More on expected inflation and unemployment

Abstract

Van Cott and Santoni [10] (hereafter V&S) have recently argued that the effect of expected inflation on real output and employment is ambiguous if we take into account the impact of expected inflation on both the aggregate demand for goods and services and the aggregate • supply of goods and services. This result is important not only because it challenges the standard conclusion that under expected inflation real output and employment must rise but also because it shows most traditional analyses of this topic (Bailey [1], Mundell [6]) to involve a serious asymmetry insofar as they focus on demand-side impacts only. Unfortunately, the supply-side structure through which V&S generate their conclusion is rather questionable, principally because it assumes yet another asymmetry: that while suppliers of labor respond to expected inflation, demanders of labor do not. The purpose of this note is to remove this deficiency. As we will show, under appropriate modifications, the ambiguity cited by V&S need not arise. V&S's analysis is cast in the following system: