Page 764 - The Principle of Economics

784 PART TWELVE
SHORT-RUN ECONOMIC FLUCTUATIONS
N Declining Commodity Prices. In the late 1990s, the prices of many basic commodities fell on world markets. This fall in commodity prices, in turn, was partly due to a deep recession in Japan and other Asian economies, which reduced the demand for these products. Because commodities are an important input into production, the fall in their prices reduced producers’ costs and acted as a favorable supply shock for the U.S. economy.
N Labor-Market Changes. Some economists believe that the aging of the large baby-boom generation born after World War II has caused fundamental changes in the labor market. Because older workers are typically in more stable jobs than younger workers, an increase in the average age of the labor force may reduce the economy’s natural rate of unemployment.
N Technological Advance. Some economists think the U.S. economy has entered a period of more rapid technological progress. Advances in information technology, such as the Internet, have been profound and have influenced many parts of the economy. Such technological advance increases productivity and, therefore, is a type of favorable supply shock.
Economists debate which of these explanations of the shifting Phillips curve is most plausible. In the end, the complete story may contain elements of each.
Keep in mind that none of these hypotheses denies the fundamental lesson of the Phillips curve—that policymakers who control aggregate demand always face a short-run tradeoff between inflation and unemployment. Yet the 1990s remind us that this short-run tradeoff changes over time, sometimes in ways that are hard to predict.
QUICK QUIZ: What is the sacrifice ratio? How might the credibility of the Fed’s commitment to reduce inflation affect the sacrifice ratio?
CONCLUSION
This chapter has examined how economists’ thinking about inflation and unem- ployment has evolved over time. We have discussed the ideas of many of the best economists of the twentieth century: from the Phillips curve of Phillips, Samuel- son, and Solow, to the natural-rate hypothesis of Friedman and Phelps, to the rational-expectations theory of Lucas, Sargent, and Barro. Four of this group have already won Nobel prizes for their work in economics, and more are likely to be so honored in the years to come.
Although the tradeoff between inflation and unemployment has generated much intellectual turmoil over the past 40 years, certain principles have developed that today command consensus. Here is how Milton Friedman expressed the rela- tionship between inflation and unemployment in 1968:
There is always a temporary tradeoff between inflation and unemployment; there is no permanent tradeoff. The temporary tradeoff comes not from inflation per se, but from unanticipated inflation, which generally means, from a rising