[MUSIC] Now besides demonstrating how politics, coupled with Keynsian activism, can lead to such an inflationary spiral. This Monetarist-inspired story I have told you also raises an obvious policy question. Namely, how do you stop such an inflationary spiral? To the monetarist, the solution is simple. Stop using expansionary Keynesian policies. And allow the economy to return to the natural or lowest sustainable rate of unemployment. But, of course, you see the problem. Even if we stop the upward spiral of inflation, we still have significant inflation. This is because a higher core rate of inflation has been built into the economy. Specifically, in this case, even if we stop inflation's upward spiral, we may still find ourselves stuck at point A three in the figure, with a new and higher inertial rate of inflation of 9%. Here's the worst part of this dilemma. Neither the traditional Keynseian or monetarist approaches to wringing this inflation out of the economy has any political appeal. The traditional Keynesian solution is a so-called incomes policy. Impose wage and price controls until the inflation dissipates. One problem with this approach, however, is that it may not work. This is a lesson President Nixon learned when his administration imposed temporary wage and price controls in 1971. And then watched helplessly as inflation jumped right back up into double digits, once the controls were lifted in 1973. The other problem with an incomes policy, is that it runs contrary to the ideological beliefs of the majority of Americans who see this country as a bastion of free market capitalism. But simply, businesses don't want the heavy handed government holding down their prices. And workers don't want that same government holding down their wages. Accordingly, there are very few advocates of wage and price controls today. That leaves the Monetarists' solution, and from a political point of view, it is equally unpalatable. Specifically, Monetarists believe that the only way to wring inflation and inflationary expectations out of the economy, is to have the actual inflation rate below the expected inflation rate. However to achieve this, the actual unemployment rate must be above the natural rate of unemployment. That means only one thing. Inducing a recession. This is at least one interpretation of what the federal reserve did beginning in 1979 under the monitors banner of setting monetary growth target. In 1979 the Fed under chairman Paul Volcker adopted a sharply contractionary monetary policy and interest rates soared to over 20%. The resulting recession was the worst since the great depression. And it probably cost President Jimmy Carter the 1980 election and a second term. Nonetheless, the Fed's bitter medicine worked. Between 1979 and 1984, inflation fell dramatically. But at great human and economic cost. This table estimates the economic cost of reducing the inertial rate of inflation in 1979 of 9%, to 4% by 1984. Over this period, because of the recession induced by the Fed, the economy produced $1.5 trillion dollars less than its potential GDP. While this $1.5 trillion dollars may have been the economic price tag of the Fed's monetarist experiment. There was a perhaps even more profound political result. The hard economic times left a bitter taste in the mouths of the American people. Now hungry for a sweeter macroeconomic cure than either the Keynesians or monetarists could offer. Enter stage right, supply side economics. [MUSIC].
