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Press Release

Economic Policymakers Walk the Walk, But Don’t Talk the Talk

The current economic expansion -- the longest in U.S. history -- has confounded the experts and caused some observers to hail the so-called "New Economy." But is the economy new?

According to an essay in the 1999 Annual Report of the Federal Reserve Bank of Cleveland, it's not that the economy is new, but rather that the vocabulary of economic policy is old. In other words, the expansion suggests a failure, not of economic theory, but of economic rhetoric.

According to the essay, titled "Theory Ahead of Rhetoric: Economic Policy for a 'New Economy," the language of monetary policy is full of concepts inherited from an era when damping business-cycle fluctuations was considered to be an essential element of successful economic policy. These concepts include potential output, the noninflationary rate of unemployment (NAIRU), growth speed limits, and the like.

The essay outlines three advances in economic theory that support a growing skepticism over the efficacy and desirability of economic policies geared toward smoothing the business cycle: rational expectations, time inconsistency, and "real" business cycles.

According to the report, rational expectations introduced forward-thinking behavior into policy discussions and sounded the death knell for the Phillips curve concept of an exploitable trade-off between inflation and unemployment.

Time inconsistency predicted adverse consequences from economic policies that failed to commit to clear and consistent long-term objectives. Because of dynamic rational expectations, short-run policies that, individually, appear to be reasonable (if not optimal) in the short run, are decidedly less than optimal when considered over time.

The essay notes that these two contributions emphasize the importance of rules, as opposed to discretion, in economic policy.

Real-business-cycle theory refers to a class of models in which aggregate outcomes are the sum of the decisions made by individual firms and households operating in fully dynamic environments. If one views the path of the economy as the dynamic unfolding of a sequence of optimal outcomes given the inherited structure of the economy, then actual and potential output become one and the same.

These ideas, says the essay, provide much of the current intellectual underpinnings of central banks' behavior all over the world-not least because they explain how policy had previously erred. In the United States, for example, the economic stabilization policies of the 1960s and 1970s, which caused instability in the purchasing power of money, produced a reduction in the national welfare.

Inflation, the nation learned, distributes wealth capriciously. And resources are redirected to protect against losses from future inflation, leaving the economy with fewer resources to devote to production. In short, knowing that the purchasing power of a dollar is stable will lead to better allocation of resources than is possible in an environment that suffers from inflation.

If the principles guiding monetary policy have changed, why do some analysts still talk about "overheating," growth above potential, unemployment rates that are "too low," and wage pressures?

According to the essay, it's because the rhetoric of monetary policy has failed to keep pace with economic theory and practice. Although policymakers may have conquered the fine-tuning impulse, they have yet to fully abandon the language that accompanies it. And in a world where expectations matter, the language of policymakers can have consequences. Therefore, says the essay, it is time to align rhetoric with reality.

Federal Reserve Bank of Cleveland

The Federal Reserve Bank of Cleveland is one of 12 regional Reserve Banks that along with the Board of Governors in Washington DC comprise the Federal Reserve System. Part of the US central bank, the Cleveland Fed participates in the formulation of our nation’s monetary policy, supervises banking organizations, provides payment and other services to financial institutions and to the US Treasury, and performs many activities that support Federal Reserve operations System-wide. In addition, the Bank supports the well-being of communities across the Fourth Federal Reserve District through a wide array of research, outreach, and educational activities.

The Cleveland Fed, with branches in Cincinnati and Pittsburgh, serves an area that comprises Ohio, western Pennsylvania, eastern Kentucky, and the northern panhandle of West Virginia.

Media contact

Doug Campbell,, 513.455.4479