November 01, 1999

Preliminary figures for the third quarter are in, and the numbers represent a major puzzle for Keynesian economists. The economy's real growth rate increased to 4.8% - the fastest pace this year-up from 1.9% during the second quarter. In turn, the GDP deflator showed modest price pressures rising at an annual rate of only 1.6% in the third quarter, a rate lower than the 1.9% annual rate of increase during the second quarter. This data is very damaging for Phillips curvers who believe that stronger growth leads to higher price pressures. In fact, the data show the opposite: that stronger growth is associated with lower inflation. It appears that Keynesians hold to their convictions despite what the data say-much like those who believed the world to be flat. In contrast, we offer a simple explanation. If inflation is too much money chasing too few goods, as we contend, unanticipated increases in real GDP will cause unanticipated increases in the demand for money and result in unanticipated lower inflation rate: Just what we had this quarter.

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