Falling Behind the Curve: A Positive Analysis of Stop-Start Monetary Policies and the Great Inflation
This chapter examines the evolution of long-run inflation expectations and models the stance of US monetary policy from 1960 to 1980. It begins by considering several distinct measures of long-run inflation expectations, which indicate that such expectations rose markedly during the late 1960s, remained elevated at that plateau through the mid-1970s, and then rose at an alarming pace from 1977 until mid-1980. The chapter then considers the stance of monetary policy in terms of the ex ante short-term real interest rate; that is, the federal funds rate less the Livingston Survey of one-year-ahead expected inflation. Next, it analyzes the behavior of real interest rates and shows that the course of monetary policy during the Great Inflation period can be represented as a series of stop-start episodes which occurred in 1968 to 1970, 1974 to 1976, and 1979 to 1980. In each case, policy tightening induced a contraction in economic activity, but that policy was not maintained long enough to induce a sustained decline in the inflation rate.
Andrew Levin is a federal employee; he did not receive any funding for this research, and he has no outside financial relationships.
John B. Taylor acknowledges research support for this project. from Stanford University, where he is a professor of economics, and from Stanford's Hoover Institution, where he is a senior fellow.