Introduction

The past decade has seen major changes in U.S. macroeconomic and micro-economic policies. The large magnitude of these changes reflects fundamental changes in philosophy rather than countercyclical adjustments of policy. Such grand-scale experimentation with the economy has produced gross imbalances, which became indisputable in 1984 and 1985: (1) a federal deficit so large that it could not be cured by growth alone; (2) a dollar exchange rate so strong and a domestic market so open to international trade that most U.S. manufacturing sectors experienced recession-like conditions, even as national spending continued to rise strongly; and (3) monetary policies so narrowly focused on reducing inflation that surprisingly sharp and negative growth and trade consequences occurred.

At the same time, the trading partners of the United States pursued independent courses that proved to be very much at odds with U.S. policy. The government deficit reduction that was sought in Europe and Japan posed substantial problems for U.S. exporters and hence for national income and employment. The dollar rose sharply to reduce the market share of American goods, while fiscal restraint simultaneously reduced the growth of the total market. Finally, the consequent weakness in overseas labor markets prevented dismantling of protectionist barriers to U.S. exports of agriculture, technical products, or basic manufactured goods.

Now, in late 1985 and early 1986, policies are about to change course radically once more. The Federal Reserve explicitly broadened its objectives to include management of the exchange rate and support of real growth as at least equal priorities with inflation control.