Added: Katye Wooding - Date: 08.03.2022 05:05 - Views: 27983 - Clicks: 3602
The Great Inflation was the defining macroeconomic event of the second half of the twentieth century. Over the nearly two decades it lasted, the global monetary system established during World War II was abandoned, there were four economic recessions, two severe energy shortages, and the unprecedented peacetime implementation of wage and price controls.
But that failure also brought a transformative change in macroeconomic theory and, ultimately, the rules that today guide the monetary policies of the Federal Reserve and other central banks around the world. If the Great Inflation was a consequence of a great failure of American macroeconomic policy, its conquest should be counted as a triumph.
Ininflation measured a little more than 1 percent per year. It had been in this vicinity over the preceding six years. Inflation began ratcheting upward in the mids and reached more than 14 percent in It eventually declined to average only 3. While economists debate the relative importance of the factors that motivated and perpetuated inflation for more than a decade, there is little debate about its source.
The origins of the Great Inflation were policies that allowed for an excessive growth in the supply of money—Federal Reserve policies. To understand this episode of especially bad policy, and monetary policy in particular, it will be useful to tell the story in three distinct but related parts. This is a forensic investigation of sorts, examining the motive, means, and opportunity for the Great Inflation to occur. The first part of the story, the motive underlying the Great Inflation, dates back to the immediate aftermath of the Great Depressionan earlier and equally transformative period for macroeconomic theory and policy.
At the conclusion of World War II, Congress turned its attention to policies it hoped would promote greater economic stability. Most notable among the laws that emerged was the Employment Act of The orthodoxy guiding policy in the post-WWII era was Keynesian stabilization policy, motivated in large part by the painful memory of the unprecedented high unemployment in the United States and around the world during the s.
The focal point of these policies was the management of aggregate spending demand by way of the spending and taxation policies of the fiscal authority and the monetary policies of the central bank. The idea that monetary policy can and should be used to manage aggregate spending and stabilize economic activity is still a generally accepted tenet that guides the policies of Best gdp episodes Federal Reserve and other central banks today. But one critical and erroneous assumption to the implementation of stabilization policy of the s and s was that there existed a stable, exploitable relationship between unemployment and inflation.
In other words, the trade-off between lower unemployment and more inflation that policymakers may have wanted to pursue would likely be a false bargain, requiring ever higher inflation to maintain. Chasing the Phillips curve in pursuit of lower unemployment could not have occurred if the policies of the Federal Reserve were well-anchored. And in the s, the US dollar was anchored—albeit very tenuously—to gold through the Bretton Woods agreement.
So the story of the Great Inflation is in part also about the collapse of the Bretton Woods system and the separation of the US dollar from Best gdp episodes last link to gold. That system, hashed out by forty-four nations in Bretton Woods, New Hampshire, during Julyprovided for a fixed rate of exchange between the currencies of the world and the US dollar, and the US dollar was linked to gold. But the Bretton Woods system Best gdp episodes a of flaws in its implementation, chief among them the attempt to maintain fixed parity between global currencies that was incompatible with their domestic economic goals.
Many nations, it turned out, were pursing monetary policies that promised to march up the Phillips curve for a more favorable unemployment-inflation nexus. As global trade grew, so too did the demand for U. For a time, the demand for US dollars was satisfied by an increasing balance of payments shortfall, and foreign central banks accumulated more and more dollar reserves.
Eventually, the supply of dollar reserves held abroad exceeded the US stock of gold, implying that the United States could not maintain complete convertibility at the existing price of gold—a fact that would not go unnoticed by foreign governments and currency speculators. As inflation drifted higher during the latter half of the s, US dollars were increasingly converted to gold, and in the summer ofPresident Nixon halted the exchange of dollars for gold by foreign central banks.
Over the next two years, there was an attempt to salvage the global monetary system through the short-lived Smithsonian Agreementbut the new arrangement fared no better than Bretton Woods and it quickly broke down. The postwar global monetary system was finished. Except during periods of global crisis, this was the first time in history that most of the monies of the industrialized world were on an irredeemable paper money standard. The late s and the early Best gdp episodes were a turbulent time for the US economy.
These growing fiscal imbalances complicated monetary policy. In practical terms, this meant the central bank would not implement a change in policy and would hold interest rates steady during the period between the announcement of a Treasury issue and its sale to the market. A more disruptive force was the repeated energy crises that increased oil costs and sapped U. The first crisis was an Arab oil embargo that began in October and lasted about five months. During this period, crude oil prices quadrupled to a plateau that held until the Iranian revolution brought a second energy crisis in The second crisis tripled the cost of oil.
In the s, economists and policymakers began to commonly categorize the rise in aggregate prices as different inflation types. It resulted from policies that produced a level of spending in excess of what the economy could produce without pushing the economy beyond its ordinary productive capacity and pulling more expensive resources into play. But inflation could also be pushed higher from supply disruptions, notably originating in food and energy markets Gordon From the perspective of the Best gdp episodes bank, the inflation being caused by the rising price of oil was largely beyond the control of monetary policy.
