In his Presidential Address, Friedman (1968) presented a theory of the short run behavior of inflation. In Friedman’s theory, inflation depends on expected inflation and the gap between unemployment and its natural rate. Friedman also suggested that “unanticipated inflation generally means a rising rate of inflation”–in other words, that expected inflation is well-proxied by past inflation. These assumptions imply an accelerationist Phillips curve that relates the change in inflation to the unemployment gap.
In the decades since Friedman’s work, his model has been a workhorse of macroeconomics. Researchers have refined the model extensively; two of the numerous examples are Gordon (1982, 1990)’s introduction of supply shocks and Staiger et al. (1997)’s modeling of a time-varying natural rate. Economists have debated how well the accelerationist Phillips curve fits the data, some declaring the equation’s demise and others reporting that “The Phillips Curve Is Alive and Well” (Fuhrer, 1995).
Debate over the Phillips curve has gained momentum during the U.S. economic slump that began in 2007. Some economists see a puzzle: inflation has not fallen as much as a traditional Phillips curve predicts, given the high level of unemployment. For example, in September 2010, John Williams (now president of the San Francisco Fed) said:
- “The surprise [about inflation] is that it’s fallen so little, given the depth and duration of the recent downturn. Based on the experience of past severe recessions, I would have expected inflation to fall by twice as much as it has.”
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The Evolution of Inflation Dynamics and the Great Recession
