The “Great Inflation” is being revisited

I have a standard quip: “The obsession with the unemployment rate in the 1960s (slowly) gave rise to the Great Inflation of the 1970s” and “the obsession with (nonexistent) inflation in 2007/08 (quickly) gave rise to the Great Recession”.

It appears that Fed policy following the Great Recession has brought back memories of the Great Inflation. Two recent books are noteworthy:

Remembering Inflation” by Brigitte Granville of Queen Mary College, University of London, Princeton University Press 2013. You can get the gist of her argument right at the preface where she writes:

“On August 19,2010, the Financial Times published an article titled “Needed: A New Economic Paradigm”, by Joseph Stiglitz. “In that article, Stiglitz wrote”:

Bad models lead to bad policy: central banks, for instance, focused on the small economic inefficiencies arising from inflation, to the exclusion of the far, far greater inefficiencies arising from dysfunctional financial markets and asset price bubbles”.

“Some readers may have been impressed by this disparagement of efforts to bear down on inflation. For me it clearly signaled that the time had come for remembering inflation. For even if the successful pursuit of low inflation in many countries since the 1980s was accompanied by failures in other areas of policy that contributed to the financial and economic shocks that crystallized in the US credit markets and burst upon the world in 2007-08, even worse outcomes could result in the future from forgetfulness about the costs of inflation”.

The other recently published book:

Michael D. Bordo and Athanasios Orphanides, editors, The Great Inflation: The Rebirth of Modern Central Banking. Chicago: University of Chicago Press, 2013

Has been informatively reviewed by Robert Hetzel:

The first point to make is that the preface understates the value of the book.  The preface promotes the book with the observation that high inflation is costly and policy makers need to learn not to repeat the experience.  True enough, the incentive to adopt price controls when faced with high inflation came close to setting the United States on a path leading to state control of the economy and away from free enterprise.  However, the book is far more than a morality tale for central bankers.  The long, stumbling process of learning engaged in by central banks about operating in a regime of fiat money provides the kind of experiments that economists require in order to identify shocks.  When it comes to these experiments, the period known as stop-go monetary policy and as the Great Inflation is “as good as it gets.”

I´ll just note this point from Hetzel´s review:

Given the Blinder-Rudd explanation of the Great Inflation that exonerates the Fed from any blame, the discussion of monetary policy in Japan and Germany is especially interesting.  Takatoshi Ito (“Great Inflation and Central Bank Independence in Japan”) contrasts monetary policy before and during the two inflation shocks of the 1970s, the first in 1973-1974 and the second in 1979-1980.  He argues that expansionary monetary policy in the early 1970s had already created high inflation before the first shock.  In the second episode, monetary restraint led to only a short-lived, moderate increase in inflation.  In a similar spirit, Andreas Beyer, Vitor Gaspar, Christina Gerberding, and Otmar Issing (“Opting Out of the Great Inflation: German Monetary Policy after the Breakdown of Bretton Woods”) credit a monetary policy, which started in the mid-1970s, with a firm nominal anchor for price stability as a source of nominal and real stability relative to other countries.  They especially emphasize the role of money targets as a commitment device for aligning inflationary expectations with the goal of price stability.

Macroeconomists cannot run controlled experiments, but they can do a much better job of identifying and elucidating the extraordinary range of experiments that central banks have delivered. The Great Inflation is a terrific example.

I am fascinated by the “Great Inflation” and will post more on it over the weeks and months ahead (after reading the new books and going over others that were written at the time – like Blinder´s Economic Policy and The Great Stagflation (1979) and Ekstein´s The Great Recession(!) (1978)).

In the meantime check the charts below in light of Hetzel´s paragraph on monetary policy in Japan and Germany.

First the commodity and oil shocks. Note that the commodity shock began more than one year before the oil shock.

Great Inflation_1

From the inflation chart, note that Japanese inflation took off at the time of the commodity shock so that by the time the oil shock happened inflation in Japan was already above 15%. Note also that the second oil shock in 1979 had little impact on Japanese and German inflation, in contrast with what happened in the US.

Great Inflation_2

Now compare the behavior of monetary policy in the three countries, here represented by the growth in NGDP.

Great Inflation_3

It´s not hard to see the reason Germany had the lowest inflation outcome and that by changing monetary policy Japan, unlike the US, mostly avoided the inflationary impact of the second oil shock.

3 thoughts on “The “Great Inflation” is being revisited

  1. I do not forget the costs of inflation…but inflation rates under 4 percent? Really, couple of years of 3 percent inflation would be costly?

    How about remembering that the 1960s saw real per capita incomes rise by 30 percent in the USA. Oh, that.

    And what of the costs to real GDP of monetarily suffocating the economy down to a 1 percent inflation rate? Or zero, as in Japan?

    Stiglitz is right, there are small economic efficiencies associated with moderate inflation, but even that is doubtful given the advent of the Internet and the ability to constantly monitor prices at no cost.

    Moreover, we live a world of rapidly evolving and differentiated goods and services. What is inflation?

    The pompous pettifogging, the insufferable sanctimonious sermonettes about the costs and immorality of inflation side-tracking central banks away from a truly good monetary policy—one that shoots for steady increases in nominal GDP.

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