Academic journal article Economic Commentary (Cleveland)

Monetary Policy in the Cold War Era

Academic journal article Economic Commentary (Cleveland)

Monetary Policy in the Cold War Era

Article excerpt

The Soviet Union officially disbanded on December 26, 1991, one day after the resignation of Mikhail Gorbachev. Ever since, the countries that made up the former USSR have been struggling both to govern themselves and to find their places in the world. The cold war against communism was over.

The palpable threat of nuclear attack by the Soviet Union brought a high degree of cohesion to U.S. foreign and defense policies. Now, the vacuum created by the "evil empire's" collapse is prompting questions that remain largely unanswered. Do we still have adversaries, and, if so, what harms can they inflict? How can we best achieve our objectives, and to what lengths are we willing to go to fulfill them? How much will these efforts cost? In a dangerous world, how much risk should we bear? Answering these questions requires making choices, and each choice comes with its own price tag. Like the former Soviet republics, we too are struggling to define our relationships with the rest of the world.

Complicating the reconstruction of a new foreign-policy framework is the fact that, seven years after the fall of the Berlin Wall, the United States faces fewer evident threats to its national security than at any time since World War II. Some argue that our defense establishment is paranoid when it seeks public support for more resources. It's not that Americans no longer care about national security. Rather, the public expects the Defense and State Departments to justify their policy stances in terms of a new world order-one that no one yet fully grasps.

I suggest that there is an analogy between the search for this new world order in foreign policy and recent attitudes about monetary policy. The cold war against communism is indisputably over; however, can the same be said about the war against inflation? The U.S. economy has been expanding almost continuously for 15 years, the unemployment rate lies near 5 percent, and inflation pressures appear scant. Yet, to take a hard line against inflation today is, like being opposed to communism, passe. Are people who advocate a pricestability objective for monetary policy indeed fighting the last war?

*The War against Inflation

In 1979, in the midst of the cold war, the United States initiated a "hot war" against another seemingly implacable foe-inflation. President Carter appointed Paul Volcker to head the Federal Reserve, giving him a mandate to eliminate double-digit inflation. In conducting that war, the Fed relied on demonstrably tight monetary policy and the public's willingness to suffer temporarily higher unemployment rates if warranted. Inflation was so intolerable that having a numerical goal was unimportant; all that mattered was bringing it down. With the support of President Reagan, the Volckerled Fed continued its use of heavy artillery to end the inflationary spiral, reducing the core inflation rate from 11 percent to 5 percent by 1983.

Under the leadership of Alan Greenspan, who took the helm in 1987, the Federal Reserve continued its battle against inflation, which it described as a campaign to achieve price stability. With inflation now a lower-level threat to economic progress, the Fed could squeeze it down more gradually. Initially, the Greenspan Fed followed a course of limited aggression and persistently combative rhetoric. This strategy finally paid off in 1991. As Boris Yeltsin faced down a tank in Red Square, the U.S. inflation trend collapsed from 5 percent to 3 percent, capitulating to a seven-year siege. The Federal Reserve reduced inflation to levels not seen since Sputnik. The monetary policy hot war was over, and the United States could feel proud of its victory.

*The Monetary Cold War Era

The surprisingly swift transition to lower and more stable inflation rates caused some to declare that inflation was dead. The economy's pace faltered after the Gulf War, and the nation's attention was focused on expansion and employment, not inflation. …

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