The Great Inflation: Did the Shadow Know Better?

Abstract

The Shadow Open Market Committee was formed in 1973 in response to rising inflation and the apparent unwillingness of U.S. policymakers to implement policies necessary to maintain price stability. This paper describes how the Committee's policy views differed from those of most Federal Reserve officials and many academic economists at the time. The Shadow argued that price stability should be the primary goal of monetary policy, and favored gradual adjustment of monetary growth to a rate consistent with price stability. The paper evaluates the Shadow's policy rule in the context of the New Keynesian macroeconomic model of Clarida, Gali and Gertler (1999). Simulations of the model suggest that the gradual stabilization of monetary growth favored by the Shadow would have lowered inflation with less impact on output growth, and with less variability in output and inflation, than a one-time reduction in monetary growth. We conclude that the Shadow articulated a sensible policy that would have outperformed the policies actually implemented by the Federal Reserve during the Great Inflation era.

Keywords: Great Inflation, Shadow Open Market Committee, monetary policy, policy rules

JEL Classification: B22, E31, E52, E58, N12