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 significanly 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 signficant 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.
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