The Phillips Curve and U.S. Macroeconomic Policy: Snapshots, 1958-1996

(ProQuest: ... denotes formulae omitted.) The curve first drawn by A.W. Phillips in 1958, highlighting a negative relationship between wage inflation and unemployment, figured prominently in the theory and practice of macroeconomic policy during 1958-1996. Within a decade of Phillips' analysis, the idea of a relatively stable longrun tradeoff between price inflation and unemployment was firmly built into policy analysis in the United States and other countries. Such a long-run tradeoff was at the core of most prominent macroeconometric models as of 1969. Over the ensuing decade, the United States and other countries experienced stagflation, a simultaneous rise of unemployment and inflation, which threw the consensus about the long-run Phillips curve into disarray. By the end of the 1970s, inflationwas historically high-near 10 percent-and poised to rise further. Economists and policymakers stressed the role of shifting expectations of inflation and differed widely on the costliness of reducing inflation, in part based on alternative views of the manner in which expectations were formed. In the early 1980s, the Federal Reserve System undertook an unwinding of inflation, producing a multiyear interval in which inflation fell substantially and permanently while unemployment rose substantially but temporarily. Although costly, the disinflation process involved lower unemployment losses than predicted by consensus macroeconomists, as rational expectations analysts had suggested that it would. By 1996, the central bank of the United States had constructed a largescale rational expectations model, without any long-run tradeoff, which it began to use to evaluate alternative policy scenarios. Monetary policymakers at that time accepted the idea that there was no long-run tradeoff at, and above, the then-prevailing price inflation rate of 3 percent. Yet many felt that there were important tradeoffs over short-run horizons, diversely defined, and some saw long-run tradeoffs near zero price inflation. This article reviews the evolving role of the Phillips curve as an element of macroeconomic policy during 1958-1996, as well as academic and central bank research on it, via a series of snapshots over this roughly 40-year period. In conducting the research summarized in this article, my motivation is to better understand the mindset about the tradeoff between inflation and unemployment over an important period of U.S. history with an eye toward ultimately better understanding the joint behavior of the Federal Reserve and the U.S. economy during that period. Diverse research in macroeconomics- notably Sargent (1999), Orphanides (2003), and Primiceri (2006)-has sought an explanation of inflation's role in the behavior of a central bank that has an imperfect understanding of the operation of the private economy. The perceived nature of the Phillips curve plays an important role in these analyses, so that my reading of U.S. history may provide input into future work along these lines. I draw upon two distinct and complementary sources of information, published articles and documents of the Federal Open Market Committee (FOMC), to trace the evolving interpretation of the tradeoff over this roughly 40-year period. The discussion is divided into six sections that follow this introduction. Section 1 provides a quick overview of the U.S. experience with price inflation and unemployment during 1958-1996. As the objective of this article is to provide a description of how policymakers' visions of the Phillips curve may have evolved during this time, resulting from empirical and theoretical developments, it is useful to have these series in mind as we proceed. Section 2 describes the birth of the Phillips curve as a policy tool, highlighting three core contributions: Phillips' original analysis of U.K. data, Samuelson and Solow's (1961) estimates of the curve on U.S. data and their depiction of it as a menu for policy choice, and the econometric analysis by Klein et al. …