In introduction, I will be expounding on the evolution of economic understanding and postwar stabilization policy from the perspective of Christina D. Romer (Professor, University of California at Berkeley) and David H. Romer (Professor, University of California at Berkeley) throughout the paper. In detail, I will cover the time periods of the 1950s to the 1990s. Finally, I will comment on the commentary and discuss the general discussion as presented by Thomas J. Sargent, Professor, Stanford University and Senior Fellow, Hoover Institution.
The evolution of economic understanding in the 1950s was realistic as it pertains to the relationship between capacity and full employment. The 1950s model held that there was a positive long-run relationship between inflation and unemployment (summarized from Romer). In other words, monetary policymakers believed if the economy should rise above full employment that inflation would occur. Thus, the monetary policies would create a domino effect by negatively impacting long-term growth, and worst, causing a recession. In addition, Federal Reserve Chairman William McChesney Martin shared a common view (depicted in Minutes, August 19, 1958, p.57) that the inflation that would result from overexpansion would eventually raise unemployment, not lower it.
In the 1950s, monetary and fiscal policymakers were 'on the same page' in regard to how the economy worked. For example, the 1956 Economic Report stated: "As a Nation, we are committed to the principle that our economy of free and competitive enterprise must continue to grow. But we do not wish to realize this objective at the price of inflation, which not only creates inequities, but also is likely, sooner or later, to be followed by depression." (EROP, 1956, p. 28.) The 1958 Economic Report warned against mortgaging the long-run health of the economy for the sake of applying measures to provide a spurt in activity. The 1959 Economic Report discussed the mechanisms by which inflation hurt economic growth.
The evolution of economic understanding in the 1960s took an optimistic turn from the economic understanding in the 1950s. For example, policymakers adopted a view of the levels (higher than the levels of the 1950s) of output and employment that could be reached without triggering inflation. Eventually, policymakers in the 1960s came to believe in a long-run tradeoff between unemployment and inflation, in stark contrast to policymakers in the 1950s. (As per Romer and Romer.)
The fiscal policy makers of the 1960s depicted the most dramatic departure from the policymaking of the 1950s. For example, "in discussing the further rise in inflation in the second half of 1967 (when unemployment was 3.9 percent), the Economic Report stated: Demand was not yet pressing on productive capacity-over-all or in most major sectors. The period of slow expansion [from mid-1966 to mid-1967] had created enough slack so that production could respond to increasing demand without significant strain on productive resources." (EROP, 1968, p. 105.) The preceding quote lends to the fiscal policymaker's, in the 1960s, strong confidence in their estimates of the sustainable rate of unemployment that they consistently attributed inflation that arose before unemployment reached this level to sources other than excess demand. (Paraphrased from Romer and Romer). The Romers gave other supporting documentation to the preceding paraphrase such as the 1962, 1966 and 1967 Economic Reports.
The monetary policymakers in the 1960s proved to be more conservative, if not ambiguous than the fiscal policymakers in the 1960s. Nonetheless, monetary policymakers were optimistic about the sustainable levels of output and employment, which reflected the views of fiscal policymakers. However, monetary policymakers did not view the high levels of activity as unsustainable. To the contrary, monetary policymakers were mainly concerned that inflation might continue, not that it would rise. (RPA, March 5, 1968, p. 117 - 123 expounded on the preceding issues.) Both monetary and fiscal policymakers expected inflation to fall although monetary policymakers were less optimistic about inflation. In other words, although monetary policymakers' view was ambiguous (like an Alan Greenspan's speech...pun intended), it was on the same page as the views of fiscal policymakers.
The evolution of economic understanding in the 1970s shifted again, especially in the early 1970s. The emergence of the Friedman-Phelps natural-rate framework was brought about by the adoption of both fiscal and monetary policymakers. The Romers continued, "Throughout the decade, policymakers believed that the change in inflation depended on the deviation of the unemployment rate from its normal level. However, the 1970s saw considerable swings in both the estimates of the natural rate and in views about the downward sensitivity of inflation to economic slack."
