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Krugman: stagflation as ambitious macroeconomic policies and conservative ideas was wrong?

Let real wages (of $15+/hour) grow faster than labor productivity for some years, undoing the wage repression of the last decades.

We have been misled by neoliberal economics for now many decades, it’s time to turn many things around in what is becoming a second-rated US economy, recently crippled by the malevolent and narcissistic “king of debt”.

In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment.

The biggest risk for the stock market in 2021 is inflation, according to Morgan Stanley. Unprecedented radical spending by the federal government and the Federal Reserve, to stave off a panic-induced market crash, helped artificially drive stocks to temporary new highs last year.…

For some, the math bore out the possibility that exuberance was rational even if the economy is always more irrational than its math. “The Lucas fantasy of costless disinflation from credible commitments in an ergodic world of rational agents was decisively falsified long ago.” 

The underlying problems of supply shocks related to Trumpian idiocy atop bailing out the banksters may have made the economy much worse. The pandemic has only made a bad situation worse, or made more of us myopic in our isolation. Paul Krugman has now taken the time to question the orthodoxy of stagflation. Darn economic orthodoxy being wrong since the 1970s.

Let me start with the inflation story the way most economists, myself included, have been telling.

In the beginning was the Phillips curve: the apparent tradeoff, fairly visible in the data, between unemployment and inflation. In the 1960s many people looked at that tradeoff, considered the mild costs of inflation versus the benefits of lower unemployment, and argued for monetary and fiscal policies aimed at running the economy hot.

But in a hugely influential speech Milton Friedman made an argument also independently made by Columbia’s Edmund Phelps: the unemployment-inflation tradeoff wasn’t real, because any sustained effort to keep unemployment low would lead not just to high inflation but to ever-accelerating inflation. They claimed, specifically, that people setting wages and prices would begin marking them up to anticipate future inflation, so that the inflation rate associated with any given unemployment rate would keep rising.

They predicted, in particular, that the course of the economy over time would look something like this:

First, a government would push unemployment down; but this would lead to ever-rising inflation, which would stay high even as the economy cooled. So it would take a sustained period of high unemployment to get inflation down again, until finally unemployment could be brought back to a sustainable level. So their analysis predicted “clockwise spirals” in unemployment and inflation. Then came the 1970s:


This sure looked like a dramatically successful out-of-sample prediction — sort of an economics version of “Light bends!” Almost everyone in the economics profession took the Friedman-Phelps analysis as confirmed. This in turn had big practical and intellectual consequences.

  • First, governments and central banks stopped pursuing low unemployment, believing that excessively ambitious stimulus caused the stagflation of the 1970s. They began aiming for stable unemployment around the NAIRU —non-accelerating-inflation rate of unemployment — instead.
  • Second, since the Friedman/Phelps prediction was based on trying to assess what rational price-setters would do, their apparent success gave a big boost to the notion that all economics should be based on maximizing behavior. Friedman always had too strong a reality sense to personally go down the rational-expectations rabbit hole that swallowed much of macroeconomics, but given the law of diminishing disciples it was bound to happen.
  • Third, the whole affair gave a boost to conservative ideology. We had seemingly seem a demonstration of the limits to government action; also, the Chicago boys had seemingly been proved right about something big. (I remember classmates in grad school saying “They were right about this. Why don’t you think they’re right about the rest?”)
  • Finally, the Volcker disinflation of the 1980s — using high unemployment to end high inflation — became, in many minds, the model of what responsible policymakers should do: make tough choices for the sake of the future.

But what if we’ve been telling the wrong story all along?


But suppose something like this is true. In that case, the narrative that saw stagflation both as the cost of excessively ambitious macroeconomic policy and as a vindication of conservative economic ideas was mostly wrong. And that matters not just for history but for policy right now, which is still to some extent constrained by the fear of a 70s repeat.

How do you ask someone to be the last worker to be unemployed for a mistake?…


The reality in a response by Lance Taylor and Nelson Henrique Barbosa Filho is that “For practical purposes, the results mean that, for the Fed to meet its inflation target, it would be necessary to let real wages grow faster than labor productivity for some years, undoing the wage repression of the last decades. Biden’s $15 minimum-wage proposal is a correct step in that direction.” This is despite so many economists taking an opposite, more cautious position.

Mainstream Economists Have Been Using a Misleading Inflation Model for 60 Years

The model Krugman (2021) cites, originally due to Paul Samuelson and Robert Solow (1960), is at best incomplete and for practical purposes wrong. It makes sense to explore the reasons why.

There are two ways to analyze inflation. One was adopted by William Phillips (1958) in his empirical discovery of an inverse relationship between wages and the rate of unemployment for the UK, from the mid-19th century and early 20thcentury. This is a standard microeconomic specification,

(1) Nominal wage growth = f(unemployment)

with a negative (usually nonlinear) slope in the unemployment versus wage plane. For purposes of econometrics, one could always throw in lags, conditioning variables, and other methods to improve the statistical fit of (1), as well as do regional analyses, as Krugman mentions.

Following Taylor and Barbosa-Filho (2021), there is also a broader cost-based macroeconomic specification relying on the equality of gross domestic product (GDP) to gross domestic income (GDI). In stripped-down form it can be written as:

(2) Value of output = GDP cost of production

= Wages + Profits + Import Costs = Gross Domestic Income = GDI

Since GDP equals GDI to within a “statistical discrepancy” and various “minor” flows ($100 billion or so) the breakdown given in (2) is built into American national accounts and can be used as a template for a macroeconomic cost function.

Krugman and the rest of the American economics profession prefer the version proposed by Samuelson and Solow (1960), who knew all about decomposition (2) but chose to replace it with

(3) Price inflation = f(unemployment),

with a negative slope. They concentrated on unemployment as the key explanatory variable and ignored or downplayed the costs on the right-hand side of (2).…


Darn historical revisionism.


Stagflation is unlikely only because some things are less stable, while globally much needs to be fixed.


“This is the nature of economic bubbles: What seems to be irrational exuberance is ultimately a bad case of extrinsically motivated myopia”. Daniel Pink




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