The Dollar and the Policy Mix: 1985

Abstract

In 1971, Robert Mundell proposed a stunning solution to the three problems then affecting the U.S. economy: high inflation and unemployment, and a weak currency. Mundell suggested that the policy mix of fiscal expansion and monetary contraction could work to raise output, reduce inflation, and strengthen the currency at the same time. This policy mix has been pursued under the Reagan administration since 1981. The paper investigates the contributions of this policy mix to disinflation and output growth. It finds that the policy mix has contributed as much as three percentage points of the reduction in inflation during 1981-84, but that the gains against inflation due to the mix will likely be lost, or more than lost, in the future.