During the five-year period of rising productivity growth, life is pretty rosy for Fed policymakers, too. They can simultaneously deliver low unemployment and falling inflation. Figure 8 shows a path for the unemployment rate that approximates the actual path seen in the United States over this period. It also shows predicted paths for output growth, wage growth, and inflation that are implied by historical relationships, given the assumed changes in productivity and unemployment. Note that wage growth is predicted to rise by over one percentage point over five years.
Inflation falls by almost the same amount.
Output growth rises from 2.25 percent in 1995 to 4.7 percent in 1999, to just over 5 percent in the year 2000. On the whole, the predicted patterns of output growth, wage growth, and inflation pretty well approximate what we've observed in the U.S. economy over this period. The exercise shown in Figure 8 makes the Fed's job look a lot simpler than it actually was. Productivity-growth and inflation trends that are obvious now weren't at all obvious at the time. Many economists were afraid that falling unemployment and rapid output growth would lead to higher inflation, and wanted a tighter monetary policy.