554 Miller Economics Today, Nineteenth Edition
Chapter 17 Stabilization in an Integrated World Economy
The Effect of Higher Inflation on Inflation Expectations
Three economists at the Federal Reserve Bank of St. Louis Andrew Levin, Fabio Nattaluci, and Jeremy
Piger have attempted to measure the effects of a short-lived increase in actual inflation on expectations
of future inflation. They considered what would happen to U.S., Japanese, and Euro-area inflation
expectations if the actual inflation rate rose by 1 percentage point for just three years.
Their estimates imply that, other things being equal, even five years after this short-lived inflation occurred,
the public would expect the future annual inflation to be about a third of a percentage point higher. As much
as 10 years later, the expected annual inflation rate would still be one-fourth of a percentage point higher.
Thus, the authors conclude that higher actual inflation has a significant holdover effect on long-term
inflationary expectations.
Rational Expectations and the Bond Market
In late November and early December 2006, there was speculation in the financial markets as to what the
Federal Reserve planned to do with interest rates. After raising the federal funds interest rate 17 consecutive
times and then keeping it constant for three months, the question was whether the Fed would begin
raising this interest rate again or perhaps even lower it. On Tuesday, December 12, the Federal Reserve
More Transparency in Financial Markets?
One of the proposals coming from Republican congressmen and senators in 2010 was the idea that the
Federal Reserve should dramatically increase the transparency of monetary policy. The idea was for the
Fed to explain exactly what it intends to do concerning interest rates and then do it. The FOMC
are subject to different interpretations. Suppose that the Fed was required to be completely transparent in
its policy decisions using precise language and then was required to actually implement the policy
unambiguously.
Lecture Extender Examples 555
Federal Reserve Policy in the Global Economy
Economic events in other countries, such as the financial crises in Eastern Europe and Asia during the
1990s, have forced the Federal Reserve to take a more global view. This is particularly relevant in how it
sets interest rate policies for the United States. When the economies of Asia suffered severe economic
crises, the value of their domestic currencies fell in international markets. This allowed U.S. companies to
buy commodities from these countries at much lower prices in terms of U.S. dollars. These falling
commodity prices apparently helped reduce any threat of inflation in the United States during this period.
Some observers argue that is why we saw robust economic growth without inflation as well as a surging
Does the Political Business Cycle Cause a Fed Bias Toward Inflation?
The rate of economic growth and the unemployment rate are key variables in determining who will be
elected president. The presidential elections in 1956, 1964, 1972, 1984, and 1996 all had the pattern of
low unemployment and higher inflation predicted by the political business cycle that favors the incumbents,
and Eisenhower, Johnson, Nixon, Reagan, and Clinton won these elections. The elections of 1960, 1968,
1976, 1980, and 2008 did not have this political business cycle pattern that favors incumbents (or incumbent
party), and the White House changed
economy had been growing for several months and the unemployment rate had been falling for the four
weeks prior to the election. The falling unemployment and rising rate of growth of real GDP was not
reported until after the election.
556 Miller Economics Today, Nineteenth Edition
What Happened to the Phillips Curve?
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unemployment rate between 1990 and 2002 appears to provide a rationale for this view. Through most of
the 1990s, reductions in the unemployment rate were accompanied by lower rather than higher rates of
inflation.
For the Federal Reserve, the changing nature of the relationship poses a problem. In the early 1990s, the
–
forecasting models or
Economists developed two possible explanations. The first focuses on the increase in competition
following widespread deregulation of many industries, reduced barriers to international trade, and the