James Tobin in “Living with Inflation” (1971):
The cruel choice between two evils, unemployment and inflation, has become the major economic issue of the day. Democrats and Republicans agree that both evils must be avoided and differ only on the means—with Democrats largely favoring the more drastic remedies. Congress has thrust upon the President authority for direct controls on wages and prices. The Administration has relied on traditional fiscal and monetary measures, including changes in taxes and spending and Federal Reserve control over the supply of money. First it tried to hold down prices by using tight money to restrain demand; now it is trying to create jobs by using budget deficits and easier money to expand demand. But the results, so far, are not encouraging. The traditional measures produced a recession and rising unemployment, but inflation hardly slowed down. Now both the recession and the inflation seem very stubborn.
Nevertheless, inflation and recession are usually alternative afflictions. One of the most dismal and best verified observations of modern economics is that there is ordinarily a trade-off between the rate of inflation and the rate of unemployment. Less of one means more of the other. Hence, full employment (which means an unemployment rate between 3 1/2 and 4 1/2 percent) can, on the average, be sustained only with 4 to 5 percent inflation. Price stability (another Pick-wickian term, meaning annual inflation of no more than 1 to 2 percent) is possible only with more than 5 percent unemployment.
We know that over the next 10 years things only got worse and only got better when Volcker decided that to “live with inflation” was not a good deal. And things really improved when the Fed managed to keep the economy tracking a stable nominal trend level path.
Now it´s Janet Yellen´s turn to head the process. The WSJ is not optimistic:
Markets are (mostly) cheering President Obama’s appointment of Janet Yellen to the second most powerful job in the world for its continuity: The current Federal Reserve vice chairman was present at the creation of Chairman Ben Bernanke’s extraordinary monetary exertions, and the market belief is that she will keep it all going. This may be true, yet it obscures an
Mr. Bernanke is more of an improvisational policy maker who came to his post-crisis actions by what he considers to be the necessities of the moment. His academic roots are as a monetarist, and he justifies his policy mainly in those terms. He considers his various quantitative easings to be entirely consistent with Milton Friedman’s monetary history of the Great Depression, however much other monetarists might disagree.
Ms. Yellen is a distinguished academic economist but she is also an unreconstructed Keynesian. She studied under James Tobin, the late Yale economist whose ideas dominated American economic policy from the 1950s through the 1970s. Friedman monetarism was in part a revolt against the Tobin school, which to oversimplify made unemployment a central focus of monetary policy. In the Tobin-Yellen view, the first task of a central banker is to promote full employment rather than to maintain price stability.
This is the intellectual underpinning to keep in mind when you read that Ms. Yellen favors “easy money” or is a monetary “dove.” And it has consequences that are likely to appear over time if she is confirmed by the Senate as expected.
One is that she believes wholeheartedly in the wisdom of government to steer the private economy and business cycle. When she testifies before Congress as chairman, you can expect her to support spending “stimulus” for growth in the short-term but tax increases to reduce deficits in the longer term. President Obama will not be disappointed.
Her ascension also means the revival of the Phillips Curve, and its academic cousin, NAIRU, or the non-accelerating inflation rate of unemployment. These nostrums hold that there is a trade-off between inflation and unemployment: that you can have rapid growth or low inflation, but you can’t have both at once for any length of time. Thus the Fed must constantly be fine-tuning Fed policy to manipulate the business cycle.
And they say good-bye to Bernanke with a ‘kick in the butt’:
Our view of the Bernanke era is that he contributed greatly to creating the bubble and panic, then acted admirably and creatively to stem the crisis. His policy since the recovery has failed to live up to its growth expectations, and now the verdict of history will depend on a monetary exit that Ms. Yellen will steer.
But the WSJ is wrong on both counts!
PS I hope Christy Romer is right:
“I think she is fundamentally committed to continuity, that we still have a problem and we still need monetary policy to be doing a fair amount,” said Christina D. Romer, a former chairwoman of Mr. Obama’s Council of Economic Advisers and a close friend of Ms. Yellen. “There’s a toughness there. And I think there’s a toughness to her that there isn’t in Bernanke.”