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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: bart13 who wrote (94241)	5/14/2008 5:29:50 PM
From: John Vosilla	Read Replies (1) \| Respond to of 110194

'You can clearly see that after Fed Chairman Paul Volker choked off inflation by causing the worst recession since the 1930s, in 1981-2, it has remained under 5% a year for almost the entire 25 years since. But notice that here we are, almost certainly at or near the trough in this 1946-2003? (low to low) or 1981 - 2040? (peak to peak) Kondratieff cycle, and again the inflation rate (currently at 4.3%) exceeds long term rates, at least as measured by the 10 year bond. Imagine what a 1946-style 20% inflationary spike would do now, with wage growth for the median American stuck at about 3% a year, and interest rates on CDs and bonds in the 4% range? Given what is happening to the dollar, to the price of oil and foodstuffs, and the inflationary impact of the Iraq war in particular, another inflationary burst marking the exact midpoint in the interest rate cycle cannot be discounted.' dailykos.com

To: bart13 who wrote (94241)	5/14/2008 5:34:11 PM
From: John Vosilla	Respond to of 110194

What Caused the Great Inflation? economistsview.typepad.com Let me give a brief sense of the evolution of economic beliefs. (Table 1 summarizes this evolution.) In contrast to Meltzer, who views 1950s policymakers as largely rudderless, we find that policymakers in this decade had a basically sound, if relatively unsophisticated, view of how the economy functioned. They believed that inflation resulted when output went above a quite reasonable view of capacity or full employment. They also believed that, while expansionary policy could reduce unemployment below normal in the short run, the resulting inflation would certainly not lower unemployment permanently and might possibly raise it. For example, Federal Reserve Chairman William McChesney Martin said in 1958: “If inflation should begin to develop again, it might be that the number of unemployed would be temporarily reduced…but there would be a larger amount of unemployment for a long time to come” (Federal Open Market Committee [FOMC], Minutes, August 19, 1958, p. 57). Because of these views, both monetary and fiscal policy were carefully tempered in the 1950s. On a number of occasions the Federal Reserve responded to rising inflation by orchestrating serious contraction. In the 1960s, policymakers clearly adopted a different model. Estimates of a “reasonable and prudent” goal for normal unemployment were substantially reduced by the Kennedy and Johnson administrations and by the Federal Reserve (Council of Economic Advisers, 1962, p. 46). And, as has been stressed by a number of scholars, a belief in a permanent trade-off between inflation and unemployment briefly held sway. These views led to highly expansionary monetary and fiscal policies, and inflation and booming real growth resulted. Around 1970, policymakers adopted a natural rate framework, but with an overly optimistic estimate of the natural rate. This view led to a half-hearted attempt at disinflation in 1969 and 1970. The result was that inflation was temporarily slowed, but not squelched. Early in his tenure as Federal Reserve Chairman, Arthur Burns added the idea that inflation was relatively insensitive to slack. He concluded that “monetary policy could do very little to arrest an inflation that rested so heavily on wage-cost pressures. In his judgment a much higher rate of unemployment produced by monetary policy would not moderate such pressures appreciably” (FOMC, Minutes, June 8, 1971, p. 51). If tight monetary policy and the resulting unemployment were ineffective against inflation, there was no reason to pursue it. Because of this view, the Federal Reserve and the Nixon administration ran expansionary macroeconomic policy and advocated dealing with inflation through wage and price controls. Economic views became substantially more sensible in the mid-1970s and, again, disinflation was attempted. Inflation fell substantially after the 1973-75 recession. However, with the election of Jimmy Carter and the appointment of G. William Miller as Federal Reserve Chairman, estimates of the natural rate were lowered and Burns’s view that inflation was insensitive to slack returned with a vengeance. The first Carter Economic Report of the President stated: “Recent experience has demonstrated that the inflation we have inherited from the past cannot be cured by policies that slow growth and keep unemployment high” (Council of Economic Advisers, 1978, p. 17). The result was fiscal expansion and monetary policy inaction in the face of high and rising inflation. This brief description of the “ideas view” of the Great Inflation points out a number of important elements. One is the notion of change. A crucial part of any explanation of the Great Inflation must be to show what changed in the 1960s that led the price stability of the 1950s to be replaced by persistent inflation. Our research, along with that of a number of other scholars, clearly shows that the economic framework took a radical turn. This same notion of change explains why the policy mistakes were so persistent. Meltzer gives as one reason that he rejects the central role of ideas that it is implausible that bad ideas would have lasted 15 years in the face of the obvious continued rise in inflation. But, as we show, policymakers did learn. The Samuelson-Solow permanent trade-off view was rejected at the start of the Nixon administration. However, it was replaced by another flawed model: first by a natural rate framework with a very low natural rate, then by a natural rate framework with an extreme insensitivity of inflation to slack. It was this succession of misguided models that gave rise to repeated policy mistakes and persistent inflation in this period.