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POLICY PREFERENCES AND POLICY MAKERS' BELIEFS: THE GREAT INFLATION

  • Gabriela Best (a1)
Abstract

The literature has proposed two potential channels through which monetary policy played a role in the Great Inflation in the United States. One approach posits that the Federal Reserve held misperceptions of the economy. An alternative explanation contends that policy makers shifted preferences from an output gap stabilization goal toward inflation stabilization after 1979. This paper develops a medium-scale macroeconomic model that incorporates real-time learning by policy makers as well as a (potential) shift in policy makers' preferences. The empirical results show that combining both views—distorted policy makers' beliefs about the persistence of inflation and the inflation-output gap trade-off, accompanied by a stronger preference for inflation stabilization after 1979—illuminates the role played by monetary policy in propagating and ending the Great Inflation.

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Corresponding author
Address correspondence to: Gabriela Best, Department of Economics, Steven G. Mihaylo College of Business and Economics, California State University, Fullerton, Fullerton, CA 92834-6848, USA; e-mail: GBest@fullerton.edu.
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I especially thank Fabio Milani for his advice and help in many aspects of this project. I also thank Bill Branch, Edward Nelson, Michelle Garfinkel, Michael Owyang, Dale Poirier, Giorgio Primiceri, Davide Debortoli, Char Weise, Ricardo Reis, Judy Ahlers, Sherif Khalifa, Pavel Kapinos, Patrick Best, anonymous referees, and all seminar participants at the 2011 Midwest Macro Meetings at Vanderbilt University, Federal Reserve Bank of St. Louis, University of California, Irvine, for important input into this paper. I also thank the Federal Reserve Bank of St. Louis for hosting me during part of this project and the Department of Economics and School of Social Sciences at the University of California, Irvine, for financial support.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
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