The effects of the Carter pay and price standards: A rational expectations approach

Scope of study. The Carter Administration, in an effort to slow the inflation rate, created economy-wide voluntary standards for wage and price increases. These standards were in existence from October, 1978 through 1980. At the aggregate level, four different hypotheses regarding these standards were tested. These hypotheses were (1) the standards brought wage demands into line with trend productivity growth, (2) the standards changed the inflation-unemployment trade-off, (3) the standards deflated inflationary expectations, and (4) the standards prevented the roughly concurrent 1979-80 energy price shock from getting passed through to wages. The last hypothesis was also tested for fifteen Standard Industrial Classification 2-digit manufacturing industries. This study is unique in that the above hypotheses were tested under the assumption that people form their expectations rationally, instead of adaptively, which had historically been assumed.;Findings and conclusions. The econometric results of this study indicate that, at the aggregate level, the Carter standards (1) did not bring wage demands into line with trend productivity growth, but actually accelerated the wage inflation rate relative to trend productivity growth, (2) caused a perverse impact on the short-run inflation-umemployment trade-off so that an increase in the unemployment rate resulted in higher, rather than lower, wage inflation, (3) deflated inflationary expectations which directly translated into a reduction in the wage inflation rate, and (4) prevented the roughly concurrent 1979-80 energy price shock from getting passed through to wages. At the industry level, the results indicated that the Carter standards prevented the 1979-80 energy price shock from getting completely passed through to wages in ten of fifteen Standard Industrial Classification 2-digit manufacturing industries studied.