Friedman "Fooling" Theory
Say you're eating a lunch at a park. A robin searches for worms in the grass. Lilacs perfume the air. A breeze massages your senses. Your lunch companion asks, "What do you think the weather will be like in a couple of hours?" If you're like many, you'll form your prediction by looking at the past. You might say, "The weather will be like it is now."
Nobel laureate, Milton Friedman, believed that consumers formed their opinions on inflation as adaptive expectations. It was like driving while looking in the rear view mirror. In other words, people would assume that inflation would be pretty much like it was last year.
Now let's say that the government sends rebate checks out an unexpected stimulates aggregate demand increasing prices. Workers now mistake the higher prices as a change in demand for their work and increase output. Workers then ask for higher wages and employers grant their request. The higher costs reduce aggregate supply and the economy equates at its natural rate of unemployment. Thus, in the short-run workers are fooled but not in the long-run.
Q. What does an economist do?
A. A lot in the short run, which amounts to nothing in the long run.
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