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Chapter 28: Problem 8

In macroeconomics courses in the \(1960 \mathrm{~s}\) and early \(1970 \mathrm{~s},\) some economists argued that one of the U.S. political parties was willing to have higher unemployment in order to achieve lower inflation and that the other major political party was willing to have higher inflation in order to achieve lower unemployment. Why might such views of the trade-off between inflation and unemployment have existed in the 1960 s? Why are such views rare today?

Short Answer

Expert verified
In the 1960s, economic theories such as the Phillips Curve depicted an inverse relationship between unemployment and inflation. Different political parties could thus prioritize either based on their economic and political ideologies. Today, these views are rare as modern economic policies and factors like technological advancement allow a balance to be maintained between inflation and unemployment, reducing the need for such trade-offs.

Step by step solution

01

Understand the trade-off between Inflation and Unemployment

In the 1960s, there was an economic theory known as the Phillips Curve that depicted an inverse relationship between unemployment and inflation - when inflation was low, unemployment was high, and vice versa. This means, reducing unemployment might be associated with higher inflation, whereas reducing inflation could lead to higher unemployment.
02

Analyze Political Parties' Perspective

Different political parties could prioritize either inflation or unemployment based on their economic and political ideologies. One party might accept higher unemployment to control inflation - perhaps focusing more on economic stability. The other party might accept higher inflation for the sake of lower unemployment - possibly focusing more on social stability.
03

Explain why such views are rare today

Over time, the inverse relationship between inflation and unemployment (as per the Phillips Curve) has been argued to be less applicable. Today, many economists believe that modern economic policies and factors such as technological advancement have enabled us to maintain a balance between inflation and unemployment, reducing the need for such a trade-off, hence these views are rare.

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Most popular questions from this chapter

Why did Milton Friedman argue that the Phillips curve did not represent a permanent trade-off between unemployment and inflation? In your answer, be sure to explain what Friedman meant by the "natural rate of unemployment."

(Related to the Apply the Concept on page 1015 ) In an opinion column in the Wall Street Journal, economist Sebastian Mallaby argued that when investors believe that financial markets will remain calm, they may be more willing to make risky investments. The result can be a financial crisis such as occurred during \(2007-2009,\) when the prices of risky mortgage-backed securities declined. Mallaby argued: The central-banking fashion now is to target inflation and to communicate prodigiously about coming interest-rate adjustments.... But stable finance often matters more than stable prices. And transparency about future interest- rate moves can induce disruptive speculation. a. What does the Fed call attempts to shape expectations of future policy decisions? b. Why did targeting inflation and communicating about future changes in interest rates become "central bank fashion"? c. Why might investors be more likely to buy risky securities if they feel confident that they know what interest rates will be in the future as a result of Fed announcements?

Robert Shiller asked a sample of the general public and a sample of economists the following question: "Do you agree that preventing high inflation is an important national priority, as important as preventing drug abuse or preventing deterioration in the quality of our schools?" Fifty-two percent of the general public, but only 18 percent of economists, fully agreed. Why does the general public believe inflation is a bigger problem than economists do?

A 2017 column in the Wall Street Journal noted that "longterm consumer inflation expectations [are] at record lows." If inflation turns out to be higher than households and firms had previously expected, will the actual real wage end up being higher or lower than the expected real wage? Will employment in the short run end up being higher or lower? Briefly explain.

During a time when the inflation rate is increasing each year for a number of years, are adaptive expectations or rational expectations likely to give the more accurate forecasts? Briefly explain.
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