[quonn]

Why? I think this would only be true if negative inflation is the goal. Since the inflation rate is computed relative to last year and as long as salaries do not increase, after a year or two of inflation the average employee has less and less disposable income left, so they can spend less unnecessarily and accordingly the inflation could go down to zero despite full employment.

As an example, if I can buy 2 units of a good this year (so demand is high) and then high inflation persists for two years and now I can only afford one unit (so demand is low) - my salary being the same, then an inflation rate of 0 in year 3 would mean everything stays the same. I can still only afford one unit and that should push prices down or at least keep them steady which is what zero inflation would mean.

Maybe the assumption is that decreased demand will necessarily cause unemployment, but this seems to be true only for domestic demand (questionable for the software industry) and in any case following this line of thought would mean the more employment the more inflation which seems absurd.

[sokoloff]

If inflation was doubling prices every two years and unemployment was low, would you really stay in a job where your salary did not change?

[quonn]

If the alternative is unemployment, maybe yes?

[sokoloff]

That's why the overall unemployment rate changes the population-wide behavior.

You, as an individual, might be forced to remain in that situation but in an environment with low overall unemployment, lots of your peers won't be so forced and so will demand either a raise or will change jobs to self-service the raise. That will tend to get you a non-zero raise (at least on a population-wide basis). If overall unemployment was quite high, employees are less willing/able to make such changes.

[_ea1k]

Yeah, it does seem like the basic premise is worth questioning. The start of inflation in this cycle looked like a supply shock. Why is the discouraging investment the right response to that?

[schnitzelstoat]

Raising rates still helps to maintain price stability even if it is a supply shock, it just does it via demand destruction.

The aim is to stop inflation i.e. achieve price stability. Keeping unemployment low is a nice bonus if it can be done.

Also although the start of the inflation seemed to have been a supply shock due to the pandemic, whether that has continued to be the cause vs. the pandemic spending, isn't so clear now. Of course, the war in Russia and now the Middle East isn't helping the supply side either.

[_ea1k]

Yeah, and that last part is where it gets confusing to me. If it is no longer just a short term supply shock, you'd actually want investment and production expansion. Those pressures seem to be in tension with interest rate increases that have the effect of deferring investment.

Presumably there is some point where raising the cost of investment is not desirable, despite relatively high prices.

[padjo]

The theory is known as the Phillips curve and is fairly widely followed by central banks and policy makers.

Is it true? Hard to say really, like most macroeconomic theory.