George Selgin has a new post on the Free Banking Blog that highlights the economic quandary the Fed now has the U.S. in. The post uses subtle sarcasm to make an excellent point, but many readers may miss Selgin’s main idea.
Selgin starts by discussing the current policy debate surrounding the Fed’s belief in achieving a trade-off between higher inflation and lower unemployment. That idea is simple: Shoot for higher inflation and you’ll increase interest rates, thus lowering the unemployment rate. Some inside the Fed, such as Janet Yellen, the candidate to succeed Fed chair Ben Bernanke, believe the Fed should actively try to induce higher inflation to drop the unemployment rate.
Aside from the question of whether undertaking this policy can be effective at all, there is at least one major historical problem: Implementing this policy led to high inflation and high unemployment in the 1970s. This combination is affectionately known as stagflation.
Selgin sarcastically gets to this issue at the bottom of his post:
It was the recession of 1960-61. The desired numbers were achieved by 1967. I can’t remember exactly what happened after that, though I’m sure it all went exactly as those clever theorists intended.
Of course, Selgin knows exactly how wrong the Fed’s Keynesian theorists were in the 1960s, as well as why they were wrong. We just need to make sure everyone else knows. Maybe Yellen reads the Free Banking Blog?