Essays in the Tradition of Jane D'Arista
Edited by Gerald A. Epstein, Tom Schlesinger and Matías Vernengo
Chapter 4: Federal Reserve priorities and the influence of capital: the evolution of monetary policy in the postwar period
Falling unemployment raises fears of rising wages, and may force the Federal Reserve to raise interest rates in order to head off inflation. This mantra was repeated over and over again by newspaper, TV, and radio correspondents in the 1980s and 1990s, conveyed to the public as if it were the obvious, and only, conclusion one could draw from the unemployment data. These commentators, either explicitly or implicitly, were basing their analysis on two important assumptions. The first is the non-accelerating inflation rate of unemployment, or NAIRU, the doctrine that asserts that inflation will accelerate if the unemployment rate drops below a fixed level, estimated in the early 1990s to be 6 percent. The second is that price stability, or zero inflation, is the only goal that the Federal Reserve should try to achieve with monetary policy. Thus, if the unemployment rate threatened to fall below NAIRU, the Fed would have no choice but to raise interest rates. The unemployment rate did in fact drop below 6 percent in 1994, and the Federal Reserve responded by raising the federal funds rate from 3 percent in 1994 to 6 percent by early 1995 (see Figure 4.1). Interestingly, not only did the unemployment rate continue to fall, but the inflation rate remained remarkably stable, at approximately 3 percent. Adherents to NAIRU scrambled to reinterpret the concept, despite its obvious empirical contradiction.
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