was the Fed Chair who got it all wrong and let the inflation genie out of the bottle. Paul Volcker had to put it back when he became Chair in 1979 – a difficult and costly task.
The 1950s to the mid-1960s were a period of remarkable price stability, strong productivity growth and rising family welfare. However, the second half of the 1960s saw a strong rise in inflation, well before the temporary oil price effect added to it in 1974. However laudable the social goals, the combined effect was to nourish the inflation process, to undermine investment and set in motion the great decline in productivity growth.
Burns noted that a premium gets built into interest rates as households and business come to believe inflation will continue into the future, thereby undermining the effectiveness of monetary policy.In such a world, interest rates at or near the rate of inflation will have little effect to bring inflation down. But central bankers around the world embraced the psychology of the day, and did not want to be seen to be working to frustrate the goals of their governments.
Raising the inflation target to 3 per cent or 4 per cent, as Olivier Blanchard wants, would build a higher inflation premium into interest rates and reduce the effectiveness of monetary policy.
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