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Drawing on an analysis of Federal Open Market Committee (FOMC) documents, this paper argues that political pressures on the Federal Reserve were an important contributor to the rise in inflation in the United States in the 1970s. Members of the FOMC understood that a serious attempt to tackle inflation would generate opposition from Congress and the executive branch. Political considerations contributed to delays in monetary tightening, insufficiently aggressive anti-inflation policies, and the premature abandonment of attempts at disinflation. Empirical analysis verifies that references to the political environment at FOMC meetings are correlated with the stance of monetary policy during this period. (JEL D72, E32, E52, E58, N12) W hat accounts for the Federal Reserve’s failure to control inflation in the United States in the 1970s? One important set of factors has been highlighted in recent research by Romer and Romer (2002), Nelson (2005), Orphanides (2002, 2003, 2004), and others. The argument set forth by these authors, which Romer (2005) calls the “ideas” hypothesis, is that the Federal Reserve’s errors were rooted in the beliefs that policymakers held about the structure of the economy. These beliefs included an unrealistically low estimate of the natural rate of unemployment, the belief that observed inflation had little to do with monetary policy and that monetary policy could do little to combat it, and an overly pessimistic estimate of the costs of disinflation. The Fed’s erroneous beliefs led it to pursue a monetary policy that was consistently over expansionary, resulting in a steadily increasing rate of inflation. According to this view, inflation only came under control in the early 1980s when policymakers’ beliefs about the economy began to change. In particular, in this period, policymakers had more realistic estimates of the natural rate of unemployment, were convinced that monetary policy was at the root of the inflation problem, and believed that the costs of disinflation could be contained if the Fed was successful in changing the public’s expectations of inflation. This paper argues that political pressures on the Federal Reserve were an impor tant additional factor for the Fed’s failure to control inflation in the 1970s. Drawing |
