On the meaning of "two goals"

Persistent attempts to expand the economy beyond its long-run growth path will press capacity constraints and lead to higher and higher inflation, without producing lower unemployment or higher output in the long run. In other words, not only are there no long-term gains from persistently pursuing expansionary policies, but there's also a price—higher inflation.

- The Federal Reserve Bank of San Francisco

What strikes me immediately is the absolute assurance of that statement. It is by no means offered as an economic theory, but as certain beyond doubt.

What strikes me next is that I don't like the statement. I still want to get the economy growing. I want to get around the obstacle that FRBSF puts in my way.

But, you know, it has to be true: Persistent attempts to expand the economy beyond its long-run growth path will press capacity constraints... Even if we don't know what "the long-run growth path" is. Actually, I'm thinking they meant "the long-run potential growth path". Yeah, that's what I was thinking.

I'm going with it. If I'm putting words in FRBSF's mouth, so be it.

Persistent attempts to expand the economy beyond its potential will press capacity constraints and lead to higher inflation.

Tautology, isn't it? Repeating the same thought in different words, no?

The quote sets up potential output as a standard by which perfection is measured, sorta like the model Hollie Witchey or the phrase "Don't mess with Mother Nature".

You can't do anything about inflation, the quote tells us. You can't do anything about unemployment. And you can't do anything about capacity constraints -- except, of course, you can make demand-side sacrifices to a supply-side god.

But you know, we've been pressing capacity limits and getting inflation at lower and lower levels for two generations now. So FRBSF's analysis is iffy.

And, you know, we don't really know the true path of potential output. Yes, without doubt, there is one. And that fact adds strength to FRBSF's claim. But don't let them fool you. Just because there *is* a true path of potential output, doesn't mean we're on that path.

And it doesn't mean, if we're not on it, that we know *why* we're not on it.


From the same article:

Monetary policy has two basic goals: to promote "maximum" sustainable output and employment and to promote "stable" prices...

Are the two goals ever in conflict?

Yes, sometimes they are. One kind of conflict involves deciding which goal should take precedence at any point in time... Another kind of conflict involves the potential for pressure from the political arena.

Wrong answer.

Hey, I know they dumb this stuff down so that people like me can "get" it. But the second kind of conflict they describe has nothing to do with economic analysis. And the first one is just a bad answer.

If you have two goals, you're supposed to have two goals. You're not supposed to have one goal for a while, and then switch off and have the other goal for a while. If that is your strategy, you failed from the start.

Despite what everyone says, though, the Federal Reserve is not a complete and utter failure. There was a time there, after the second World War, when inflation and unemployment were both pretty low for a spell.

Two goals: To control inflation by limiting demand, and to control unemployment by unleashing demand. Are the two goals ever in conflict?

The two goals are always in conflict.


It is a beautiful day. There is a magnificent, wide boulevard with fields of flowers left and right. We put the top down. We drive.

When there is inflation, there is too much spending, the road is too wide on the right. Policy makes a correction, and the pavement narrows a bit.

When there is unemployment, we need more spending, the road is too wide on the left. Policy makes a correction, and the road narrows a bit.

We drive. The road occasionally narrows a bit. We drive.

The road narrows. We find ourselves coursing a mountain, with solid rock on the one side and sheer drop on the other. We drive. The road narrows.

There is inflation, and the rock face comes closer to us. There is unemployment, and the sheer drop comes closer to us. We drive. Suddenly we realize there is no guarantee that the road will always be as wide as our vehicle. Then it starts to snow.

The economy of the 1950s provided a wide boulevard for policy actions. But the road narrowed substantially by the 1970s. And it has continued to narrow while both the terrain and the weather became less accommodating. Our own policy choices narrow the options left open to us and put us on a path we cannot navigate, going to a place we do not want to be.

The problem is not the Federal Reserve. The problem is that we do not know how to deal with the fact that our goals are always in conflict.

We want to be moving full speed ahead, but policy has created a narrow, washed-out, dangerous dirt road that leads up a mountain to nowhere.


We know there is a true path of potential output, just as there is a median family income, and just as there is a "best case" in any set of options. There is some dispute over what that true path is. So policymakers work backwards, believing that if there is too much inflation we are pressing the limits of capacity, and the road must be narrowed further.

But it is our make-the-road-narrow policy that undermines and reduces the long-run potential growth of output.

When their concern is inflation, policymakers raise interest rates and take money out of circulation. When their concern is unemployment, they reduce interest rates and encourage the use of credit.

But our concern, really, is always inflation and unemployment. Two goals. To honor these goals, policymakers raise and lower interest rates. And they take away money but encourage the use of credit.

They take away money but encourage the use of credit: They make using money more costly, and they leave us with nothing but debt.

Making money more costly is an unintended consequence of policy. It arises from the effort to meet goals that are always in conflict.

And debt? Debt is not the consequence of government spending or prodigal consumers or bad business practice. Not the massive debt we have. Our debt is an unintended consequence of policies that remove money from circulation and encourage the use of credit.

It is all just one big mistake.