Chapter 4 of 6

Chapter iv · Expectations and markets

1973

Inflation and unemployment rise together.

Arab oil producers imposed an embargo in October 1973, and by January 1974 the price of oil had quadrupled. Policymakers had treated a little more inflation as the price of lower unemployment, but Milton Friedman and Edmund Phelps warned that the trade-off would not last; through the 1970s both rose, and Robert Lucas and others rebuilt macroeconomics around how people form expectations. In 1977 Finn Kydland and Edward Prescott showed why policymakers who cannot commit to a rule end up with high inflation, work that later influenced the reform of central banks.