Is Inflation Dead?

Is Inflation Dead? I n the past few years the United States has enjoyed the unique economic duet of very low unemployment and declining price inflation. For decades, we have come to associate tight labor markets with accelerating wages and prices. But in 1997, the unemployment rate sank below 5 percent and neither wage nor price inflation became a problem. Have our inflation processes fundamentally changed for the better? Are we in a new era of permanently better economic performance due to new behavior by our citizens? Or are we simply enjoying good luck in the form of positive supply shocks? The overwhelming majority of research economists had previously estimated that an unemployment rate of about 6 percent was the lowest level that could be sustained. Below the vicinity of 6 percent, employers would compete aggressively for scarce labor by offering wage increases exceeding prevailing norms. The lower the unemployment rate, the greater the percentage wage gain would likely be. As wage increases pushed above existing price inflation and productivity gains, producers would raise prices to cover higher costs. The ensuing wage-price inflation spiral would not be broken until unemployment once more moved above 6 percent, a development typically caused by rising interest rates, as financial markets and the Federal Reserve reacted to the growing inflation problem. The experience of the late 1980s seemed to confirm the modern validity of this decades-old perspective. The national unemployment rate fell from 6.2 percent in 1987 to 5.5 percent in 1988 and 5.3 percent in 1989; in response, wage increases jumped from 3.1 percent to 3.7 percent and then 4.2 percent. Wholesale price inflation rose from 1.9 percent in 1987 to 2.4 percent in 1988 and then to 3.9 percent in 1989; consumer price inflation jumped from 3.7 percent to 4.1 percent and on to 4.8 percent. Rising prices for imported goods, including oil, contributed significantly to the nation's inflation problems, but most of the blame was placed on excessive tension in domestic labor markets. In other words, lessons