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Aslo, a few links are below.
From BusinessWeek in 1997 http://www.businessweek.com/1997/30/b353757.htm COMMENTARY: IN THE NEW ECONOMY, THE OLD RULES STILL LIVE These are tough times for traditional inflation theory. A soaring U.S. economy, fueled by the forces of globalization and technology, has pushed joblessness down to levels not seen in decades. But consumer inflation remains tame, and producer prices are actually falling. Convinced that the New Economy can continue along this course, investors have bid the stock market to new highs. But there's a more classical view of the economy that still should be heeded. Virtually all mainstream economists say it's too early to scrap economic theories that for decades have reliably predicted inflation. Ignoring these basics is especially risky in a high-flying financial climate that is sensitive to Federal Reserve policy decisions. INFLATION AND JOBS. First, a review of the Econ 101 lectures you may have slept through. The topic: Phillips curve theory and the concept of NAIRU, a clunky acronym for ''non-accelerating-inflation rate of unemployment.'' Together, these relate joblessness and inflation--NAIRU being the jobless rate at which inflation is stable. The Phillips curve/NAIRU model suggests that inflation is caused by excess demand--demand beyond what available workers and machines can satisfy. The excess occurs when the jobless rate dips below NAIRU, causing wages and inflation to accelerate. But the process doesn't end there. Higher inflation reduces demand and labor markets readjust, pushing joblessness back to the NAIRU level. But the inflation persists at the higher level, partly because people adjust to it. Despite the current, unusual situation of low unemployment and low inflation, the old model is alive and well among economists--and at the Fed. ''I am a strong and unapologetic proponent of the Phillips curve and the NAIRU concept,'' says Federal Reserve Governor Laurence H. Meyer. Chairman Alan Greenspan, warming to the New Economy, is less enamored. But he appreciates the model's solid track record. The Phillips/NAIRU model has practical limitations. But understanding those limits doesn't mean junking the theory. The model can still work, but it's crucial to peg the level of NAIRU--a moving target. Before globalization and technology pushed NAIRU below 6% a few years ago, the model had a two-decade run as one of forecasters' best-performing tools. Now NAIRU may be even lower than the generally accepted range of 5 1/2% to 5 3/4%. It can take a year or more for inflation to pick up after a gap opens between the unemployment rate and NAIRU. That's why the Fed's experiment to test the economy's inflationary limit is dangerous. The wider the gap, the more inflation will rise--and it will not fall until the jobless rate exceeds NAIRU. That is, until the Fed steps in to clamp down on the economy, thus throwing a lot of people out of work. ECONOMIC WINDFALLS. Another consideration: The Phillips/NAIRU model cannot reflect good economic luck, and this U.S. business cycle has had more than its share: falling oil prices, a stronger dollar, and weaker growth among overseas competitors. Also, a slowdown in benefit expenditures has curbed labor costs, even as wage growth has picked up--as the model predicts. Right now, the model does not forecast any strong pickup in inflation. But for every half point the jobless rate stays below NAIRU for a year, inflation will accelerate by a quarter point. And a stronger second half could send the unemployment rate even lower. That's great--if you're seeking employment. But traditional inflation theory says that, if the Fed's current gamble with tight job markets fails, the costs of excess demand now will be foregone output and income later on. Even in the New Economy, the old approach to gauging future inflation should scarcely be ignored--it should be embraced. By James C. Cooper Updated July 17, 1997 by bwwebmaster Copyright 1997, by The McGraw-Hill Companies Inc. All rights reserved. Terms of Use LINKS I) My colleague Brad DeLong has a nice multimedia demonstration. Check out his site, being sure to let pages run for a minute or 2: http://econ161.berkeley.edu/multimedia/PCurve1.html II) A British on-line model of the economy has two articles / sub-sites: 1. Unemployment Theories - Phillips Curve - Is unemployment inflated? http://bized.ac.uk/virtual/economy/policy/outcomes/unemployment/unempth4.htm and 2. Inflation Worksheet - The Phillips Curve - Trading off unemployment and inflation http://bized.ac.uk/virtual/economy/policy/outcomes/inflation/inflws2.htm III) Nouriel Roubini has an overview article and additional links to the current debate on NAIRU and limits to growth at http://equity.stern.nyu.edu/~nroubini/NAIRU.HTM David I. Levine Associate professor Haas School of Business ph: 510/642-1697 University of California fax: 510/643-1420 Berkeley CA 94720-1900 email: levine@haas.berkeley.edu http://web.haas.berkeley.edu/www/levine/
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