Additional Application
Summary of the article:
The Man Who Deflated Inflation
msnbc.com
Motley Fool
By Brian Lawler
October 12, 2006
The 2006 Nobel Prize in Economics was awarded to Edmund Phelps of Columbia University for his body of work pertaining to macroeconomic issues. Among Phelps’ many contributions to economics, his most influential addresses the relationship between unemployment and inflation. Phelps challenged the accepted notion that a negative linear relationship exists between inflation and unemployment, the theory popularized by economist A.W. Phillips and represented by what has become known as the Phillips curve. Following the Phillips argument, many economists believed that by increasing the money supply through lower interest rates, the Fed could eliminate unemployment. Phelps claimed that only unanticipated inflation would impact unemployment, but anticipated inflation would cause no change in employment levels.
In the 1970s, Phelps’ theory was put to the test as central banks throughout the world embarked on previously announced expansionary monetary policies which increased inflation but did not subsequently increase employment. Phelps, with his expectations-augmented Phillips curve, theorized that monetary policy changes need to be unexpected to have any sustained impact on the macro economy. Phelps’ distinguishing the differences that anticipated and unanticipated inflation will have on an economy explains why the Federal Reserve is hesitant to announce its intentions on upcoming changes in interest rates.
According to Phelps' theory, if the inflation rate unexpectedly increases, it is likely that workers will not fully anticipate some of this sudden increase. This will cause
▸ anticipated inflation to exceed actual inflation.
▸ anticipated inflation to equal actual inflation.
▸ nominal inflation to exceed real inflation.
▸ actual inflation to exceed anticipated inflation.
Quick Reply
