Three Great American Disinflations
Michael D. Bordo
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Christopher J. Erceg
Federal Reserve Board - Trade and Quantitative Studies
Andrew T. Levin
Federal Reserve Board
University of Michigan at Ann Arbor - Department of Economics
NBER Working Paper No. w12982
This paper analyzes the role of transparency and credibility in accounting for the widely divergent macroeconomic effects of three episodes of deliberate monetary contraction: the post-Civil War deflation, the post-WWI deflation, and the Volcker disinflation. Using a dynamic general equilibrium model in which private agents use optimal filtering to infer the central bank's nominal anchor, we demonstrate that the salient features of these three historical episodes can be explained by differences in the design and transparency of monetary policy, even without any time variation in economic structure or model parameters. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach (as in the 1870s) rather than a sudden change in policy (as in 1920-21). In contrast, for a policy institution with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents.
Number of Pages in PDF File: 43working papers series
Date posted: March 23, 2007
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