In short, the lessons learned from America’s Great Inflation, by both the Fed and political leaders, make a repeat of that experience highly unlikely. The Fed today recognizes that it must take the leading role in controlling inflation, and it has the tools and sufficient political independence to do so. After a delay caused by a misdiagnosis of the economy in 2021, the Fed has accordingly turned to tightening monetary policy, ending its pandemic-era bond purchases, announcing plans to shrink its securities holdings and raising short-term interest rates.
Markets and the public appear to understand how the Fed’s approach has changed from the earlier era I described. Although the Fed has raised interest rates only twice this year (this week’s meeting will no doubt bring an additional increase), financial conditions have already tightened significantly (for example, mortgage rates have risen by more than two percentage points in the past year) as markets anticipate that policymakers will persist in their anti-inflation campaign. And while market indicators and surveys of consumers reveal that inflation is expected to remain high over the next year or two, for the most part, they suggest continued confidence that, over the longer term, the Fed will be able to bring inflation down close to its 2 percent target.
This confidence in turn makes the Fed’s job easier, by limiting the risk of an “inflationary psychology,” as Burns once put it, on the part of the public. Since Mr. Volcker’s conquest of inflation in the 1980s, bursts of inflation have tended to die away more quickly and with less need for monetary restraint than in previous episodes.
None of this implies that the Fed’s job will be easy. The degree to which the central bank will have to tighten monetary policy to control our currently high inflation, and the associated risk of an economic slowdown or recession, depends on several factors: how quickly the supply-side problems (high oil prices, supply-chain snarls) subside, how aggregate spending reacts to the tighter financial conditions engineered by the Fed and whether the Fed retains its credibility as an inflation fighter even if inflation takes a while to subside.
Of these, history teaches us, the last may be the most important. Inflation will not become self-perpetuating, with price increases leading to wage increases leading to price increases, if people are confident that the Fed will take the necessary measures to bring inflation down over time.
The Fed’s greater policy independence, its willingness to take responsibility for inflation and its record of keeping inflation low for nearly four decades after the Great Inflation, make it much more credible on inflation today than its counterpart in the ’60s and ’70s. The Fed’s credibility will help ensure that the Great Inflation will not be repeated, and Mr. Powell and his colleagues will put a high priority on keeping that credibility intact.