August 12, 2019

The Fed and other policymakers have expressed a desire to return to interest rate normalcy. The question is how to achieve the objective. There are two distinct possibilities of generating a interest rate. An increase in aggregate demand will do the trick, as would a reduction in aggregate supply. However, the impact on the level of output GDP is very different. Notice that a demand driven increase in the real interest rate results in a higher level of output and employment, while a supply driven increase leads to a lower output and employment. Which solution should policymakers choose? The Humphrey-Hawkins legislation full employment mandate leads us in the direction of an aggregate demand shift.

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