Steady Anticipated Inflation: Mirage or Oasis?
June 1, 1971
THE TWIN PHRASES “FULL EMPLOYMENT” and “reasonable price stability” usually appear at the beginning of any discussion of the goals of stabilization policy, whether it is a President’s economic report, a journalist’s
financial column, or an economist’s principles course. Unemployment and
inflation are both “bads,” which should be eliminated. Price stability is
sufficiently important that if an increase in unemployment is required to
eliminate inflation, either that extra unemployment must be tolerated
(Nixon-Shultz pre-August-1971 “gradualism”) or the inflation must be
suppressed by partial or complete controls (many “Democratic econo-
mists” and post-August Nixon).
But full employment and price stability do not deserve equal primacy as
stabilization goals. Most of the evils commonly associated with inflation
occur only when the actual inflation rate deviates from that which is expected, that is, when the inflation is a surprise. The welfare costs of a fully
anticipated inflation, although a popular subject in economics journals and
graduate theory exams, are not widely discussed or understood elsewhere.
In this paper I first discuss the costs of maintaining a steady inflation at a
rate similar to the 5 percent annual average that has obtained in the United
States since the beginning of 1968.