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Three great American disinflations

  • Michael Bordo
  • Christopher Erceg
  • Andrew Levin
  • Ryan Michaels

This paper analyzes the role of transparency and credibility in accounting for the widely divergent macroeconomic effects of three episodes of deliberate monetary contraction: the post-Civil War deflation, the post-WWI deflation, and the Volcker disinflation. Using a dynamic general equilibrium model in which private agents use optimal filtering to infer the central bank’s nominal anchor, we demonstrate that the salient features of these three historical episodes can be explained by differences in the design and transparency of monetary policy, even without any time variation in economic structure or model parameters. For a policy regime with relatively high credibility, our analysis highlights the benefits of a gradualist approach (as in the 1870s) rather than a sudden change in policy (as in 1920–21). In contrast, for a policy institution with relatively low credibility (such as the Federal Reserve in late 1980), an aggressive policy stance can play an important signalling role by making the policy shift more evident to private agents.

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Volume (Year): (2007)
Issue (Month): ()
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Handle: RePEc:fip:fedfpr:y:2007:x:5
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  2. Laurence Ball, 1993. "What determines the sacrifice ratio?," Working Papers 93-21, Federal Reserve Bank of Philadelphia.
  3. Erceg, Christopher J. & Henderson, Dale W. & Levin, Andrew T., 2000. "Optimal monetary policy with staggered wage and price contracts," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 281-313, October.
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  11. Laurence Ball, 1990. "Credible Disinflation with Staggered Price Setting," NBER Working Papers 3555, National Bureau of Economic Research, Inc.
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