Steady Anticipated Inflation: Mirage or Oasis?

This article argues that the institutions of the U.S. economy do adapt to inflation, once it becomes fairly steady, and thus automatically offer protection against the costs associated with accelerating inflation. Full employment and price stability do not deserve equal primacy as stabilization goals. Most of the evils commonly associated with inflation occur only when the actual inflation rate deviates from that which is expected, that is, when the inflation is a surprise. The welfare costs of a fully anticipated inflation, although a popular subject in economics journals and graduate theory exams, are not widely discussed or understood elsewhere. The article first discusses the cost of maintaining a steady inflation at a rate similar to the 5 percent annual average that has obtained in the U.S. since the beginning of 1968. This analysis does not depend on the existence of a long-run tradeoff between the expected rate of inflation and the unemployment rate. The accelerationist position that no long-run tradeoff exists is relevant for the choice of the optimal unemployment rate, not the inflation rate: In the absence of a long-run tradeoff, steady inflation can be maintained only at a single natural rate of unemployment, whereas a negatively sloped long-run tradeoff allows the choice among many alternative unemployment rates.