FREE ESSAY ON TODAY'S REALITIES...YESTERDAY'S MODELS

TODAY'S REALITIES...YESTERDAY'S MODELS

Today's realities do not necessarily fit yesterday's models.
In a universe where shifting paradigms are the norm, scientists are in continued search
to establish cause and effect relationships between events that can be modeled. We see
behaviorists scurrying for specific reasons as to why two youths could commit such
heinous acts in Colorado. Their existing models could not predict such atrocity.
Meteorologists and environmentalists are developing an explanation for global warming.
What new factors will explain the condition? Will updated models accurately predict
future trends?
Economists are not exempt from this process. In today's world, where markets are defying
what was previously considered rational thought, economists are continually challenged to
investigate, establish cause and effect relationships and develop new models to explain
and predict our economic condition.
A dramatic example of this process is the economist's efforts to explain the relationship
between unemployment, the failure of the economy to employ it's labor force fully, and
inflation, a sharp drop in the value of a nations currency that causes a rise in the
general level of prices in the economy. In the past there were numerous theories that
linked the two factors in a polar relationship. Simply put, when unemployment was low,
inflation was high, and when unemployment was high, inflation was low.
Today, however, traditional thought that linked unemployment and inflation is being
challenged. As Alan Greenspan, Chairman of the Federal Reserve, told Congress earlier
this when discussing the relationship of inflation to unemployment, At some point, the
general notion that a different type process is involved here is going to gain a majority
view among economists.(Stevenson, April 11,1999).
What did past theory tell us about the inflation - unemployment relationship? What is the
current economic climate has changed to cause us to reevaluate these theories? What new
theory suggests an explanation of the current condition that will enable us to model
future events?
There are two major historical views to the unemployment - inflation theory. From the
1930's to the 1970's, the Keynesian model was utilized to explain the relationship
between full employment and stable prices. In it's most basic form, Keynes' theory states
that  the economy may realize either unemployment or inflation, but not both
simultaneously.(McConnell and Bure, pg 338)
The inverse relationship between unemployment and inflation was further supported by the
British economist A.W. Phillips. Phillips theorized that high demand drives higher
inflation and the growth of real output and corresponding lower unemployment
rates.(McConnell and Bure, pg. 339)
The viability of these models was challenged with the events of the 1970's and 1980's.
Specifically, we began to see the simultaneous co-existence of both rising unemployment
and inflation that was not indicated in either Keynes or Phillips' models.
Stagflation was the word used to describe this new phenomenon in which the economy was
impacted by high inflation rates and high unemployment. The reality of the current events
do not fit this model.
The theories and terms used in the past modeled the times but none serve as a guide to
describe today's reality.
Unemployment has been falling for the past several years, and last month dipped to 4.2
percent, its lowest level in nearly three decades and well below any mainstream estimate
of the natural unemployment rate. Economic growth, while slowing somewhat, remains
robust. Yet, the predicted inflation is nowhere to be found.(Stevenson, April 11,1999)
We are in the longest peacetime expansion in American history. We continue to move into
uncharted water(Thurow). The growth rate for 1998 was 3.8 percent, the third consecutive
year the economy has expanded at nearly 4 percent. Previous economic theory held that the
economy could not grow in excess of 2.5 percent without igniting inflation.(Stevenson).
Again, past theory does not reflect today's realities of inflation rates of less than 1
percent with nearly a quarter of a million jobs added in each of the last twelve months.
(Nason).
Surely, the Federal Reserve monetary policy has been used wisely to positively impact
these results. Surely, advancements in new technology has created new markets for labor
and reduced costs and increased outputs. The improved productivity levels have served to
suffocate inflation.
The best explanation for today's condition, which began with the bull markets of the
1990's, closing in excess of 11,000 on May 3 of this year, is the Perpetual Motion
Economy Theory. Each part of the economy works in conjunction with the other. Each part
keeps the other moving indefinitely and positively. Mr. Richard T. Curtain, Director of
the University of Michigan's Consumer Surveys coined the flow as a  virtuous
cycle.(Uchitelle).
In a Perpetual Motion Economy model, the rising stock market drives households wealth
that encourages borrowing that pays for spending. This increase in spending creates more
jobs that produce higher wages. This generates confidence that encourages people to
invest in the stocks and causes the market to rise and so on and so forth.
As Stephen Roach, Chief Economist at Morgan Stanley Dean Witter, aptly observed, Many of
us who have been doubters are starting to believe this can go forever. That is a
complacency we may live to regret. But I cannot really substantiate doubt for a good
analytic reason.(Uchilette) Buying into the Perpetual Motion Theory allows for a world in
which low inflation and low unemployment can not only coexist, but also serve to feed a
self-perpetuating process.
Even the staunchest proponents of the Perpetual Motion Theory acknowledge that there is a
trade off in the long term between inflation and unemployment. The question is not that
these relationships exist, but rather are the relationships consistent enough to predict
rates in a rapidly changing world.
L. Douglas Lee, Chief Economist at HSBC Securities, best sums up both current and past
theory.  These various road maps or rules that we use are valid at times but what you
always have to remember is that the U. S. economy is a very dynamic creature and things
don't remain fixed. What works at one point in terms of understanding inflation may not
work in another, but then may change and work again. The trick for policy makers is to
remain flexible and to recognize when their old assumptions are no longer working. Policy
makers, and all of us , have to stay on top of things so we do not use the old map on a
new road.(Stevenson, April 11,1999)
Today's realities do not necessarily fit yesterday's models.
Bibliography
McConnell, Campell R. and Bure, Stanley L.(1996), Economics: Principles, Problems, and
Policies. Thirteenth Edition. McGraw-Hill, Inc. 
Nasar, Sylvia, January Gain in Jobs Doubled the Forecast, New York Times, February 6,
1999
Stevenson, Richard W., Joblessness is Down. Prices Aren't Going Up. Go Figure., New York
Times, April 11, 1999
Stevenson, Richard W., Fed Decides to Maintain Interest Rates, New York Times, 
Thurow, Lester C., The Boom that Wasn't, New York Times,
Uchitelle, Louis, The Stronger It Gets, The Sweatier the Palms, New York Times,