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Three great American disinflations

  • Michael D. Bordo
  • Christopher J. Erceg
  • Andrew T. 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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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 898.

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Date of creation: 2007
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Handle: RePEc:fip:fedgif:898
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  1. John M. Firestone, 1960. "Federal Receipts and Expenditures During Business Cycles, 1879-1958," NBER Books, National Bureau of Economic Research, Inc, number fire60-1, October.
  2. Christopher J. Erceg & Luca Guerrieri & Christopher J. Gust, 2004. "Can long-run restrictions identify technology shocks?," International Finance Discussion Papers 792, Board of Governors of the Federal Reserve System (U.S.).
  3. Erceg, Christopher J. & Levin, Andrew T., 2003. "Imperfect credibility and inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 915-944, May.
  4. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
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  13. Lars E. O. Svensson, 2003. "What is Wrong with Taylor Rules? Using Judgment in Monetary Policy through Targeting Rules," NBER Working Papers 9421, National Bureau of Economic Research, Inc.
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