There are times when the direction for fiscal and monetary policy is obvious. During the Great Recession in 2007-09, it was clear to most that the Federal Reserve should be reducing interest rates and the federal government should be running larger budget deficits, to counter the effects of the recession. Perhaps this seems obvious? But during the Great Depression in 1932, the federal government reacted to lost tax revenue from higher unemployment with a large tax increase. A year earlier in 1931, the Federal Reserve has raised interest rates out of desire to maintain the gold standard (that is, to keep the same value between US dollars and gold). Fiscal and monetary policy in the early 1930s were rowing together, but in the wrong direction.
Christina D. Romer discusses these and other episodes in “Rowing Together:
Lessons on Policy Coordination from American History” (Hutchins Center Working Paper #105, February 2026). She writes:
It is not enough for monetary and fiscal policy to be well coordinated. They also need to be moving toward the appropriate goal. To put it another way: Rowing together is great when the boat is headed in the right direction; it can be a disaster when the boat is headed in the wrong direction. Coordinated policy was a godsend in 2009; it was a tragedy in 1931. A corollary to this fundamental point is that sometimes rowing in opposite directions can be preferable. At least then, the boat stays where it is rather than move in the wrong direction. If monetary or fiscal policy is going astray, it is vitally important that the other tool of macropolicy be uncoordinated.
The current policy issue is that the federal government is running an expansionary fiscal policy with large budget deficits, and President Trump would like the Federal Reserve to run a more expansionary monetary policy as well with dramatic interest rate cuts. But as Romer points out in her review of historical examples, the US economy has some precedents here worth considering.
First, in the late 1960s and early 1970s, fiscal and monetary policy were coordinated on a substantial stimulus. There was a big tax cut in 1964, then spending increases related to the Vietnam War and social programs (“guns and butter,” it is sometimes called), followed by more tax cuts and spending increased when President Nixon assumed office. Meanwhile, the Federal Reserve was cutting interest rates. The new head of the Federal Reserve under Nixon, Arthur Burns, viewed himself as a political ally for Nixon and cut interest rates further in 1971 to stimulate the economy in the lead-up to the 1972 election.
A prevailing economic theory of that time held that stimulating the economy in this way could lead to faster growth and only modest inflation. That theory went badly off the tracks by the mid-1970s as inflation and recession combined in what was called “stagflation.”
A second example, from the late 1970s and into the early 1970s, was that the federal government kept running large budget deficits, in part in response to the deep recession of 1974-75 and the double-dip recessions from 1980-1982. However, the Federal Reserve under Paul Volcker did not coordinate with an expansionary monetary policy, and instead raised interest rates by six percentage points (!), and kept the rates that high for two years until inflation came down.
A third example, from the mid-1990s was that tax increases and minimal spending increases early in the Clinton administration, combined with the “dot-com” economic boom of the 1990s, led not only to lower budget deficits but to actual budget surpluses for a couple of years. During this time, the Federal Reserve did not raise interest rates, thus keeping a monetary stimuls in place. The overall result of this 1990s policy–contractionary fiscal policy and expansionary monetary policy–was that the US economy managed to dramatically reduce its budget deficits while continuing to grow.
These kinds of examples are what economists have in mind as they consider the current mix of fiscal and monetary policy. Here’s a figure showing the inflation rate on which the Federal Reserve focuses: core PCE inflation. “Core” means that price changes in food and energy are not included, because these fluctuate a lot, and the Fed is trying to focus on longer-term inflationary momentum. PCE refers to “personal consumption expenditures” index, which included more of consumer spending, and using a more flexible formula to allow for substitution between goods, than does the better-known Consumer Price Index measure of inflation.
Inflation spiked during pandemic, under pressure from coordinated strong expansions of fiscal and monetary policy, along with supply chain disruptions. Although core PCE inflation has come down since then, it’s still not yet down to pre-pandemic levels. In this situation, the Federal Reserve is going to be hesitant to cut interest rates dramatically. Among central bankers, the remembrance of what happened when Arthur Burns cut rates in the early 1970s and inflation took off remains crystal-clear.
As best I can tell, the strong preference for the Federal Reserve would be to re-run the 1990s, in which the government made a substantial effort to reduce budget deficits, and the Fed could then make sure that economic growth remained solid by counterbalancing the tighter fiscal policy with looser monetary policy. However, the Fed was also been gritting its teeth back around 2022 for a possible repeat of the early 1980s, when the central bank might need to fight inflation all by itself with a large jump in interest rates. Inflation has come down enough that a large jump no longer seems needed, but remains high enough that a large interest rate cut doesn’t make sense either. The lesson from the early 1970s about not letting a president prod a central bank into interest rate cuts for his own political purposes remains clear-cut, as well.
