The Federal Reserve’s continued interest rate increases lead many to wonder, “What are they thinking?” The Fed pretty much mirrors professional economics opinions, which have evolved over time to a strong preference for low inflation.
. They found evidence that money supply fluctuations drove short-term changes in the overall economy, including periods of inflation and deflation.
The Phillips Curve tradeoff between inflation and unemployment was then attacked by two economists who would go on to win Nobel prizes in economics, Milton Friedman and Edmund Phelps. They separately developed similar models, in which the inflation-unemployment tradeoff worked for a particular public expectation of future inflation. But when inflation expectations changed, then the tradeoff curve shifted. The implication of this model was that no long-term tradeoff existed.
Analysis of long-run trends found a startling new relationship: Economies with low inflation tend to have stable economic growth, while high-inflation economies tend toward boom-bust cycles. That statistical correlation was also captured in a new approach to econometric modeling . The simple logic is that high inflation will often lead the Fed to tighten monetary policy, resulting in recessions.
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