If we are to believe official government statistics, the U.S. economy of the 1970's displayed symptoms of economic maladies that earlier generations of economists thought could not coexist. The decade was plagued with high rates of inflation, unacceptable levels of unemployment, slowed growth, and declining productivity. The simultaneous occurrence of inflation and recession baffled economic diagnosticians and precipitated what has been called a crisis in macroeconomic analysis. The inconsistency between the predictions of conventional macroeconomic theories and the “facts” of economic life have led to a reexamination of both the theories and the facts.

During the earlier decade of the 1960's, our theories and experience led us to believe that the economy was characterized by a stable downward-sloping Phillips curve, a menu of trade-offs between unemployment and inflation from which to choose the most socially desirable combination. Macroeconomic models provided relatively accurate forecasts of future economic activity. Policymakers pursued conventional Keynesian policies in efforts to fine tune the economy, working to stabilize it at full employment. The prevailing optimism of the time encouraged the belief that relatively low levels of unemployment could be attained while maintaining reasonable price stability and a healthy rate of economic growth. Since inflation was thought to have negligible economic consequences, full-employment policies could be pursued that would cyclically balance budgets, while providing the economic growth necessary to generate the government revenues required to finance the growing demands for social expenditure programs. These optimistic hopes were rudely shattered by the economic facts of the past fifteen years.