Historically, economists saw a tradeoff between inflation and unemployment which came to be famously represented in the Phillips Curve.  Our economy's experience with stagflation (rising prices and high unemployment) in the 1970s suggested that a strict long-term relationship between the two variables was anything but a law.  Nevertheless, there came to be a division among voting members of the Federal Open Market Committee, which convenes to set interest rates.  There were two camps, those who favored price stability-- the inflation hawks, and those who favored stronger economic growth-- doves.

     The 1970s and 1980s created a large number of inflation hawks.  During the period, soaring oil prices and general inflation eroded real incomes and caused significant economic damage.  Many economists, including Nobel winner Milton Friedman, had long attributed inflation to excessive monetary growth.  Some policy makers even perceived inflation as another form of taxation, because excessive monetary growth granted larger seignorage (or a greater amount of money for the government to spend).  In some sense this is true, particularly in the developing world.  In many countries, the monetary authority lacks any serious level of independence from political influence.  This creates a principal agent problem in which government doesn't always act in the best interest of citizens to control the price level.

       When a central bank lacks power to responsibly manage the money supply, or when the government simply takes control and prints money to suit its needs, the government can benefit from the added revenue.  At the same time, serious damage is done to consumers, savers, and lenders.  One current Fed President noted for being an inflation hawk is Richmond Fed President Broaddus.  During one speech to homebuilders in Virginia during a period of high interest rates, Broaddus found himself face to face with a crowd carrying two-by-fours as a sign of protest.

      President Broaddus was noted for dissenting from Federal Reserve policy in favor of higher interest rates in the early 1990s.  Greenspan's reign as Fed Chairman has been characterized by unanimous interest rate decisions-- to the extent that Broaddus has been almost alone in moving against the herd so often.  Today, distinctions between doves and hawks are much less common.  The long-term Phillips Curve is rarely discussed as economic fact.  The fact is that worries over significant inflation simply aren't present in today's economy.  At the same time however, Broaddus has recently switched tracks, dissenting in favor of lower rates.  Why would someone so staunchly concerned with inflation make such a dramatic change?

      The answer is that Mr. Broaddus, as with many hawks, was concerned more with the concept of price stability than with preventing inflation.  Japan's recent decade long recession has helped to illustrate that an economy can suffer dramatic woes from falling prices, or deflation.  The lessons from Japan's situation, discussed in earlier newsletters covering liquidity traps, are indeed valuable.  It appears that Mr. Broaddus and his senior policy advisor Marvin Goodfriend, who happens to have advised the Bank of Japan in July, 2000, have taken these lessons to heart.  A commitment to price stability means acting to prevent not just dramatic inflation but deflation as well.  Such thinking can help keep America from suffering the same fate as our Pacific neighbor, a somewhat reassuring thought.