Inflation, Unemployment, and Monetary Policy (Alvin Hansen Symposium Series on Public Policy)

137 Pages·1999·1.66 MB·English

by  Robert M. Solow

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Inflation, Unemployment, and Monetary Policy
Robert M. Solow and John B. Taylor
The Alvin Hansen
Symposium on
Public Policy
Harvard University
edited and with an
introduction by
Benjamin M. Friedman
The MIT Press
Cambridge, Massachusetts
London, England
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First MIT Press paperback edition, 1999
© 1998 Massachusetts Institute of Technology
All rights reserved. No part of this book may be reproduced in any form by any electronic or mechanical
means (including photocopying, recording, or information storage and retrieval) without permission in
writing from the publisher.
This book was set in Palatino by Achorn Graphic Services and was printed and bound in the United
States of America.
Library of Congress Cataloging-in-Publication Data
Alvin Hansen Symposium on Public Policy (1st: 1995: Harvard
University)
Inflation, unemployment, and monetary policy / Robert M. Solow
and John B. Taylor; edited and with an introduction by Benjamin M.
Friedman.
p. cm.
Papers and discussion presented at the First Alvin Hansen
Symposium on Public Policy, held at Harvard University on April 24,
1995.
Includes bibliographical references and index.
ISBN 0-262-19397-3 (hc : alk. paper), 0-262-69222-8 (pb)
1. Monetary policy—United States—Congresses. 2. Inflation
(Finance)—United States—Congresses. 3. Unemployment—United
States—Congresses. 4. Board of Governors of the Federal Reserve
System (U.S.) I. Solow, Robert M. II. Taylor, John B. III. Title.
HG540.A37 1995
332.4'973—dc21 97-14979
CIP
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Contents
Introduction vii
Benjamin M. Friedman
1 How Cautious Must the Fed Be? 1
Robert M. Solow
2 Monetary Policy Guidelines for Employment and Inflation Stability 29
John B. Taylor
3 Comments 55
Benjamin M. Friedman
James K. Galbraith
N. Gregory Mankiw
William Poole
4 Responses 89
Robert M. Solow
John B. Taylor
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5 Rejoinder 103
John B. Taylor
Robert M. Solow
Contributors 107
Notes 109
References 111
Index 115
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Introduction
Benjamin M. Friedman
The connection between price inflation and real economic activity has been a central focus of interest to
macroeconomists for much of the last century. It has likewise been a, if not the, central issue in the
making of monetary policy. Moreover, opinion among both economists and policymakers has swung
widely over the years on even the most basic questions concerning how economies actually behave in
this regard, and therefore on just what monetary policy can and should do.
As of today, practically everyone interested in the conduct of monetary policy acknowledges that central
bank actions can and often do affect both inflation and measures of real economic activity like output,
employment, and incomes. Modern macroeconomics has established familiar sets of conditions under
which this would not be so—that is, conditions under which monetary policy would influence prices
while leaving aggregate real activity unchanged—but to state these conditions and understand just how
they would render monetary policy neutral in this sense is different from believing that they actually
obtain in any known
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economy. As a result, the tension created by the joint effect of central bank actions on inflation and on
aggregate output, or employment, is usually of the essence whenever public policy discussion turns to
monetary policy.
Merely to say that monetary policy affects both inflation and real economic outcomes, however, is to
ignore the subtlety of the matter as well as to understate the difficulty of the resulting set of problems
confronting monetary policymakers. The two-way interaction between monetary policy and economic
behavior is a process that operates over time. Some consequences of central bank actions occur before
others. Some are permanent, others only transitory. And some may be transitory yet sufficiently
long-lasting that in the eyes of policymakers and the public (not to mention researchers who try to infer
such distinctions on the basis of empirical evidence), for all practical purposes they might just as well be
permanent. These complex and imperfectly understood dynamics present particular difficulties for
monetary policymakers, whose responsibility it is in a democratic system to reflect public views of the
public good.
A key reason for the continual evolution of opinion on how policymakers should resolve these and other
related tensions is the difficulty of establishing with any precision how the world that is relevant to
monetary policymaking actually works. Macroeconomics is not a laboratory science. The basis for
