The Fiscal-monetary Policy Mix

In the early postwar years, during the heyday of fiscal fine-tuning, monetary policy was not widely considered a particularly interesting or important topic. The predominant view was that the main function of monetary policy was to “stimulate” debt-financed purchases by keeping interest rates low. Inflation was first considered a useful lubricant to be traded for lower unemployment, and inflation could be reduced only by tolerating high unemployment. In the late sixties and early seventies, when the shrinking dollar proved less popular than expected, inflation was routinely described by a thermal metaphor (“overheating”), and regarded as an endemic problem to be endlessly “fought” by using fiscal policy (a surtax) and incomes policy (wage-price controls), but never monetary policy. In reality, the steadily accelerating inflation from 1965 to 1970 was not due to massive “guns and butter” budget deficits, as an historical hoax maintains, but to careless monetary policy. The deficit in 1967 was no higher than it was in 1998, as a share of GDP, and inflation did not reach 4 percent until after the surtax of mid-1968 when money growth briefly accelerated. As Karl Brunner and Alan Meltzer (1997: 69) later observed, “The reason for increasing money growth, in Keynesian analysis, was to get a proper mix of monetary and fiscal policy.”