Hmm. I thought I might respond to something that has been coming up in comments and emails recently. I’ve been writing about how macroeconomic reality under Ronald Reagan didn’t actually match the myth, and many people are inevitably upset. And one of the things they tend to bring up is the hoary old myth that the 80s success in taming inflation was somehow a terrible shock and surprise to Keynesians, who had no explanation.

This is, as it happens, completely wrong: what actually happened in the 80s was, quite literally, a confirmation of the validity of textbook Keynesian economics.

OK, first the facts: the 80s were marked first by a simultaneous surge in unemployment and plunge in inflation. Then unemployment came down but inflation stayed low(ish):

So what would textbook macro have led us to expect? The two leading undergrad macro textbooks at the time were Dornbusch-Fischer and Gordon, both with first editions published in 1978. (Gordon has a retrospective (pdf) on all this, which tells me something I didn’t know: in both cases the analysis drew on a handout presented by Rudi in 1975). Both books presented an adaptive-expectations Phillips curve, in which inflation depended both on the unemployment rate and on lagged inflation, which was supposed to determine expectations:

Inflation rate = -α(u – NAIRU) + Lagged inflation rate

where u was the unemployment rate and the NAIRU was the non-accelerating-inflation rate of unemployment.

And what did this approach predict about disinflation? It said that if policy makers were willing to impose a period of very high unemployment, they could bring inflation down — and that even if unemployment then fell back to the NAIRU, inflation would stay down.

I still have my copy of the original Dornbusch-Fischer, which declares on p. 421,

We should not be surprised if the level of output and the inflation rate move in opposite directions at some stages of the adjustment process.

That is, we should not be surprised by the very thing that supposedly shocked, surprised, and refuted Keynesian economics.

The truth, which Gordon has been trying to get out, is that 1978-vintage macro has actually done very well these past three decades. Unfortunately, a couple of generations of economists have never seen that stuff.