OriginsoftheGreatInflation.pdfVIP

Origins of the Great Inflation Allan H. Meltzer The Great Inflation from 1965 to 1984 is the climactic monetary event of the last part of the 20th century. This paper analyzes why it started and why it continued for many years. Like others, it attributes the start of inflation to analytic errors, particularly the widespread acceptance of the simple Keynesian model with its implication that monetary and fiscal policy should be coordinated. In practice, that meant that the Federal Reserve financed a large part of the fiscal deficit. This paper gives a large role to political decisionmaking. Continuation of inflation depended on political choices, analytic errors, and the entrenched belief that inflation would continue. Federal Reserve Bank of St. Louis Review, March/April 2005, 87(2, Part 2), pp. 145-75. he Great Inflation of 1965 to the mid- used, is misleading. It mixes the effects of one- 1980s was the central monetary event time price level changes (from currency devalua- of the latter half of the 20th century. Its tions, tariffs, and excises, but, in the 1970s, mainly economic cost was large. It destroyed supply shocks) with sustained rates of price theT Bretton Woods system of fixed exchange rates, change arising from the demand side. This is par- bankrupted much of the thrift industry, heavily ticularly important for the Great Inflation because taxed the U.S. capital stock, and arbitrarily redis- the recorded peak rates of inflation reflect both tributed income and wealth. the flawed or mistaken management of economic It was also a political event, as are all major policies and the two large oil price shocks of the policy issues. This paper argues that the Great 1970s. Figure 1 shows the rise a