The ‘great inflation’ of the 1970s had many causes. The policy objective of full employment had already led to high inflation by the end of the 1960s. Two oil shocks and the depreciation of the dollar caused additional increases. The key factor was monetary policy, which was not adapted to the circumstances. It reflected the view that the Fed did not have a mandate to tolerate the sizeable increase in unemployment that might have ensued from the aggressive tightening needed to bring inflation under control. In addition, inflation was considered to be a cost-push phenomenon that could be addressed with wage and price controls. Today’s situation is very different. The Federal Reserve is an independent central bank and inflation expectations are well-anchored. However, letting the economy run hot is reminiscent of the 1960s. Should inflation be above target for too long, the Federal Reserve will need to have the courage to tighten policy sufficiently despite the potential cost to the economy.
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