Michael Ryan on whether fighting inflation always leads to recession

We've just finished teaching the macroeconomics section of ECONS101 for this trimester (which brings our teaching to a close). The last week covers the Phillips Curve - the empirically-observed short-run trade-off between inflation and unemployment. The implication of the Phillips Curve is that if the government wants to reduce inflation, it can do so only at the cost of higher unemployment. And if the government wants to reduce unemployment, it can do so only at the cost of higher inflation.

My colleague Michael Ryan wrote on The Conversation recently on the topic of whether fighting inflation leads to recession. He wrote:

But are reductions in inflation inextricably linked to recessions?

New Zealand’s own economic history, it turns out, can give some guidance on this, and point to the risk factors within the country’s economic outlook...

Since 1961, New Zealand has experienced eight falls in inflation (disinflations) of four percentage points or more. (Disinflation refers to when inflation drops but remains positive, while “deflation” occurs when the inflation rate falls below zero).

This four percentage point drop is required for New Zealand’s inflation to reach the Reserve Bank’s target of 1-3%, down from the 7.3% recorded in the third quarter of 2022...

Then, after looking at New Zealand's history of periods of disinflation since 1960, he concludes that:

The message is a positive one: a fall in inflation does not necessarily have to be associated with a recession.

That was a bit of a relief to me, given that I wrote at the end of 2022 (also in The Conversation) that the Phillips Curve relationship is not causal, but that nevertheless:

...we can probably expect unemployment to move upwards as the Reserve Bank’s inflation battle continues. Not because lower inflation causes higher unemployment, but because worker and consumer expectations take time to reflect the likelihood of lower future inflation due to the Reserve Bank’s actions.

And since workers negotiate only infrequently with employers, there is an inevitable lag between inflation expectations changing and this being reflected in wages. Alas, for ordinary households, there is no quick and easy way out of this situation.

It is good that Michael Ryan and I are not inconsistent with each other! In theory at least, when the Reserve Bank manages to reduce inflation and unemployment is not negatively affected (that is, the economy doesn't enter recession), it's because inflation expectations have adjusted quickly. That is not always the case.