Milton Freidman was wrong about rational expectations?

Old-Keynsians claim that inflation is the result of too much money chasing too few goods and that therefore there is an implicit tradeoff between employment (wages) and inflation. Monetarists (like Friedman) argue that people are paid based on their productivity so the primary determinant of inflation is simply the expectation of changes in the money supply by the government. Arnold Kling, notes that wages track expected productivity:

Productivity is what determines our standard of living. In the long run, productivity is what determines how much workers are paid. (In the short run, wage growth sometimes diverges from productivity growth. If there is a sudden surge in productivity, it usually takes a couple of years for this increase to work its way into wages. Conversely, if there is a productivity growth slowdown, as in the 1970’s, it takes a while for wage growth to slow down to match.)

In other words, inflation results from over-estimates by employers about the future productivity of their employees and deflation the reverse. Cool.


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