Deficits, Monetary Policy, and Real Economic Activity

The coincidence in the 1970s of apparently large, structural federal deficits, substantial and growing unemployment and inflation rising to double-digit levels brought widespread questioning of the hitherto dominant Keynesian paradigm. Indeed, Robert Lucas (Lucas and Sargent, 1978; Lucas, 1981) indicated this coincidence as a motivation for his own rejection of that paradigm and search for new macroeconomic theory. In short, he explained, the Keynesian model suggested that expansive fiscal and monetary policies might cause some inflation but would reduce unemployment. But to the contrary, he indicated, these policies begot accelerating inflation and high unemployment.