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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

Which development in the 1970s most directly undermined confidence in the Keynesian demand-management consensus and supported the monetarist critique of a stable long-run Phillips curve?

Inflation and unemployment rising together undermined the Keynesian consensus. It contradicted a stable Phillips curve trade-off and supported the monetarist argument that, once expectations adjust, the long-run curve is vertical at the natural rate of unemployment.

  1. APersistently low inflation alongside very low unemployment
  2. BRising inflation coinciding with rising unemploymentCorrect
  3. CFalling oil prices and rapid productivity growth
  4. DA sustained fall in money supply growth with stable prices
  5. Rising unemployment accompanied by falling inflation expectations

Explanation

Friedman and Phelps argued that the trade-off disappears once expectations adjust, so the long-run curve is vertical at the natural rate. Inflation and unemployment rising together in the 1970s fitted this view and conflicted with a stable trade-off. Low inflation with low unemployment would have supported the old view.

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