Understanding Inflation in the 1980s

Abstract

THE ASSOCIATION between .he inflation rate and the level of aggregate demand, and the related concept of the natural unemployment rate, have been perennial Brookings Panel topics. This fifteenth anniversary of the Panel seems an appropriate occasion to take another look at the U.S. inflation process. After a series of inflationary surprises during the 1970s, when the inflation rate was regularly underpredicted by forecasters and inflatiorn analysts, inflation has decelerated faster and further since 1980 than many thought possible. Does the disinflation of the early 1980s call for a new approach to the study of the inflation process, as did the stagflation of 1969-71 and the supply shocks of 1973-74? Or has the research effort of the 1970s yielded a quantitative representation of the inflation process and the natural rate of unemployment that remains relatively intact in the mid-1980s? At the tenth anniversary meeting of the Brookings Panel, James Tobin lamented the constantly worsening views of the inflation-unemployment trade-off and the natural unemployment rate presented in papers over the first decade of the Panel: One regularity of Brookings panel meetings and papers has been the relentless rise in numerical estimates of the fullemployment rate of unemployment. . . From 3 percent in the early 1950s, these explicit or implicit estimates of the natural rate seem to have risen successively to 4 percent in the 1960s, 5 percent in the early 1970s, then 6 percent. In the early 1980s, it is easy to predict, the magic number will not be lower than 7 percent. 1 I