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How soon we forget

Summary:
This Bloomberg headline caught my eye: Have people already forgotten the 1970s?  From 1973 to 1981, inflation fluctuated between 6% and 13%.  Even if you (wrongly) believe that inflation was caused by supply-side factors, the ultra-dovish Fed was not even trying to reduce inflation during that period.  Both inflation and NGDP growth were quite high, and the Fed set the real fed funds rate at a negative level throughout most of 1974-81. On numerous occasions, they actually reduced interest rates sharply despite extremely high inflation rates.  At the time that the target interest rate was cut to 9% in July 1980, the inflation rate was still over 13%! The subhead is also questionable: The central bank’s new policy framework tolerates above-target price increases.

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This Bloomberg headline caught my eye:

Have people already forgotten the 1970s?  From 1973 to 1981, inflation fluctuated between 6% and 13%.  Even if you (wrongly) believe that inflation was caused by supply-side factors, the ultra-dovish Fed was not even trying to reduce inflation during that period.  Both inflation and NGDP growth were quite high, and the Fed set the real fed funds rate at a negative level throughout most of 1974-81. On numerous occasions, they actually reduced interest rates sharply despite extremely high inflation rates.  At the time that the target interest rate was cut to 9% in July 1980, the inflation rate was still over 13%!

How soon we forget

The subhead is also questionable:

The central bank’s new policy framework tolerates above-target price increases. Now all we need is economic growth.

Economic growth does not cause inflation.  The Fed was able to create plenty of inflation throughout the 1970s, even in years without strong economic growth.  Perhaps the 11% NGDP growth rate from 1971-81 had something to do with it.

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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