Activist stabilization policy and inflation

There is widespread agreement that the objective of monetary policy in the United States over the past several decades has been the pursuit of price stability and maximum sustainable growth over time. Recent studies have suggested that activist stabilization policy rules that respond to inflation and the level of economic activity can achieve these objectives and attain both a low and stable rate of inflation as well as a high degree of economic stability. ¹ A critical aspect that differentiates these rules from alternative guides to policy such as policies that concentrate on inflation or stable money and nominal income growth, is the emphasis they place on the level of economic activity in relation to a concept of the economy’s potential—that is the “output gap” or the related “unemployment gap.” A prominent example of such a strategy is the policy rule proposed by Taylor (1993). Unfortunately as a practical matter, the informational requirements of implementing these activist policies, especially the measurement of the “output gap” or “unemployment gap” present substantial difficulties. As a result, activist stabilization strategies that might appear promising when these difficulties are ignored may instead prove counterproductive when implemented in practice.