Changing Labor Markets and Inflation

Abstract

WHAT RATES OF INFLATION will accompany various unemployment rates? This question is the central concern of stabilization policy today and also a major source of uncertainty for economic forecasting. Whether the approach was made through informed judgment or rigorous research, investigators have sought the answer to this question in the historic relation between unemployment rates, on the one hand, and rates of wage increase on the other, with wage increases then used to explain inflation. With many variations and refinements, this concept of a trade-off between wage changes and the aggregate unemployment rate has been the framework for most discussions of inflation during the past decade. In this view of the inflationary process, the aggregate unemployment rate has served as a proxy for the tightness of labor markets. But significant changes have been taking place in the composition of the labor forcenotably an increase in the proportion of teenagers and women-and in the unemployment experience of different age-sex groups. As a result, the aggregate unemployment rate in recent years has been an increasingly misleading proxy for comparing the current labor market with earlier ones. A given unemployment rate is associated with a tighter overall labor market today than it was ten or twenty years ago. And this means that the trade-off between inflation and the aggregate unemployment rate has shifted: To-