inflation “was rising in the hierarchy of national problems, simply
because there was more of it,” but “it was not an issue about which
anyone felt deeply.”^14 Scholars were nevertheless intrigued by the
simultaneous persistence of both inflation and unemployment.
Acknowledging this difficulty, British economist Alban Phillips sug-
gested that there was in fact an imperfect trade-off between employ-
ment and inflation. In practice, governments that sought a very low
level of unemployment had to accept some inflation.^15
Characteristically, Friedman used the high visibility of his presi-
dential address to the American Economic Association in 1967 to
attack this standpoint, which made some inflation acceptable. The
trade-off observed by Phillips, he argued, only worked in the short
term. Economic agents soon realized that full-employment policies
led to higher wages and prices, and they adjusted. With time, eco-
nomic expansion could only be bought at the cost of increasingly
high inflation rates: “there is no permanent trade-off,” Friedman
concluded.^16 This was the case because each society had a “natural”
rate of unemployment, below which it was difficult to go. This
“natural” rate, which later was more appropriately named the non-
accelerating inflation rate of unemployment (NAIRU), was deter-
mined by social institutions and legislation, and it could only be
reduced through structural reforms that enhanced market mechan-
isms. Reducing the minimum wage or the strength of trade unions,
for instance, would lower the NAIRU and raise the non-inflationary
level of employment better than any fiscal policy could.
This argument – which was simultaneously made in less flamboyant
but more sophisticated terms by Columbia economist Edmund
S. Phelps – proved extremely powerful, because it predicted the
combined rise of unemployment and inflation that was about to come
and that would be called “stagflation.” The diagnostic suggested,
too, a working policy response, something the Keynesian approach
(^14) Herbert Stein,Presidential Economics: The Making of Economic Policy from
Roosevelt to Reagan and Beyond, second revised edition, Washington, DC,
15 American Enterprise Institute for Public Policy Research, 1988, p. 134.
As we have seen earlier, this conclusion did not hold for countries that had
maintained a firm commitment to full employment and succeeded in
negotiating wage moderation. This comparative fact escaped most economists,
who were focused on the Anglo-American situation.
(^16) Milton Friedman, “The Role of Monetary Policy,”American Economic
Review, vol. 58, no. 1, March 1968, 1–17, p. 11.
The triumph of market democracy (1980–2007) 141