The period from the late 1990s to the winter of 2000 was marked by falling unemployment rates and falling inflation rates as well. How does economic theory explain this apparent violation of the Phillips curve model?

Just as the stagflation of the 1970s and early 1980s could be explained by adverse shifts of the aggregate supply curve, the positive developments of the 1990s can be explained by fortuitous shifts in the aggregate supply curve. The U.S. economy in the 1990s benefited from a whole series of lucky breaks. Among them were a decline in energy prices, the increased value of the dollar and consequent decrease in the price of foreign goods and services, the benefits of significant advances in technology that lower the price of computer power significantly. All of these factors acted in such a way as to shift the aggregate supply curve outward, causing downward pressure on prices, at the same time increasing the level of real GDP and employment. As it has been presented in the Baumol and Blinder text, favorable supply shocks should produce rapid economic growth with falling inflation.