Government Intervention in the Inflation Process: The Econometrics of "Self-Inflicted Wounds"

Abstract

The high variance and continued acceleration of inflation during the 1970's pose new challenges to the time-series econometrician. The theme of this paper is that inflation in the past decade has depended not only on the level of aggregate demand and the role of inertia-the two explanatory variables stressed in the conventional Phillips curve framework-but also on a number of different supply shocks. Two of these, the increase in the relative price of oil and decline in the rate of productivity growth, have been outside of the direct control of the government, particularly in the short run. But both the variance and acceleration of inflation have been aggravated by three measures within the purview of government policymakers: increases in the effective Social Security tax, increases in the minimum wage rate, and episodes of direct government intervention in the price-setting process. Because of their futility, these intervention episodes can be regarded as self-inflicted wounds, like the tax and minimum wage changes that normally are described by this term.