And that leads us to Lesson 5: to achieve good macroeconomic outcomes, the central bank should have sensible objectives that include aversion to both inflation and unemployment. During the Fabulous Decade, the Greenspan Fed revealed itself to be much enamored of economic growth - much more so than, say, the old Bundesbank or the current European Central Bank, with its mandate to pursue price stability only. It is true that the favorable supply shocks of the later 1990s cut the FOMC a lot of slack: even though they allowed aggregate demand to soar, inflation fell. But think about what the Fed did both before and after the good luck period (1996-98). By the fall of 1995, Greenspan had already been chairman of the Fed for eight years, and during that time the inflation rate had been beaten down from about 4 percent to about 3 percent. Does that suggest a single-minded devotion to the goal of price stability? And after core inflation bottomed out at just below 2 percent at the end of 1999, it crept up more than 0.5 percentage point (as of this writing) without any noticeable effort by the Fed to push it back down. (The Fed has been pretty clear that the 1999-2000 tightening cycle was intended to slow the growth rate of aggregate demand to that of aggregate supply, thereby capping inflation - not bringing inflation back to 2 percent.) Headline inflation has roughly doubled, largely because of rising energy prices, and the Fed has essentially swallowed this increase with barely a whimper.
The Federal Reserve's attitudes toward inflation and unemployment - and especially the way it "split" the gains offered by the supply shocks - go a long way, we believe, toward explaining why the Fabulous Decade was so fabulous.
Janet Yellen, the Eugene E. and Catherine M. Trefethen Professor of Business Administration at the Haas School of Business, was a member of the Federal Reserve Board from 1994 to 1997 and then served as chair of the Council of Economic Advisors at the end of the second Clinton administration. Alan Blinder, professor of economics at Princeton University, served on the Council of Economic Advisors in the first Clinton Administration and then as vice chairman of the Board of Governors of the Federal Reserve system from 1994 to early 1996.
Reprinted with permission from Alan Blinder and Janet Yellen, "The Fabulous Decade: Macroeconomic Lessons from the 1990s" (New York: The Century Foundation Press, 2001).
Main Story /
Lesson 1 /
Lesson 2 /
Lesson 3 /
Lesson 4 /