Williamson_3e_IM_17

Williamson_3e_IM_17 - Chapter 17 Inflation the Phillips...

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Chapter 17 Inflation, the Phillips Curve, and Central Bank Commitment ± Teaching Goals In some ways, discussion of Phillips curves has become less topical, as contemporary policy discussions rarely utilize this terminology. However, because Phillips curves did play a prominent role in policy discussions during the 1960s and 1970s, an understanding of Phillips curves is necessary to properly understand the history of Federal Reserve policy over the second half of the 20th century. The most important points are that stable Phillips curves, if they exist at all, are only short-run phenomena, and that policymakers’ attempts to exploit the Phillips curve may lead to a permanent increase in inflation and at best a temporary increase in aggregate output. The primary subject of this chapter is to develop a positive theory of inflation. In the short run, central banks face a given level of expected inflation. Over time, policy behavior affects the future course of expectation formation. The interplay of central bank behavior and the behavior of the public generates the equilibrium rate of inflation. This model can be used to make potentially refutable predictions about the genus of inflation in different times and places. The remainder of the material is devoted to applications of inflation theory to historical inflation episodes. A principal result is that U.S. inflation experience from 1970 to the early 1980s is likely due to the Fed’s initial misunderstanding of the true nature of the Phillips curve relationship. ± Classroom Discussion Topics Public discussion periodically focuses on whether the Fed should be given less discretion. This topic was given more attention during the 1970s and early 1980s when the Fed allowed the rate of inflation to get higher than what the public was willing to tolerate. On the one hand, if the Fed is charged only with control of the rate of inflation, and given clear performance standards, theory suggests that the rate of inflation will remain closer to its preferred level. However, discretion may be needed for the Fed to properly respond to macroeconomic disturbances. How do students feel about giving the Fed less discretion? How does the answer to this question depend on the students’ judgments about the validity of competing theories of the business cycle? What does the change of leadership at the Fed have to do with rules vs. discretion? There is some conflict between the Friedman–Lucas money surprise model of the Phillips curve and the assumed properties of central bank preferences. In particular, the model assumes that the central bank always prefers higher output. However, if the Friedman–Lucas model is correct, then aggregate output can be above trend only when workers are fooled into working more hours than they would actually prefer.
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Williamson_3e_IM_17 - Chapter 17 Inflation the Phillips...

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