ABSTRACT
As the long recession of the early 1990s made clear, there is something fundamentally wrong with macroeconomic policy-making in the United States. In the face of enormous economic stress, fiscal policy sat immobilized, leaving to monetary policy the job of fighting the economic slump. The Federal Reserve’s policy of repeated but hesitant and small reductions in interest rates, guided by its overriding concern about fighting inflation, has failed to restore robust economic growth.
Monetary policy’s failure is only the latest in a series of monetary policies that have failed to restore the U.S. economy to health and, at worst, have been a significant part of the U.S. economy’s problems. Since 1979, the Federal Reserve has been conducting a policy biased toward fighting inflation, even at extraordinarily high costs in terms of economic growth, productive investment, and unemployment.
What is required is a new set of goals for monetary policy. Monetary policy should focus more on promoting productive investment and fighting unemployment, giving these goals equal weight with maintaining a stable rate of inflation. To implement the new set of goals, a new policy structure is also required—one in which the Federal Reserve is more accountable to the public, in which monetary policy coordination with fiscal policy is facilitated, and in which policies to improve credit allocation and reduce financial speculation are implemented as needed.
However, there are three major, commonly perceived obstacles to shifting the goals of monetary policy: the costs of inflation itself (the inflation constraint), the constraints imposed by highly integrated international financial markets (the external constraint), and the difficulties of controlling the activities of huge and highly liquid financial markets (the financial market constraint).
In an evaluation of these three constraints, it is crucial to make a distinction between two aspects of each one: economic barriers, which relate to the effects 66of policies on the size of the economic pie, and political barriers, which involve the effects of policies on the distribution of that pie among different groups. Groups harmed by policies try to put up political barriers to changing them, often by arguing that the policies would have large economic costs.
This chapter argues that the economic constraints to reorienting monetary policy away from a sole concern with inflation fighting, though sometimes important, are not as serious as widely believed; on the other hand, the political barriers can be very strong and therefore must be challenged.
