The Great Inflation Drift

A standard statistical perspective on the U.S. Great Inflation is that it involves an increase in the stochastic trend rate of inflation, defined as the long-term forecast of inflation at each point in time. That perspective receives support from two sources: the behavior of long-term interest rates which are generally supposed to contain private sector forecasts, and statistical studies of U.S. inflation dynamics. We show that a textbook macroeconomic model delivers such a stochastic inflation trend, when there are shifts in the growth rate of capacity output, under two behavioral hypotheses about the central bank: (i) that it seeks to maintain output at capacity; and (ii) that it seeks to maintain continuity of the short-term interest rate. The theory then identifies major upswings in trend inflation with unexpectedly slow growth of capacity output. We interpret the rise of inflation in the U.S. from the perspective of this simple macroeconomic framework.(This abstract was borrowed from another version of this item.)