The Conquest of American Inflation: A Summary

Summarizing Sargent’s “The Conquest of American Inflation,” this essay compares two interpretations of the postwar rise and fall of U.S. inflation, both built around policymakers learning a version of the natural-rate hypothesis but differing in how that learning is modeled. The “triumph of natural-rate theory” story has the government eventually learn the correct rational-expectations version of the theory and simply cease exploiting an illusory long-run Phillips curve trade-off, ushering in the low-inflation “Ramsey outcome.” The essay’s preferred “vindication of econometric policy evaluation” story instead keeps the government using the very Tinbergen-Theil-style econometric procedures Lucas’s Critique condemned – estimating a Phillips curve from recent data and resetting policy accordingly, generating exactly the kind of drifting coefficients Lucas identified as a symptom of policy-dependent behavior but left unexplained. Working through the Kydland-Prescott one-period model, the essay first shows the Nash outcome (positive inflation, unemployment at its natural rate) arises when the government ignores the effect of its rule on expectations, while the Ramsey outcome (zero inflation) arises when it accounts for that effect; it then introduces “self-confirming equilibria,” in which the government’s beliefs about the Phillips curve are validated by the data its own policy generates, reproducing the Nash outcome as a steady state. The essay’s central mechanism is “escape dynamics”: because the government’s learning algorithm discounts older observations (suspecting, incorrectly, that the true relationship is unstable), chance disturbances can occasionally push its estimated Phillips curve toward vertical, triggering a real disinflation whose own resulting data temporarily reinforce that belief – generating, in simulations, long stretches near the efficient Ramsey outcome that “resemble Arthur Burns as well as ones that look like Paul Volcker.” But because the true short-run trade-off never actually disappeared, the same dynamics eventually push the government to rediscover it and drift back toward the high-inflation Nash outcome, so the disinflation is not permanent. The essay closes by stressing this is an exercise in positive, not normative, economics – its simulations do not vindicate the underlying econometric procedures as good policy design – and expresses the explicit hope that the truth is instead the more reassuring “triumph” story, since otherwise “the dynamics governing adaptation threaten eventually to rekindle inflation.”

The Conquest of Inflation: An Introduction to Sargent's Analysis

Introducing Thomas Sargent’s monograph “The Conquest of American Inflation” to a central-bank audience, this short essay frames the postwar rise and fall of OECD inflation as a test case for whether “central bankers have learned to control inflation, or… the current situation of low and stable inflation [is] simply a result of a series of favorable but temporary factors.” It lays out the standard Kydland-Prescott/Barro-Gordon time-inconsistency account of why inflation rose – a central bank tempted to exploit an inflation-unemployment tradeoff, rational private expectations that anticipate this temptation, and the impossibility of binding commitment, yielding an inefficiently high-inflation “Nash outcome” – and the two “traditional” competing explanations for why it later fell: either a deliberate institutional reorientation toward low-inflation mandates (the “Ramsey outcome,” more plausible for Europe’s newly independent, price-stability-mandated central banks) or, per Peter Ireland (1999), an unchanged policy simply riding a series of favorable shocks that lowered the natural rate of unemployment (offered as the more plausible account for the U.S., where institutional reforms were more limited). The essay then previews Sargent’s own, third account: the central bank behaves under similar assumptions to Kydland-Prescott and Barro-Gordon but has incomplete knowledge of the true Phillips curve, continually updating its beliefs from recent data and thereby making its own beliefs partly self-fulfilling, since the estimated tradeoff itself shifts as policy shifts. On this reading, the Fed reduced inflation not because it concluded unemployment could never be affected, but because the recently estimated tradeoff had become “unfavorable” enough that exploiting it was not worthwhile – leaving open the possibility that new disturbances could make the tradeoff look favorable again and revive inflation. The essay stresses Sargent does not claim to have identified the correct account of U.S. policy, only that both the reorientation and adaptive-learning stories are consistent with theory and evidence, and argues the warning implicit in Sargent’s analysis is more relevant to the U.S., given its comparatively weak formal anti-inflation mandate, than to Europe.

Sveriges Riksbank Economic Review | Macro Paper Warehouse

The Conquest of American Inflation: A Summary

The Conquest of Inflation: An Introduction to Sargent's Analysis