Chapter 26 Transmission Mechanisms of Monetary Policy: The Evidence. Since 1980, the . economy has been on a roller coaster, with output, unemployment, and inflation undergoing drastic fluctuations. | Chapter 2O Transmission Mechanisms of Monetary Policy The Evidence PREVIEW Since 1980 the . economy has been on a roller coaster with output unemploy- ment and inflation undergoing drastic fluctuations. At the start of the 1980s inflation was running at double-digit levels and the recession of 1980 was followed by one of the shortest economic expansions on record. After a year the economy plunged into the 1981-1982 recession the most severe economic contraction in the postwar era the unemployment rate climbed to over 10 and only then did the inflation rate begin to come down to below the 5 level. The 1981-1982 recession was then followed by a long economic expansion that reduced the unemployment rate to below 6 in the 1987-1990 period. With Iraq s invasion of Kuwait and a rise in oil prices in the second half of 1990 the economy again plunged into recession. Subsequent growth in the economy was sluggish at first but eventually sped up lowering the unemployment rate to below 5 in the late 1990s. In March 2001 the economy slipped into recession with the unemployment rate climbing to around 6 . In light of large fluctuations in aggregate output reflected in the unemployment rate and inflation and the economic instability that accompanies them policymakers face the following dilemma What policy or policies if any should be implemented to reduce output and inflation fluctuations in the future To answer this question monetary policymakers must have an accurate assessment of the timing and effect of their policies on the economy. To make this assessment they need to understand the mechanisms through which monetary policy affects the economy. In this chapter we examine empirical evidence on the effect of monetary policy on economic activity. We first look at a framework for evaluating empirical evidence and then use this framework to understand why there are still deep disagreements on the importance of monetary policy to the economy. We then go on to examine the .
