Academic journal article Journal of Money, Credit & Banking

America's Historical Experience with Low Inflation

Academic journal article Journal of Money, Credit & Banking

America's Historical Experience with Low Inflation

Article excerpt

THE BURST OF INFLATION that struck the United States in the 1970s shapes much American thought about macroeconomic policy. The decade of the 1970s saw GDP-deflator inflation rates peak at nearly 10 percent per year. It saw consumer price inflation rates peak at 3 or 4 percent higher. See Figure 1.


This burst of inflation was sufficiently high for economists' standard models to predict that it would significantly distort investment. Because America's tax system does not adequately adjust for the difference between nominal and real income, the interaction of inflation with the tax system twists incentives in harmful ways. The burst of inflation transferred substantial wealth from creditors to debtors. And it rendered thoroughly untrustworthy any accounting statements constructed according to generally accepted accounting principles.

In addition, the inflation of the 1970s has cast its shadow upon forecasts of the likely future of the American economy. Everyone's expectations of what inflation will be in the future are powerfully influenced by the memory of the 1970s, when the American price level did rise by more than 80 percent.

Yet a look back at history reveals that the sustained inflation of the 1970s was an anomaly in American history. The American economy had occasionally suffered peaks of inflation higher than the levels that were reached in the 1970s. The two highest peaks, however, had come during World Wars I and II--and one expects to see considerable inflation whenever one's country is engaged in a total war. The third twentieth-century inflation peak that was higher than the peak inflation rate reached in the 1970s took place in the 1930s. It was part of the recovery from the mammoth deflation of 1929-1933.

Such a momentary bounce-back inflation is different. It did not rapidly and substantially raise the price level above marks that had previously been considered normal. Instead, it restored prices to levels that had been considered normal before the coming of the Great Depression. It should be viewed primarily as an undoing of a previous rapid deflation, rather than as an inflation with significant consequences of its own.

Moreover, these previous spikes of inflation had been very transitory. They lasted for no more than a few years. They did not last for the decade-plus period from the late 1960s into the 1980s during which inflation was a principal economic policy concern. And these three episodes were clearly breaks from normal patterns of behavior produced by emergency circumstances. For the entire remainder of the century between the end of the Civil War and the coming of the Vietnam War, inflation in the United States as measured by the GDP deflator had usually been less than 3 percent per year. It had always been less than 5 percent per year. During peacetime, for the whole the century before 1968, the United States had been a hard-money country.

There is little reason to think that the inflation of the 1970s marks a structural shift away from this peacetime history as a low-inflation country. The causes of the inflation of the 1970s were unique, and are unlikely to be repeated.(1) More typical is that William Jennings Bryan lost the election of 1896 when he campaigned on the platform of free coinage of silver at a rate of 16-to-1 (see Goodwyn 1978). Neither the Republican nor the Democratic Party sought at the end of 1970s to run on a platform of tolerating the "head cold" of 10 percent per year's worth of inflation in order to achieve the benefits of a high-pressure economy.(2) Both political parties today--save at their fringes--are eager to praise senior Federal Reserve officials who have pursued monetary policies that have successfully minimized inflation.

It is the inflation of the 1970s that is the significant exception.

Thus, it is probably best to think of the current relatively low rate of inflation as a return to a typical American pattern. …

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