Learning from the Great Inflation

Many are worried that the exploding Federal debt and the expanded Federal Reserve Balance sheet will lead to a large increase in inflation. But when and how fast? A session at the recent American Economic Association meetings on the Great Inflation of the late 1960s and 1970s provides some historical perspective on the question. Andrew Levin of the Federal Reserve Board staff and I presented one of the papers. We looked at the timing of the inflation increase and the monetary responses.

As this chart from our paper shows, the increase in inflation was not sudden. The chart plots CPI inflation and a measure of inflation expectations based on the Livingston expectation survey. Inflation was in the 1-1/2 percent range through the early 1960s. Then, starting around 1965, it gradually started to rise and by the end of the 1970s it was in double digits. There were several boom-bust cycles during this period as the Fed fell behind the curve, attempted to catch up by raising interest rates, and then eased again before inflation returned to low levels.

We found that monetary policy was significantly affected by political factors during the period. It was only after Paul Volcker was appointed Fed Board Chairman in 1979 that inflation was brought back down, but by then significant damage had been done. And even then there was one more pull back from tightening during the 1980 election. So this is one plausible way that inflation might rise again. Of course it does not have to be this way. With increased globalization and interconnectedness of markets, inflation could rise more quickly. Or with a policy correction we could completely avoid an another great inflation.

About John B. Taylor 117 Articles

Affiliation: Stanford University

John B. Taylor is the Mary and Robert Raymond Professor of Economics at Stanford University and the Bowen H. and Janice Arthur McCoy Senior Fellow at the Hoover Institution. He formerly served as the director of the Stanford Institute for Economic Policy Research, where he is now a senior fellow, and he was founding director of Stanford's Introductory Economics Center.

Taylor’s academic fields of expertise are macroeconomics, monetary economics, and international economics. He is known for his research on the foundations of modern monetary theory and policy, which has been applied by central banks and financial market analysts around the world. He has an active interest in public policy. Taylor is currently a member of the California Governor's Council of Economic Advisors, where he also previously served from 1996 to 1998. In the past, he served as senior economist on the President's Council of Economic Advisers from 1976 to 1977, as a member of the President's Council of Economic Advisers from 1989 to 1991. He was also a member of the Congressional Budget Office's Panel of Economic Advisers from 1995 to 2001.

For four years from 2001 to 2005, Taylor served as Under Secretary of Treasury for International Affairs where he was responsible for U.S. policies in international finance, which includes currency markets, trade in financial services, foreign investment, international debt and development, and oversight of the International Monetary Fund and the World Bank. He was also responsible for coordinating financial policy with the G-7 countries, was chair of the working party on international macroeconomics at the OECD, and was a member of the Board of the Overseas Private Investment Corporation. His book Global Financial Warriors: The Untold Story of International Finance in the Post-9/11 World chronicles his years as head of the international division at Treasury.

Taylor was awarded the Alexander Hamilton Award for his overall leadership in international finance at the U.S. Treasury. He was also awarded the Treasury Distinguished Service Award for designing and implementing the currency reforms in Iraq, and the Medal of the Republic of Uruguay for his work in resolving the 2002 financial crisis. In 2005, he was awarded the George P. Shultz Distinguished Public Service Award. Taylor has also won many teaching awards; he was awarded the Hoagland Prize for excellence in undergraduate teaching and the Rhodes Prize for his high teaching ratings in Stanford's introductory economics course. He also received a Guggenheim Fellowship for his research, and he is a fellow of the American Academy of Arts and Sciences and the Econometric Society; he formerly served as vice president of the American Economic Association.

Before joining the Stanford faculty in 1984, Taylor held positions as professor of economics at Princeton University and Columbia University. Taylor received a B.A. in economics summa cum laude from Princeton University in 1968 and a Ph.D. in economics from Stanford University in 1973.

Visit: John Taylor's Page, Blog

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