POLICY PREFERENCES AND POLICY MAKERS' BELIEFS: THE GREAT INFLATION

Gabriela Best ()

Macroeconomic Dynamics, 2017, vol. 21, issue 8, 1957-1995

Abstract: The literature has proposed two potential channels through which monetary policy played a role in the Great Inflation in the United States. One approach posits that the Federal Reserve held misperceptions of the economy. An alternative explanation contends that policy makers shifted preferences from an output gap stabilization goal toward inflation stabilization after 1979. This paper develops a medium-scale macroeconomic model that incorporates real-time learning by policy makers as well as a (potential) shift in policy makers' preferences. The empirical results show that combining both views—distorted policy makers' beliefs about the persistence of inflation and the inflation-output gap trade-off, accompanied by a stronger preference for inflation stabilization after 1979—illuminates the role played by monetary policy in propagating and ending the Great Inflation.

Date: 2017
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