ABSTRACT
In recent years it has become common to describe macroeconomics as being in disarray. The combination of high inflation and unemployment during much of the 1970s in most market-oriented economies could not easily be explained by conventional Keynesian theory alone. This theory had been the most widely accepted explanation of how aggregate income, output, and employment are determined. This paper focuses on the relationship between current “neoclassical” explanations of inflation, which buttress the case for nonintervention by government, and the original classical explanation leading to the same policy conclusion. The role of rationality in both is considered and related to the phenomenon of “inflationary psychology,” frequently cited as a major cause of the intractability of the inflation problem in the modern world. The attitude of behavioral economics to rationality as it applies to the inflation problem is stressed throughout.
