The Evolution of Economic Understanding and Postwar Stabilization Policy

Over the past fifty years, there have been large changes in aggregate demand policy in the United States, and, as a consequence, substantial changes in economic performance. In the 1950s, monetary and fiscal policy were somewhat erratic, but moderate and aimed at low inflation.As a result, inflation was indeed low, and recessions were frequent but mild. In the 1960s and 1970s, both monetary policy and fiscal policy were used aggressively to stimulate and support rapid economic growth, and for much of the period unemployment was remarkably low. But inflation became a persistent problem, and periodic severe recessions were necessary to keep inflation in check. In the 1980s and 1990s, aggregate demand policy became more temperate and once again committed to low inflation. Not surprisingly, inflation has been firmly under control for almost twenty years now, and the American economy experienced two decade-long expansions at the end of the twentieth century, interrupted only by one of the mildest postwar recessions. Given the consequences of these changes in policy, it is important to understand what has caused them. Our contention is that the fundamental source of changes in policy has been changes in policymakers' beliefs about how the economy functions. We find that while the basic objectives of policymakers have remained the same, the model or framework they have used to understand the economy has changed dramatically. There has been, as our title suggests, an evolution of economic understanding. However, the evolution of economic understanding that has occurred is not one of linear progression from less knowledge to more. Rather, it is a more interesting evolution from a crude but fundamentally sensible model of how the economy worked in the 1950s, to more formal but faulty models in the 1960s and 1970s, and finally to a model that was both sensible and sophisticated in the 1980s and 1990s.download