mr. meyer reviews the economic outlook and challenges for monetary policy in the united states remarks by mr. laurence h. meyer, a member of the board of governors of the us federal reserve system, at the charlotte economics club, charlotte, north carolina on 16 / 1 / 97. 1996 was an extraordinarily good year for the economy. measured on a fourth quarter to fourth quarter basis, it appears that gdp advanced around 3 % and prices, measured by the chain price index for gdp, increased just above 2 %. a little historical perspective will help us further appreciate recent economic performance. inflation in 1996, measured by the chain price index for gdp or the core cpi, was the lowest in 30 years. and this was not a one - year fluke. last year was the fifth consecutive year that inflation, measured by the chain gdp price index, was 2. 6 % or lower and the 5 - year compound annual inflation rate is now 2. 5 %, the lowest since 1967. the extraordinary achievement of 1996, of course, was reaching such low levels of unemployment and inflation at the same time. the 5. 4 % unemployment rate in 1996 was the lowest annual rate since 1988 and before that since 1973. specifically, the surprise was a decline in measures of core inflation for consumer and producer goods and in the inflation rate for the gdp price index during a year when the unemployment rate declined and averaged more than ½ percentage point below levels that in the past had been associated with stable inflation. in the second half of the year, growth slowed, the unemployment rate stabilized, and inflation remained well contained. there is little evidence of imbalances that would jeopardize the expansion. as a result, the consensus forecast projects growth near trend and relatively stable inflation and unemployment rates. we should not, however, let ourselves be overcome by our good fortune. the business cycle is not dead and monetary policy is certain to be challenged again. at the moment, trend growth near full employment appears to be a reasonable prospect in the year ahead. still we want to remain alert for challenges that might lie just over the horizon. in particular, there remains some uncertainty as to whether the current unemployment rate will prove consistent with stable inflation over time and we need to pay some attention to the challenge of how we approach our longer - term goal of achieving and maintaining price stability. first i will discuss the risks in the outlook. next i will consider some explanations for the surprisingly good recent inflation performance and implications for inflation going

in this genre is the “ job insecurity ” hypothesis and a second is the “ absence of pricing leverage ” hypothesis. both are consistent with anecdotal accounts we read about almost daily in the newspapers and hear from businesses, but both of these explanations are difficult to quantify and therefore to test. let ’ s begin with the favorable supply shock story. we start with a simple version of the phillips curve which relates inflation to expected inflation and the gap between unemployment rate and nairu. estimated versions of such a phillips curve typically also take some supply shocks into account. supply shocks refer to exogenous changes in sectoral prices ( or wages ) which may affect the overall price ( or wage ) level and, at least temporarily, the overall inflation rate. the classic examples would be legislated changes in the minimum wage, weather - related movements in food prices, and politically inspired changes in energy prices. an adverse supply shock - - an increase in oil prices, for example - - would raise the rate of inflation at any given unemployment rate. traditionally, nairu is estimated assuming an absence of supply shocks. it is the unemployment rate that is consistent with stable inflation in the long run, or, alternatively, is consistent with stable inflation in the absence of supply shocks. we can also calculate a short - run or effective nairu as the unemployment rate consistent with stable inflation given whatever supply shocks are in play at the moment. in the case of an adverse supply shock, for example, the short - run or effective nairu would be higher than the long - run nairu. this simply means that the unemployment rate required to hold overall inflation constant in the face of an increase in oil prices has to be high enough so that inflation in the non - oil sectors will slow on average. before we can tell the story about favorable supply shocks, i should note that 1996 featured an unusual coincidence of adverse supply shocks. first, the minimum wage was increased ; this should boost overall wage gains, labor costs and hence prices. second, both food and energy prices increased faster than other prices. as a result of the food and energy price increases, there were wide gaps between overall and core measures of inflation for both the ppi and the cpi. the overall cpi increased about ¾ percentage point more than the core cpi and overall ppi increased more than two percentage points faster than core ppi. however, because minimum wage increases, food and energy price increases are routinely included as shock terms in estimated phillips curves