In the early 1970s, the policymakers adopted the natural-rate framework. In the middle part of the 1970s, policymakers returned to more conventional views of the dynamics of inflation. Thus, the optimism, in the 1960s, of views concerning sustainable output and unemployment was dampened over the early and mid-1970s. Both fiscal and monetary policymakers underwent a similar evolution.
In the late 1970s, the natural rate framework was not emphasized or utilized, effectively, in policymaking. The preceding trend is a slight reversal of the model used in the early and mid-1970s. For example, President Carter's signed section of the 1978 Economic Report underlines the difference.
The evolution of economic understanding in the 1980s and 1990s is termed 'The Modern Consensus' by the Romers. The Romers described 'the modern consensus'as a new consensus of beliefs with four critical elements beyond the central place of he natural-rate hypothesis. First, policymakers in the early 1980s had substantially higher estimates of sustainable unemployment than many of their predecessors over the previous two decades as illustrated by the 1982 Economic Report. Second, policymakers returned to the view that aggregate demand policies did provide a means of reducing inflation as illustrated by the early Economic Reports of the Reagan Administration. Third, the agreement that means other aggregate demand policies were not viable cures for inflation as illustrated by the 1982 Economic Report. Fourth, the agreement that the costs of inflation were substantial as illustrated by the 1982 and 1983 Economic Reports. Both Monetary and Fiscal policymakers shared the same view.
There was continuity and change in the 1990s. As a matter of fact, in the 1980s and 1990s, there was little change in the views of policymakers as it pertains to 'harm to inflation' as illustrated by Federal Reserve Chairman Alan Greenspan (Greenspan, 1997, p. 1.) In addition, a natural-rate framework continued to be a core element of policymakers' beliefs illustrated by George H. W. Bush Administration. (EROP, 1990, p. 177.)
The postwar stabilization policy in the 1950s was an early commitment to aggregate demand management. Both fiscal and monetary policymakers reacted to macroeconomic conditions and make adjustments to stabilize the economy.
The postwar stabilization policy in the 1960s as it relates to the macroeconomic beliefs affected was two-edged sword, especially on the fiscal policy. The 60s witnessed a large-scale tax cut, which was similar to George W. Bush's tax cuts of the 2000s. Ironically, the 1964 Economic Report argument that fiscal expansion was necessary because the current unemployment rate was above its normal, sustainable level is similar to President Bush's argument for a tax-cut rate because of our current unemployment rate in 2003. Moreover, George W. used a clip of JFK speaking about the early 1960s tax cut in his Presidential campaign. In a state of Déjà vu, "The combined effect of these actions, together with the initial spending increases resulting from the Vietnam War (in Bush's case, Gulf War II), reduced the ratio of the high-employment surplus to GDP from 1.6 percent at the end of 1960-1.8 percent at the end of 1965. (Summarized from Romer and Romer.) In other words, history repeats itself.
The monetary policy was more stable and consistent during the 1960s, except the Federal Reserve kept real interest rates low despite high output, low employment, and rising inflation. The theory behind the above action was that many members of the FOMC was convinced by the model at the time that inflation would disappear on its own if output growth merely returned to normal.
The postwar stabilization policy in the 1970s (as described by the Romers) was a period of rapidly fluctuating beliefs about the macroeconomy, which resulted in rapidly fluctuating macroeconomic policies. In part, politics played a role in the macroeconomic policies under President Carter. Plus, policymakers, at the beginning of the Carter administration increased their estimates of the natural rate and began to believe once more that aggregate demand contraction could lower inflation. Chairman Burns, who stated in September 1974 that he "would not wish to see a prompt recovery in economic activity, expressed this view. If recovery began promptly, economic activity would turn up at a time when inflation was continuing at a two digit rate." (Minutes, September 10, 1974, p. 65)
The postwar stabilization policy in the 1980s and 1990s utilized the Volcker disinflation. The Volcker disinflation led to a massive and long-lasting shift to tighter monetary policy in late 1979. The Volcker disinflation was inspired by the FOMC under Chairman Paul Volcker. Basically, the policy was motivated by the belief among policymakers that inflation was very costly and that unemployment above the natural rate was the only way to reduce it. Thus, throughout the 80s, the Committee repeatedly expressed its willingness to accept high unemployment to bring inflation down. (For example of the preceding paraphrase of Romer and Romer, see RPA, July 6-7, 1981, p. 116; February 1-2, 1982, p. 89.) The preceding policy was accepted and reflected the views of the Reagan Administration, also.
