Unit 19 — Inflation

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Purpose:

To show the gradual development of inflationary pressures in the postwar U.S. economy, and to show why these pressures posed problems for policymakers and also for Keynesian economics.

Objectives:

  1. By inflation, we mean a general rise in the overall price level as measured by a price index, say the Consumer Price Index (CPI).
  2. Inflation, especially unexpected inflation, imposes costs on the economy. These costs include:

    1. distortions in the tax system;
    2. gains by debtors and losses by creditors;
    3. increased uncertainty;
    4. losses by people with fixed incomes.
  3. In the 1960s and 1970s, inflation became a problem principally because the economy was operating close to or at the vertical portions of the aggregate supply curve. This meant that boosts to aggregate demand, through stimulative fiscal policy, not only raised growth, but also raised prices.
  4. Because the ideas of Keynes were conceived at a time when the world economy was in a depression, he was not overly concerned with the problems of inflation. Keynesian economics implicitly assumed a flat aggregate supply curve.
 When an economy is not in a depression or recession, monetary influences in the economy, both on GDP/GNP and prices, become more important. Also, inflation expectations can play an important role. These subjects were given little attention by most of Keynes’s followers.

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Meet the Series Experts

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Walter Heller

Walter Heller

Influential American economist of the 1960s and Chairman of President John F. Kennedy’s Council of Economic Advisers, 1961–1964.

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Victor Gotbaum

Victor Gotbaum

American labor leader who was President of AFSCME District Council 37 (DC37), the largest municipal union in New York City, from 1965 to 1987.

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Paul McCracken

Paul McCracken

Chairman of President Richard Nixon’s Council of Economic Advisers, now the Edmund Ezra Day Distinguished University Professor Emeritus of Business Administration, Economics, and Public Policy at the University of Michigan.

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  1. Inflation occurs whenever:

    the average price of most goods and services rises.

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  2. When prices creep up slowly over a period of several years at a rate of two or three percent per year, what is the LIKELY impact on production? Such inflation will probably:

    increase output in the short run.

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  3. Which of the following MUST decline in order to slow demand-pull inflation?

    Spending

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  4. George B. is disgusted with the way things have been going in the economy. Like many of his friends, he has been out of work for some months and has all but given up looking for work as a machinist. With his savings virtually depleted and unemployment benefits about to run out, he feels he’ll have little choice but to take whatever job he can get, whether he is able to use his skills or not. “Prices keep going up, up, up,” he sighs. “Everything costs more every time you go to the store—and still you can’t get work. Where are we supposed to get the money to pay for it all?” The situation George is describing in this scenario can BEST be termed:

    stagflation.

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  5. Based on the diagram below, we can conclude that the maximum national output and employment will occur when the economy is operating in:

    chart chart

    Range C.

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  6. Which of the following is the BEST appraisal of inflation and unemployment during the late 1970s and early 1980s?

    The U.S. has experienced less inflation than many European nations, but our unemployment rate has been consistently higher.

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