There’s great discussion out there on this topic, see Steve Randy Waldman’s links list here.
Karl Smith gives us this graph and asks:
I mean, honestly, would you look at the graph above and conclude that during the 1970s the economy dangerously overheated.
I’d like to offer a perhaps more useful (though more complicated) look. Here’s NGDP/capita, RGDP/capita, and the Civilian Unemployment Rate (the NGDP/RGDP gap is accounted for by inflation):
Here’s a story to match that:
In the late 70s, Arthur Burns managed to drive down unemployment even in the face of a historically monumental labor-force surge, while maintaining healthy RGDP growth — but at the cost of high inflation. (The famous unemployment surge arose after two years of NGDP/RGDP declines ’78-’80, and briefly held steady during the ’80/’81 GDP surge.)
The “cost” of that inflation? A massive transfer of real buying power share from creditors/holders of financial assets to debtors/holders of real assets (assets such as…the skills and ability to work). Think: Workers’ relative claims to a share of the future production pie. Don’t even start to talk to me about the trivial effects of “menu costs” and such relative to this huge and inexorably arithmetic “textbook” effect.
Monetarists dismissing Steve’s labor-surge effect seem to be claiming that the Phillips curve had shifted, and that tighter Fed policy (given the understandings and tools at the time) would not have increased the unemployment rate. Is that realistic?
Or: higher unemployment would have been acceptable to maintain and protect the relative buying-power of creditors/holders of financial assets.
Cross-posted at Asymptosis.