Knowledge that Transforms

George Fane uses adjectives such as ad hoc, obscure, mechanistic not to mention wrong to characterize aspects of my discussion in this Review of recent British inflation; so it is safe to assume that he disapproves of it. However it is one thing to express disapproval, and another thing to justify it. Fane does not back up his assertions of disagreement with convincing arguments. To begin with I quite agree with Fane that the natural unemployment rate hypothesis, combined with an application of the adaptive expectations mechanism to the generation of the expected domestic inflation rate, will not explain recent British experience. I never claimed that it would. It is clear that, if a monetarist explanation of inflation is to be reconciled with the facts of the behavior of the price level and the unemployment rate in the British economy since 1967, two things must be shown to have happened. First it must be shown that the expected inflation rate accelerated after 1967 independently of the past behavior of the domestic price level. Secondly it must be shown that the natural unemployment rate of the British economy increased. My argument proceeded along just such lines. I pointed to several factors as being responsible for these changes. It is refreshing for a monetarist to be criticized for having adopted a multicausal explanation of a series of events and that is what Fane does. In particular he remarks that although there have been frequent changes in most of these factors during the postwar period, Laidler never considers their possible relevance on the various occasions when the natural rate hypothesis gives correct predictions (p. 722). Both assertions are inaccurate. I attributed the step-up in inflation expectations to the devaluation of 1967, and the simultaneous acceleration in the world inflation rate. The devaluation was a unique event in the post-Korean War period, and its effect on inflation expectations has been thoroughly investigated by other workers (see John Carlson and J. Michael Parkin). Data presented in my paper showed that the acceleration in the world inflation rate that began in the late 1960's was a new phenomenon, completely distinct from anything that had happened before. Moreover the effect of the world inflation rate on British inflation expectations, as well as on those in a number of other countries, was investigated in much more detail for the entire post-Korean War period by Rodney Cross and the author. Among factors affecting the natural unemployment rate, I referred to changes in unemployment benefits introduced in 1966. Since Fane seems to agree that these did affect the natural unemployment rate, there is no need to comment on this matter further. However I also referred to changes in the demographic structure of the labor force that took place in the late 1960's. J. I. Foster shows that such changes did take place, and were unique in postwar history. According to Jim Taylor's work (for example, 1972) the shake out of formerly hidden unemployment was a phenomenon that became important for the first time at the turn of the decade. Only when it comes to the matter of the role of the dispersion of demand between industries and regions during the 1973 boom is there any basis to Fane's assertion that I have failed to consider the relevance of such a factor at other periods, but even here it is worth noting that the National Institute found the data on this phenomenon striking enough to warrant extensive comment in *University of Western Ontario.