|Reviewer(s):||Perez, Stephen J.|
Published by EH.NET (January 2000)
Thomas Mayer, Monetary Policy and the Great Inflation in the United States:
Federal Reserve and the Failure of Macroeconomic Policy,
1965-79. Cheltenham, UK and Northampton, MA: Edward Elgar Publishing,
1999. ix + 151 pp $70.00 (cloth), ISBN: 1-85898-953-1.
Reviewed for EH.NET by Stephen J. Perez, Department of Economics,
Washington State University.
Why did inflation rise to such frightening levels in the U.S. during the 1970s?
In his book, Monetary Policy and the Great Inflation, Thomas Mayer
analyzes and describes a vast amount of largely narrative evidence regarding
the formulation of monetary policy from 1965-1979. He uses a maintained
hypothesis that the Great Inflation was caused by monetary policy and takes as
his charge explaining the Federal Reserve’s willingness to accommodate the high
rates. According to Thomas Mayer,
“[t]here are several villains, and the biggest one turns out to be then
prevailing views of economists, and not malicious political interference with
the central bank, or cartel-imposed supply shocks. We have met the enemy and
he is (or rather was) us” (p. 117).
Professor Mayer uses sources ranging from the minutes of Federal Open Market
Committee (FOMC) meetings to economic textbooks of the time to interviews with
policy makers conducted in 1996 to try and sort through
several possible explanations for why the Federal Reserve pursued an
expansionary policy during the Great Inflation. The possible explanations
include: bad forecasting by the Federal Reserve, poor control over the money
supply, cognitive errors, political pressure, wage, price, dividend,
and interest rate controls (Nixon’s incomes policies), and poor economic
As a graduate student at UC Davis, I had the distinct pleasure of taking two
classes in monetary theory and policy from Professor Mayer. I
am heartened to know that he continues to attack problems with the methodical
and intellectual style with which he taught. Professor Mayer systematically
evaluates the possibility that each of the above reasons could have lead to the
Federal Reserve’s role in the Great Inflation. In each case, he makes great
use of the minutes and interviews he conducted detailing evidence both for and
against each explanation.
Is it possible that the Federal Reserve was simply misled by poor forecasts of
future economic performance? It is true that the Federal Reserve staff
systematically underestimated future inflation and overestimated potential
output. However, Professor Mayer attributes a maximum of 3 to 10% of the
inflation to these misestimates. Did poor control
over the money supply lead to excessive monetary growth? Although there may
have been an accommodative policy bias, poor control of the money supply should
have led to mistakes towards accommodative and restrictive policy.
Professor Mayer attributes a small possible role to cognitive errors such as
vagueness of policy, procrastination, a short run bias, the role of
expectations, etc. But, the most interesting analysis lies in chapters
pressure, price controls, and the influence of economists.
Professor Mayer looks very carefully for evidence that the Federal Reserve
experienced pressure from the administration or Congress to follow an
accommodative policy. Other than a few instances, the following excerpt
summarizes the role of political influence: “The political pressures the Fed
actually experienced appear to have played only a relatively minor role in the
Great Inflation, so that direct cause of the Great Inflation was primarily the
Fed’s own inflationary proclivity. But if the Fed had been much less inclined
to tolerate inflation, political pressures might well have forced it to do so”
The possibility of political pressure also plays a role in the discussion of
the role of how the Nixon wage and price controls affected
the formulation of monetary policy. Professor Mayer finds evidence that the
FOMC may have been influenced by the specter of interest rate controls if it
became too contractionary. The wage and price controls may have also lead the
FOMC to become more expansionary with the belief that the incomes policies
would hold down inflationary expectations.
Professor Mayer finds the main cause of the expansionary monetary policy to be
the correlation of the FOMC’s attitudes towards inflation with those of
economists. In particular, both the FOMC and academic economists felt that
monetary policy should play a reduced role in fighting cost-push inflation,
that the cost of fighting cost-push inflation was very high, and that the NAIRU
was relatively low and
both failed to fully realize the lack of a tradeoff between inflation and
unemployment in the long run. In summary, Professor Mayer states: “My own
ranking [of causes of the Great Inflation] is to put the intellectual
atmosphere in first place, and cognitive errors, political pressures and the
wish to avoid interest-rate fluctuations, in second, third and fourth place
respectively, Well behind these come inadequate operating procedures, and
even further behind, the pressures exerted from the imposition
of wage and price controls” (p. 120).
Monetary Policy and the Great Inflation in the United States is a very
enlightening description of how monetary policy lead to the Great Inflation.
Professor Mayer displays his typically thorough analytical skills
and clear writing style while describing a wealth of source level evidence
regarding the thought process of monetary policy makers.
Stephen J. Perez is Assistant Professor of Economics at Washington State
University. He is author of numerous works including “Data Mining
Reconsidered: Encompassing and the General-to-Specific Approach to
Specification Search.” Econometrics Journal, Vol. 2, (with Kevin D.
Hoover); “Causal Ordering and the ‘Bank Lending Channel’.” Journal of
Applied Econometrics, (Nov.-
Dec. 1998); “Testing for Credit Rationing: An Application of Disequilibrium
Econometrics.” Journal of Macroeconomics,
(Fall 1998); “Post Hoc Ergo Propter Hoc Once More: An Evaluation of ‘Does
Monetary Policy Matter?’ in the Spirit of James Tobin.” Journal of Monetary
Economics, (August 1994) (with Kevin D. Hoover).
|Subject(s):||Financial Markets, Financial Institutions, and Monetary History|
|Geographic Area(s):||North America|
|Time Period(s):||20th Century: WWII and post-WWII|