In conclusion, I expounded on the evolution of economic understanding and postwar stabilization policy from the perspective of Christina D. Romer (Professor, University of California at Berkeley) and David H. Romer (Professor, University of California at Berkeley) throughout the paper. In detail, I covered the time periods of the 1950s to the 1990s.
In regard to the commentary and the general discussion as presented by Thomas J. Sargent, Professor, Stanford University and Senior Fellow, Hoover Institution, I will just make a few points. The commentary and the general discussion pointed out the shortcomings and failures of the Romers' failure to discuss, in detail, about the political climate, pressures and constraints the FOMC and its Chairman worked under. For example, the 1970s fits the bill. In turn, the Romers defensively stated (and I quote):
"Ms. Romer: I will be brief too. I want to make one thing clear: We
are very much not about where policymakers' beliefs came from. One
of the ways that we limited our paper is to only look at what policy-
makers believed not why they believed it. The role of academics and
the role of learning are at some level outside our story. It is not that we
don't think these issues are important, it is just that they are beyond
the scope of this study.
Likewise, on the role of politics, the way we envisioned our question
is how far can we get in explaining the changes in stabilization policy
with only the change in policymakers' beliefs. Again, I agree that an ele-
ment of politics is certainly important. What I think surprised us is how
far we could get in explaining the evolution of policy with only views.
On Chairman Martin, one thing to say is he may have not said that
he had a macro model, but he had a framework. He was making deci-
sions, he had views about how the economy worked, and what infla-
tion did to the economy. You can't make policy without some view
about how the economy works. On this idea about how quickly the
framework changes, and how Martin changes, it is not necessarily that
a particular person.s view changes. Rather, what may change is the
belief carrying weight within the FOMC. Our view of Martin is that at
some point.and again this is speculating and something we are work-
ing on.loses faith in his own framework, the framework that had
inflation being very costly.
In response to Allen Sinai's comment on the Greenbooks, again
we're looking for data. We were trying to get some indicator of poli-
cymakers' beliefs other than narrative evidence. When the Fed staff
members make their forecast, does that reflect the Board? Does it
influence the Board? I guess my naive view is that if the staff were
coming in with a wacky model that wasn't being supported by the
members of the FOMC, they wouldn't be there for long. So, I would
still stand by this notion that there is some relationship between the
model inherent in the staff forecast and the beliefs of actual policy-
makers. And, whether the modern Federal Reserve rejected the natu-
ral rate hypothesis in the 1990s, I think the much more plausible view
of what happened is that they kept the framework and they greatly
lowered the estimate of the natural rate. So, I don't think you have to
say they threw away the whole model.
Mr. Romer: Two very brief things. Alan cited the standard error for
estimates of the natural rate. That was a paper published in roughly
1997. It was a stunning result. Reading especially the Economic
Reports of the 1960s, you expect from their tone to see the second and
third decimal places on their estimates of the natural rate. They really
think they understand what is going on, and they are willing to dis-
count evidence that goes against it. They are willing to work very hard
to move the economy to what they think is the natural rate.
Regarding politics, Tom Mayer had a line that I found very persua-
sive. He said, .If the political story were really central, what you
would see in reading the records of the Fed, is that the Fed is straining
at the leash all the time.. You occasionally see a Fed that is in conflict
with the White House. You don't see a Fed that for two decades is try-
ing to do something that it wants to do but feels grossly constrained by
outside pressures."
In empathy with the Romers, my paper could have discussed more points in the
Romers' paper. Furthermore, I could have developed my paper a bit further as
reflected by my ambitious outline (as pointed out by Dr. H. Gram as it pertains to a
three page paper of summary). However, (as I implied in the prior parenthesis),
is not that I don't think these issues are important, it is just that they are beyond
the scope of this paper. (A paraphrased comment from Ms. Romer's response in
The General Discussion held by Dr. Sargent).
