ABSTRACT
While economists generally accept that monetary policy can influence nominal variables such as the price level and inflation, they continue to debate the relationship between monetary policy and real variables such as the unemployment rate and real gross domestic product (GDP). Validation of the Phelps-Friedman argument by the experience of the 1970s still left open the possibility that policymakers might exploit a short-term or transitory link between inflation and real activity to smooth business cycle fluctuations. The strong growth of real GDP over this period could thus be interpreted as reflecting an upward shift in the economy’s ability to produce goods and services—a shift that people view as permanent based on the strong growth of their consumption.
