Published online by Cambridge University Press: 24 March 2010
Developments in the U.S. economy in the first half of the 1980s were dominated by a dramatic shift in the mix of fiscal and monetary policy. A restrictive monetary policy aimed at controlling inflation was combined with a highly stimulative fiscal policy that propped up domestic demand. The major benefit of the policy mix has been a large decline in inflation at less cost in terms of domestic unemployment than would otherwise be the case. The combination of fiscal expansion and monetary restraint also led to an appreciation of the dollar exchange rate, thereby reducing import prices and inflation while sustaining domestic output. The exchange rate revaluation shifted much of the burden of reducing inflation to other countries, as the price of internationally traded goods fell in dollars and rose in other currencies.
The cost has been the decline in the national saving rate and large current account deficits. Thus, the policies placed a burden on future generations, who will inherit less wealth; and the loss of international competitiveness has had a severe impact on U.S. export- and import-competing industries. The federal budget deficit now absorbs nearly two-thirds of net private saving and the United States must borrow 3 percent of its income annually overseas. Between 1980 and 1985 the rise in the exchange rate drove up the cost of producing goods and services in the United States by more than 40 percent in comparison with the cost to its major competitors.
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