6 - Inflation Is a Nonmonetary Phenomenon

Summary

From the mid 1960s through the end of the 1970s, low, stable unemployment became an objective of monetary policy. The resulting experiment in aggregate demand management produced what became known as stop–go monetary policy. The assumption that monetary policy could control the unemployment rate rested on a nonmonetary view of inflation. If real factors controlled inflation, the Fed could manipulate aggregate nominal demand to control unemployment.

Inflation at Full Employment

In the Kennedy administration, the conservatism of Treasury Secretary Douglas Dillon, Treasury Undersecretary Robert Roosa, and William McChesney Martin shaped policy. However, the activist Council of Economic Advisers chaired by Walter Heller shaped the intellectual climate. It wanted to make the 1946 Employment Act the organizing force behind economic policy. Although the act mandated “maximum employment” as a national goal, its general language robbed it of substance. As written, it was nothing more than a statement of good intentions.

The CEA made the Employment Act into a driving force for expansionary policy by assigning a number to full employment. “[A]n unemployment rate of about 4% is a reasonable and prudent full employment target for stabilization policy” (1962 Economic Report, 46). Henceforth, unemployment rates in excess of 4% generated public pressure for activist policies. Four percent unemployment became the banner for economic activism. Walter Heller (Hargrove and Morley 1984, 176) said later: “Putting … goals in quantitative terms was … terribly important. … [Q]uantitative goals … [got] the president committed to an expansionary economic policy.