A reappraisal of the inflation-unemployment-productivity nexus

This paper offers a reappraisal of the inflation-unemployment tradeoff, based on "frictional growth", describing the interplay between nominal frictions and money growth. When the money supply grows in the presence of price inertia (due to staggered wage contracts with time discounting), the price adjustments to each successive change in the money supply are never able to work themselves out fully. In this context, monetary shocks have a gradual and delayed effect on inflation, and these shocks also generate plausible impulse-responses for unemployment. Although our theory contains no money illusion, no permanent nominal rigidities, and no departure from rational expectations, there is a long-run inflation-unemployment tradeoff. Our analysis suggests that the US experience of the 1990s - in particular, the falling unemployment at moderate inflation rates - can be explained in terms of prolonged effects of money growth on unemployment, and counterveiling effects of money growth and productivity growth on inflation