Saturday, May 26, 2012

Explaining stagflation

The name "NAIRU" arises because with actual unemployment below it, inflation accelerates, while with unemployment above it, inflation decelerates. With the actual rate equal to it, inflation is stable, neither accelerating nor decelerating. One practical use of this model was to provide an explanation for stagflation, which confounded the traditional Phillips curve.
- Phillips curve, Wikipedia

The Phillips curve said there was a tradeoff between inflation and unemployment -- one went down when the other went up. But then in the 1970s, unemployment and inflation both went up. The Phillips curve was "confounded" and a new explanation was needed.

That's when Keynesian economics fell into disrepute, and economists invented new explanations like the NAIRU.

After 30 years of building upon such explanations, the economy tanked.

To explain the problems in our economy you cannot go back to the subprime crisis or to the 1990s or the 1980s when policy fixes were being put into place. To explain the problems you have to go back to when those problems first arose -- back to the "Great Inflation" beginning in the mid-1960s. You have to go back to what the problems and policies were, then.

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