Thomas Mayer. Monetary Policy and the Great Inflation in the United States: The Federal Reserve and the Failure of Macroeconomic Policy 1965-79. Cheltemham, UK and Northampton, Mass.: Edward Elgar, 1999. ix + 151 pp. $70.00 (cloth), ISBN 978-1-85898-953-2.
Reviewed by Stephen J. Perez (Department of Economics, Washington State University)
Published on EH.Net (January, 2000)
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 inflation 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 advice.
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 regarding political 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" (p. 81).
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 academic 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, ^E 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).
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Citation:
Stephen J. Perez. Review of Mayer, Thomas, Monetary Policy and the Great Inflation in the United States: The Federal Reserve and the Failure of Macroeconomic Policy 1965-79.
EH.Net, H-Net Reviews.
January, 2000.
URL: http://www.h-net.org/reviews/showrev.php?id=3740
Copyright © 2000, EH.Net and H-Net, all rights reserved. This work may be copied for non-profit educational use if proper credit is given to the author and the list. For other permission questions, please contact the EH.NET Administrator (administrator@eh.net; Telephone: 513-529-2850; Fax: 513-529-3309). Published by EH.NET.