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The Evolution of Economic Understanding and Postwar Stabilization Policy

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  • Christina D. Romer
  • David H. Romer

Abstract

There have been large changes in the conduct of aggregate demand policy in the United States over the past fifty years. This paper shows that these changes in policy have resulted largely from changes in policymakers' beliefs about the functioning of the economy and the effects of policy. We document the changes in beliefs using contemporaneous discussions of the economy and policy by monetary and fiscal policymakers and, for the period since the late 1960s, using the Federal Reserve's internal forecasts. We find that policymakers' understanding of the economy has not exhibited steady improvement. Instead, the evidence reveals an evolution from a fairly crude but basically sound worldview in the 1950s, to a more sophisticated but deeply flawed model in the 1960s, to uncertainty and fluctuating beliefs in the 1970s, and finally to the modern worldview of the 1980s and 1990s. We establish a link between policymakers' beliefs and aggregate demand policy by examining narrative evidence on the motivation for key policy choices. We also compare monetary policymakers' choices with the implications of a modern estimated policy rule and show that the main differences are consistent with the changes in beliefs that we observe.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9274.

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Date of creation: Oct 2002
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Publication status: published as Christina D. Romer & David H. Romer, 2002. "The evolution of economic understanding and postwar stabilization policy," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 11-78.
Handle: RePEc:nbr:nberwo:9274

Note: DAE EFG ME
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  1. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  2. Romer, Christina D. & Romer, David H., 1994. "Monetary policy matters," Journal of Monetary Economics, Elsevier, vol. 34(1), pages 75-88, August.
  3. Orphanides, Athanasios, 1999. "The Quest for Prosperity Without Inflation," Working Paper Series 93, Sveriges Riksbank (Central Bank of Sweden).
  4. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  5. Frederic S. Mishkin, 1981. "The Real Interest Rate: An Empirical Investigation," NBER Working Papers 0622, National Bureau of Economic Research, Inc.
  6. John B. Taylor, 1998. "An Historical Analysis of Monetary Policy Rules," NBER Working Papers 6768, National Bureau of Economic Research, Inc.
  7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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