The Trade-Off between Inflation and Unemployment.

An economic policy which is designed to stabilize aggregate economic activity must be based on three fundamental decisions. They are, first, the decision on the optimum pressure of effective demand upon the aggregate productive capacity of the economy (this optimum pressure need not necessarily remain constant over the relevant planning period); second, the decision on the methods and speed of adjusting the present level of effective demand to its optimum; and, third, the decision on the methods by which the actual level of effective demand is to be kept at its optimum. The three decisions may be interdependent, and particular economic policy makers need not take them separately or explicitly; their policy measures, however, will imply them. The present paper is devoted almost exclusively to a discussion of the first type of decision, but this should not be taken to imply that the other two are either unimportant or easily taken. In Part III of this paper, some empirical evidence on the nature of the A-B trade-off curve has been presented. It looks as though the curve is approximately linear but that it is fairly fiat in the short run. The reason for this small slope has been found to be the negative relationship between aggregate excess demand and the rate of change of the non-wage markup. In view of some long-run evidence, it has been argued that this negative relationship is likely to be strictly short-run and that the long-run trade-off curve is likely to have a steeper slope than the short-run trade-off curve. The estimates of short-run and long-run effects are presented in Table 1. In Part III an attempt was made to test the predictions of the expectations hypothesis, which is illustrated in Figure 2. The most important prediction was that there ought to be clockwise loops around the relationship between the rate of inflation and the level of unemployment. A number of Phillips-curve estimates were referred to; they all yielded anti-clockwise loops wh... [ABSTRACT FROM AUTHOR]