distinguishing among competing hypotheses is not replicated experimentation, but inference from limited
actual experience that normally represents anything but a controlled experiment. Hence the same
observed behavior of the economy—the same recessions, the same inflations,
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the same economic responses to not only central bank actions but also fiscal changes and asset price
movements and exchange rate variations and oil price shocks and countless other events, all happening at
once—is subject to sometimes widely differing interpretations. And, moreover, objective aspects of the
economic environment also change. Even if economists at some time could give policymakers a
satisfactorily accurate description of how specific central bank actions affected inflation and real activity,
changes over time in the composition of industry, in the structure of the financial markets, in the
economy's openness to flows of goods and assets, in government regulation, and in everyday business
practice would soon render that description out of date.
The papers presented by Robert Solow and John Taylor at the first Alvin Hansen Symposium on Public
Policy address the practical dilemma currently confronting American monetary policy. Inflation has
slowed from the rapid pace that aroused such intense public dismay a decade and a half ago. Economic
expansion since the last recession ended has been persistent though hardly vigorous. Both employment
and unemployment have reached levels that in the past have often caused prices to accelerate. In these
circumstances policymakers face opportunities as well as risks, and the uncertainties—not only on
specifics but also about more fundamental aspects of how the economy behaves and how monetary
policy affects that behavior—are, as always, large. How, then, should the Federal Reserve System
proceed? The objective of these papers and the discussion that follows is to make a practical contribution
to resolving this important public policy question.
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Acknowledgments
The papers and discussion published here were presented at the first Alvin Hansen Symposium on Public
Policy, held at Harvard University on April 24, 1995. In introducing these proceedings, I want to express
my very sincere personal thanks, as well as the gratitude of the Harvard Economics Department, to
Marian Hansen Merrifield and Leroy Sorenson Merrifield. Their generosity has made possible not only
this first Alvin Hansen Symposium but also the entire series of public policy symposia that the
Economics Department will now sponsor at Harvard in Alvin Hansen's name. I have enjoyed enormously
working with Marian and Leroy throughout the process of establishing this symposium series. I admire
both their generosity and their sense of public purpose.
Numerous former students of Alvin Hansen also contributed to making this symposium series possible,
and on behalf of the Harvard Economics Department I thank them as well. Their eager participation in
this effort stands as testimony to the profound and positive effect that Professor Hansen had on so many
younger economists.
I am also grateful to James Duesenberry and Richard Musgrave, who served with me on the organizing
committee that established the Alvin Hansen Symposium series and then arranged the content of this first
symposium; to Helen Deas, who did a prodigious amount of work in arranging the symposium's logistics;
to Terry Vaughn of the MIT Press, for his support in bringing these proceedings to publication; and
especially to Robert Solow and John Taylor, as
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well as my three fellow discussants, for contributing their papers and comments.
In 1967 Alvin Hansen, then in his 80th year, received the American Economic Association's Francis E.
Walker medal. James Tobin, in presenting this award, described him as follows:
Alvin H. Hansen, a gentle revolutionary who has lived to see his cause triumphant and his heresies orthodox,
an untiring scholar whose example and influence have fruitfully changed the directions of his science, a
political economist who has reformed policies and institutions in his own country and elsewhere without any
power save the force of his ideas. From his boyhood on the South Dakota prairie, Alvin Hansen has believed
that knowledge can improve the condition of man. In the integrity of that faith he has had the courage never to
close his mind and to seek and speak the truth wherever it might lead. But Professor Hansen is to be honored
with as much affection as respect. Generation after generation, students have left his seminar and his study not
only enlightened but also inspired—inspired with some of his enthusiastic conviction that economics is a
science for the service of mankind.