Page 754 - The Principle of Economics

774 PART TWELVE SHORT-RUN ECONOMIC FLUCTUATIONS
IN THE NEWS
The Benefits of Low Expected Inflation
IN THE 1960S AND 1970S, POLICYMAKERS learned that high expected inflation shifts the short-run Phillips curve out- ward, making actual inflation more likely. In the 1990s, the opposite oc- curred, as expected inflation fell and helped keep actual inflation low.
The Virtuous Circle of Low Inflation
BY JACOB M. SCHLESINGER Why does inflation remain so low?
Some experts credit greater cor- porate efficiency. Others cite a growing labor force. Luck, in the form of cheap oil and a strong dollar, helps. But the raging economic debate often overlooks one simple answer: because inflation remains so low. In other words, it isn’t just a mat- ter of mathematical formulas such as a Phillips-curve tradeoff between inflation and jobs; it also is the nebulous matter of mass psychology. The economy may be
entering a phase in which low inflation is no longer considered a lucky, transitory phenomenon but an integral part of its fabric. And if enough executives, suppli- ers, consumers and workers believe it will last, they will act in ways that help make it last.
“For the past couple of years, peo- ple were expecting inflation to rise, but it hasn’t,” says Janet Yellen, the chief White House economist and former Fed- eral Reserve governor. “Slowly, people are being convinced that inflation is down and it’s going to stay down, [which] is helpful in keeping inflation down. Inflationary expectations feed directly into wage bargaining and price setting.”
This substantial exorcising of the inflationary specter flows partly from the Fed’s new credibility: a widespread belief that it is committed to keeping prices relatively stable and knows how to do so. . . .
A widely cited measure of public attitudes, the University of Michigan’s Survey of Consumers, is reflecting two significant changes this year, says Richard Curtin, its director. First, long- term inflation expectations—the pre- dicted annual inflation rate for the next five to 10 years—have slipped below 3% for the first time since the survey began asking the question nearly two decades ago. Second, long-term inflation
expectations now nearly equal short- term expectations. . . .
This outlook eases inflationary pres- sures in many ways. Recall the 1970s, Ms. Yellen says, “when expectations of future inflation led workers to demand wage increases that would compensate them for expected inflation, and firms to give wage increases believing they could pass on price increases.” . . .
“In the 1970s and 1980s, we had price increases baked into our projec- tions,” says Warren L. Batts, chairman of both Premark International Inc. and Tupperware Corp. and head of the National Association of Manufacturers. “We thought we could charge our cus- tomers [more], and therefore we could pay our suppliers. [Now], you know you can’t charge, so you don’t pay.”
Of course, inflationary fears aren’t completely cured, as last week’s stock and bond market jitters show. Rampant inflation in the 1970s shattered the no- tion that America was immune to the problem. Remaining traces of apprehen- sion may not be all bad. “The moment we become complacent about infla- tion,” says Deputy Treasury Secretary Lawrence Summers, “is the moment we will start to have an inflation problem.”
SOURCE: The Wall Street Journal, August 18, 1997, p. A1.
SHIFTS IN THE PHILLIPS CURVE: THE ROLE OF SUPPLY SHOCKS
Friedman and Phelps had suggested in 1968 that changes in expected inflation shift the short-run Phillips curve, and the experience of the early 1970s convinced most economists that Friedman and Phelps were right. Within a few years,