Monetary Policy in the 1980s

Twenty years ago policymakers were optimistic that monetary and fiscal policies were capable of maintaining both full employment and price stability. With longer lags involved in deciding on and implementing tax and budget policies, fiscal policy became a more complicated process, less able to respond quickly to adverse shifts in employment and output. Consequently, the responsibility for stabilizing the economy fell more and more to the nation's central bank, and monetary policy objectives alternated between fighting inflation and fighting unemployment. At the peak of the business cycle, monetary policy was aimed primarily at subduing inflation; at the trough of the business cycle, monetary policy was directed at spurring business activity. By switching objectives between inflation and unemployment, both battles were lost. Experience shows that the Federal Reserve cannot, for very long, trade off a little more inflation for a little less unemployment. Indeed, our experience in the past 20 years has been the opposite, as inflation rose to higher levels in each expansion period and unemployment rose to new heights in each recession.