The Key Discovery, the One Success

What caused the Great Inflation? According to Arthur Burns, the Fed Chairman who presided over much of that inflation, cost-push pressures caused it. In a post I return to again and again, Marcus Nunes summarizes that other Arthur's view:

According to Robert Hetzel, during the period of the Great Inflation, the prevailing view, and the one embraced by Arthur Burns, Fed chairman from 1970 to 1977, was that inflation was a real (cost-push), and therefore non-monetary, phenomenon.

Nick Rowe writes

I know what it's like to live in a demand-side world, because I used to live in one....

I left that world: when I discovered we lived in a monetary exchange economy (like a fish discovering it swims in water); when I saw the Phillips Curve shift in the 1970's; when I discovered Milton Friedman, and learned not only that units didn't matter but that the rate of change of units didn't eventually matter either.

In comments, Scott Sumner responds:

I remember those days. The key discovery was that changing the trend rate of inflation (within reason) had no impact on the average rate of unemployment.

I cropped a "But mostly..." sentence from Nick, to focus on Phillips and Friedman. That's the part Sumner calls the "key discovery". Obviously, it is pretty important to Nick Rowe, as well.


Let me re-summarize a little history from Stephen Williamson, some U.S. macroeconomic economic history starting with the 1960s:

Let's review that.
(i) Samuelson/Solow and others think that the Phillips curve is a structural relationship - a stable relationship between unemployment and inflation that represents a policy choice for the Fed.
(ii) Friedman (in words) says that this is not so. There is no long-run tradeoff between unemployment and inflation. It is possible to have high inflation and high unemployment.
(iii) Macroeconomic events play out in a way consistent with what Friedman stated. We have high inflation and high unemployment.
(iv) Lucas writes down a theory that makes rigorous what Friedman said...
(v) Paul Volcker takes Friedman seriously.

Nothing technical. There's never anything technical. There is only a sort of reverence, a kneeling before the great and wonderful Oz.

Since that Friedman thing, his 1968 speech to the AEA and its aftermath, since it is "the key discovery" and all, shouldn't there be a bit of technical presentation somewhere that lays it out like science? Don't you think? Not too technical, or I would fail to understand. But something more than a blind, religious embrace would be nice.

Religious, yeah. Nick Rowe's post, linked above, is a story of his conversion to the new faith. That's what bothers me. That is what I had in mind when I wrote to Marcus,

It seems people say he [Friedman] predicted the high-inflation-high-unemployment combination that showed the mis-use of the Phillips curve.

It seems the Friedman event brought “expectations” into economics. But I never see any but non-technical acceptance of what Friedman [supposedly] said.

Nothing technical. Perhaps this is what Williamson meant when he wrote "Friedman (in words)". Mark Thoma lays it out well:

Estimates of the Phillips curve that produced stable looking relationships were based upon data from time periods when inflation expectations were stable and unchanging. Friedman warned that if policymakers tried to exploit this relationship and inflation expectations changed, the Phillips curve would shift in a way that would give policymakers the inflation they were after, but the unemployment rate would be unchanged... When subsequent data appeared to validate Friedman's prediction, the New Classical, rational expectations, microfoundations view of the world began to gain credibility over the old Keynesian model...

The subsequent data appeared to validate Friedman's prediction.


At Angry Bear, back in May 2012, Robert asked a question:

Did Samuelson and Solow claim that the Phillips Curve was a structural relationship?

Did they claim that it showed a permanent tradeoff between inflation and unemployment.

James Forder says no.

This is an important post for me, Robert's post. Nick Rowe and Sumner and Williamson and Nunes and many others point to Milton Friedman's put-down of the Phillips curve. That put-down, it seems, was the birth of an alternative to Keynesian economics. That alternative was based on Samuelson and Solow being wrong about the trade-off.

But there are doubts about that. That's what Robert's post is about. And that's why his post is important. Robert writes:

Paul Krugman, John Quiggin and others (including me [Robert writes]) have argued that the one success of the critics of old Keynesian economics is the prediction that high inflation would become persistent and lead to stagflation.

That's the key point, for me: one success, parlayed. Friedman predicted stagflation, and when his prediction came true, Friedman became like a religious icon. But, see, I have a different explanation of stagflation than Friedman. So if Friedman is right, I must be wrong.

I don't think I'm wrong.