Inflation and Macroeconomic Policy in the Long 1970s

In Chapter 1, I criticised the origin myth of the ‘new macroeconomic consensus’. In this chapter, after giving an overview in §6.2 of the operation and context of fiscal policy in this period, I turn in §6.3 to the origins of the origin myth itself — the emergence of the ‘natural-rate, expectations-augmented Phillips curve’ (N-REAP) model of inflation. To recall, this story of policy transition is very simple. Policymakers had a conception of the economic system in which aggregate demand was set so as to make a choice within a stable trade-off between unemployment and inflation. This policy strategy failed because it was mistaken about the stability of the trade-off, because it neglected the effect of adaptive expectations on inflation. An alternative, superior strategy developed to take account of the impact of expectations and the fact that there was no long-run trade-off between inflation and unemployment. In Tinbergen’s terms, the instruments remain the same, and one goal is redefined downwards: instead of ‘full employment’, which is unsustainable under any policy arrangement, the target becomes the ‘natural rate of unemployment’. This shift takes place within the sphere of policy decision-making with existing instruments; there is no need for ‘qualitative policy’ or seeking to change the institutional configuration of policy or the broader economic system.