James Tobin in “Living with Inflation” (1971):
The cruel choice between two evils, unemployment and inflation, has become the major economic issue of the day. Democrats and Republicans agree that both evils must be avoided and differ only on the means—with Democrats largely favoring the more drastic remedies. Congress has thrust upon the President authority for direct controls on wages and prices. The Administration has relied on traditional fiscal and monetary measures, including changes in taxes and spending and Federal Reserve control over the supply of money. First it tried to hold down prices by using tight money to restrain demand; now it is trying to create jobs by using budget deficits and easier money to expand demand. But the results, so far, are not encouraging. The traditional measures produced a recession and rising unemployment, but inflation hardly slowed down. Now both the recession and the inflation seem very stubborn.
Nevertheless, inflation and recession are usually alternative afflictions. One of the most dismal and best verified observations of modern economics is that there is ordinarily a trade-off between the rate of inflation and the rate of unemployment. Less of one means more of the other. Hence, full employment (which means an unemployment rate between 3 1/2 and 4 1/2 percent) can, on the average, be sustained only with 4 to 5 percent inflation. Price stability (another Pick-wickian term, meaning annual inflation of no more than 1 to 2 percent) is possible only with more than 5 percent unemployment.
We know that over the next 10 years things only got worse and only got better when Volcker decided that to “live with inflation” was not a good deal. And things really improved when the Fed managed to keep the economy tracking a stable nominal trend level path.
Now it´s Janet Yellen´s turn to head the process. The WSJ is not optimistic:
Markets are (mostly) cheering President Obama’s appointment of Janet Yellen to the second most powerful job in the world for its continuity: The current Federal Reserve vice chairman was present at the creation of Chairman Ben Bernanke’s extraordinary monetary exertions, and the market belief is that she will keep it all going.
*Read the full blog post here.