Working Paper: NBER ID: w14862
Authors: Marvin Goodfriend; Robert G. King
Abstract: A standard statistical perspective on the U.S. Great Inflation is that it involves an increase in the stochastic trend rate of inflation, defined as the long-term forecast of inflation at each point in time. That perspective receives support from two sources: the behavior of long-term interest rates which are generally supposed to contain private sector forecasts, and statistical studies of U.S. inflation dynamics. We show that a textbook macroeconomic model delivers such a stochastic inflation trend, when there are shifts in the growth rate of capacity output, under two behavioral hypotheses about the central bank: (i) that it seeks to maintain output at capacity; and (ii) that it seeks to maintain continuity of the short-term interest rate. The theory then identifies major upswings in trend inflation with unexpectedly slow growth of capacity output. We interpret the rise of inflation in the U.S. from the perspective of this simple macroeconomic framework.
Keywords: inflation; monetary policy; stochastic trends
JEL Codes: E3; E43; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| slow growth in capacity output (D25) | higher inflation (E31) |
| central bank's behavior (E58) | stochastic trend in inflation (E31) |
| slow growth in capacity output (D25) | stochastic trend in inflation (E31) |