Managing Disinflations

What do history and a simple model teach us about the prospects for central bank efforts to lower inflation to target from recent multi-decade highs? To answer this question, we start by analyzing the large disinflations that occurred since 1950 in the United States and several other major economies. Then, we estimate and simulate a standard model over several time periods, using various linear and nonlinear measures of labor market slack. We draw three main lessons from the analysis: (1) there is no post-1950 precedent for a sizable central-bank-induced disinflation that does not entail substantial economic sacrifice or recession; (2) regardless of the Phillips curve specification, models estimated over a historical period that includes episodes of high and variable inflation do a better job of predicting the post-pandemic inflation surge than those estimated over the stable inflation period from 1985 to 2019; and (3) simulations of our baseline model suggest that the Fed will need to tighten policy significantly further to achieve its inflation objective by the end of 2025. Going forward, our analysis supports a return to the strategy of preemptive policy. We also argue that raising the Fed’s inflation target is a misguided alternative to incurring the sacrifice needed to achieve the 2 percent target.