The Great Inflation Drift
This chapter examines the rise and variability in inflation rates in the United States in the 1970s using two aspects of Federal Reserve policy behavior during the period--smoothing short-term interest rates and stabilizing the output gap--objectives that were considered more important than a third objective: keeping inflation low. This strategy is referred to as "business as usual," an approach under which shocks to the real interest rate will raise the trend inflation rate. The Fed may later tighten policy to roll back inflation, but if their credibility is low they will quickly return to business as usual and inflation will pick up again--a process that generates a pattern of stop-go inflation. These views are developed in a three-equation New Keynesian Phillips curve model.
Marvin Goodfriend served as a consultant to the Federal Reserve Bank of New York while this research was undertaken.
Robert G. King served as a consultant to the research department at the Federal Reserve Bank of Richmond during the course of this research.
However, the views expressed in this paper are not necessarily those of the FRB Richmond, the FRB New York, or the Federal Reserve System.
Marvin Goodfriend was Senior Vice President and Policy Advisor at the Federal Reserve Bank of Richmond until 2005. He is currently a member of the Economic Advisory Panel of the Federal Reserve Bank of New York. He was a member of the Monetary Policy Advisory Panel of the Federal Reserve Bank of New York in 2009. He is a member of the Federal Reserve System’s Centennial Advisory Council. He served as a compensated consultant for a Federal Reserve Bank. He received compensation for presenting research findings at a conference sponsored by a Federal Reserve Bank. He has been a visiting scholar at three Federal Reserve Banks. He has received compensation from hedge fund, commercial bank, and accounting firms for speaking at sponsored gatherings. He served as a compensated consultant for a hedge fund.