But the rise in unemployment that was occurring in response to the jump in oil prices was not. Motivated by a mandate to create full employment with little or no anchor for the management of reserves, the Federal Reserve accommodated large and rising fiscal imbalances and leaned against the headwinds produced by energy costs. These policies accelerated the expansion of the money supply and raised overall prices without reducing unemployment. Bad data or at least a bad understanding of the data also handicapped policymakers. Looking back at the information policymakers had in hand during the period leading up to and during the Great Inflation, economist Athanasios Orphanides has shown that the real-time estimate of potential output was ificantly overstated, and the estimate of the rate of unemployment consistent with full employment was ificantly understated.
In other words, policymakers were also likely underestimating the inflationary effects of their policies. And to make matters worse yet, the Phillips curve, the stability of which was an important guide to the policy decisions of the Federal Reserve, began to move. Phelps and Friedman were right. The stable trade-off between inflation and unemployment proved unstable. The trade-off that policymakers hoped to exploit did not exist.
As businesses and households came to appreciate, indeed anticipate, rising prices, any trade-off between inflation and unemployment became a less favorable exchange until, in time, both inflation and unemployment became unacceptably high. Ten years later, inflation would be over 12 percent and unemployment was above 7 percent. By the summer ofinflation was near Federal Reserve officials were not blind to the inflation that was occurring and were well aware of the dual mandate that required monetary policy to be calibrated so that it delivered full employment and price stability. Humphrey-Hawkins explicitly charged the Federal Reserve to pursue full employment and price stability, required that Best gdp episodes central bank establish targets for the growth of various monetary aggregates, and provide a semiannual Monetary Policy Report to Congress.
As Fed Chairman Arthur Burns would later claim, full employment was the first priority in the minds of the public and the government, if not also at the Federal Reserve Meltzer But there was also a clear sense that addressing the inflation problem head-on would have been too costly to the economy and jobs. There had been a few earlier attempts to control inflation without the costly side effect of higher unemployment.
The Nixon administration introduced wage and price controls over three phases between and Those controls only temporarily slowed the rise in prices while exacerbating shortages, particularly for food and energy. The Ford administration fared no better in its efforts. It was a failure. By the late s, the public had come to expect an inflationary bias to monetary policy. And they were increasingly unhappy with inflation.
Survey after survey showed a deteriorating public confidence over the economy and government policy in the latter half of the s. And often, inflation was identified as a special evil. Interest rates appeared to be on a secular rise since and spiked sharply higher still as the s came to a close.
And inflation was widely viewed as either a ificant contributing factor to the economic malaise or its primary basis. But once in the position of having unacceptably high inflation and high unemployment, policymakers faced an unhappy dilemma. Fighting high unemployment would almost certainly drive inflation higher still, while fighting inflation would just as certainly cause unemployment to spike even higher.
When he took office in August, year-over-year inflation was running above 11 percent, Best gdp episodes national joblessness was just a shade under 6 percent. By this time, it was generally accepted that reducing inflation required greater control over the growth rate of reserves specifically, and broad money more generally. But it was clear that sentiment was shifting with the new chairman and that stronger measures to control the growth of the money supply were required.
In Octoberthe FOMC announced its intention to target reserve growth rather than the fed funds rate as its policy instrument. Fighting inflation was now seen as necessary to achieve both objectives of the dual mandate, even if it temporarily caused a disruption to economic activity and, for a time, a higher rate of joblessness. Over time, greater control of reserve and money growth, while less than perfect, produced a desired slowing in inflation.
This tighter reserve management was augmented by the introduction of credit controls in early and with the Monetary Control Act. Over the course ofinterest rates spiked, fell briefly, and then spiked again. Lending activity fell, unemployment rose, and the economy entered a brief recession between January and July.
Inflation fell but was still high even as the economy recovered in the second half of But the Volcker Fed continued to press the fight against high inflation with a combination of higher interest rates and even slower reserve growth. The economy entered recession again in Julyand this proved to be more severe and protracted, lasting until November The Great Inflation was over. By this time, macroeconomic theory had undergone a transformation, in large part informed by the economic lessons of the era.
The important role public expectations play in the interplay between economic policy and economic performance became de rigueur in macroeconomic models. The importance of time-consistent policy choices—policies that do not sacrifice longer-term Best gdp episodes for short-term gains—and policy credibility became widely appreciated as necessary for good macroeconomic.
Today central banks understand that a commitment to price stability is essential for good monetary policy and most, including the Federal Reserve, have adopted specific numerical objectives for inflation. To the extent they are credible, these numerical inflation targets have reintroduced an anchor to monetary policy. And in so doing, they have enhanced the transparency of monetary policy decisions and reduced uncertainty, now also understood to be necessary antecedents to the achievement of long-term growth and maximum employment.
Friedman, Milton. Gordon, Robert J. Meltzer, Allan H. Louis Review 87, no. Chicago: University of Chicago Press, Phelps, E. Phillips, A. Siegel, Jeremy J. New York: McGraw-Hill, Steelman, Aaron. Arthur F. Burns Chairman. Paul A. Volcker Chairman. Current Fed leaders.Best gdp episodes
email: [email protected] - phone:(339) 606-8876 x 3175
Cookie Consent and Choices