South-Western College Publishing - Economics  

Evaluating the New Economics
Subject Macroeconomic Performance
Topic Monetary Policy
Key Words Macroeconomics, Inflation, Unemployment, Growth, Federal Reserve, Larry Meyer, Alan Greenspan
News Story If we were to grade our current macroeconomic performance, the grade would have to be an "A." Inflation is low, the unemployment rate is close to a 25 year low, profits are rising, and the stock market has experienced the longest bull market on record. This raises the question as to whether current macroeconomic theory with its assumed underlying relationships between unemployment, growth, and inflation are still reliable or even valid.

The central tenet of policy making at the Fed has been that if the economy grows faster than a 2.2% rate for a long period with low unemployment and high capacity utilization, inflation will result. This, in turn, would dampen growth or even cut off the expansion and lead to unemployment and higher interest rates. Recent experience argues against this tenet and has led some to propose that we may have entered a new era of economics.

Larry Meyer, one of the governors on the Federal Reserve’s Board has argued that although the old limits may have changed, there still are new limits that must be respected. Mr. Meyer believes that good policy balances regularities and possibilities. Mr. Meyer still believes in the natural rate of unemployment and Phillips curve relationships. Mr. Meyer recently lowered his estimate of the natural rate of unemployment from 6 to 5.5%. Mr. Greenspan believes that policy makers need to be flexible in how they assess the economy’s performance. Clearly there is uncertainty about future inflation. Some would argue that the best course for monetary policy is to be reactive while others would argue for more aggressive measures. (Updated January 15, 1998)

Questions
  1. What is the Phillips curve?
  2. What is the natural rate hypothesis?
  3. What is the difference between a reactive monetary policy and an aggressive one?
Source Richard W. Stevenson, "Fed Official Resists Notion of a New Era in Economics," The New York Times, September 28, 1997

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