporarily lower unemployment and boost income,
but eventually unemployment returns to the natural rate. Thus, the policy question
is whether the temporary fall in unemployment is worth the potential cost of
higher inflation.
A key issue for policymakers is identifying the natural rate of unemployment
and potential GDP in a dynamic economy. At one time, economists thought the natural
rate was around 6 percent. Unemployment rates below that level were expected
to lead to increases in the inflation rate. When the unemployment rate fell below 6
percent in 1995 and below 5 percent in 1997 without causing inflation to rise, economists
needed to reassess their estimates. We will discuss shifts in the natural rate
later in this chapter.
Wrap-Up
BASICS OF INFLATION ADJUSTMENT
Short-run inflation adjustment (SRIA) curve: shows the relationship between inflation
and output for given inflation expectations; the higher that output is, relative to
potential, the higher the inflation rate.
Expectations-augmented SRIA curve: the SRIA curve with expectations of inflation
explicitly incorporated. The level of inflation associated with any level of output depends
on expectations concerning inflation; the higher the inflationary expectations,
the higher the level of inflation associated with any level of output. As inflationary
expectations increase, the SRIA curve shifts up.
Case in Point
NOBEL VIEWS ON INFLATION AND
UNEMPLOYMENT
Our understanding of the shifting relationship between unemployment
and inflation owes much to the contributions of Milton Friedman and Robert
Lucas, the 1976 and 1995 winners of the Nobel Prize in Economics. Friedman
and Lucas are two of the giants of monetary economics. Friedman is most widely
known for his emphasis on the role of monetary policy as a force in shaping the
course of inflation and business cycles. He is best known to the lay public for his
advocacy of free markets. Lucas is probably unfamiliar to most noneconomists,
but like Friedman, he has made fundamental contributions to the study of money,
inflation, and business cycles.
SHORT-RUN INFLATION ADJUSTMENT ∂ 827