It was big news last week when the Federal Reserve announced that it wants to maintain its current low-interest rate policy until unemployment, now 7.7 percent, drops to at least 6.5 percent. The Fed was correctly portrayed as favoring job creation over fighting inflation, though it also set an inflation target of 2.5 percent.
What was missing from commentary was caution based on history: The Fed has tried this before and failed — with disastrous consequences.
By "this," I mean a twin targeting of unemployment and inflation. In the 1970s, that's what the Fed did. Targets weren't announced but were implicit. The Fed pursed the then-popular goal of "full employment," defined as a 4 percent unemployment rate; annual inflation of 3 percent to 4 percent was deemed acceptable. The result was economic schizophrenia. Episodes of easy credit to cut unemployment spurred inflation, which inspired tighter credit that boosted joblessness. By 1980, inflation was 13 percent and unemployment, 7 percent.