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Published by EH.NET (January 2000) 
 
Thomas Mayer, _Monetary Policy and the Great Inflation in the  
United States: The Federal Reserve and the Failure of  
Macroeconomic Policy, 1965-79_. Cheltenham, UK and  
Northampton, MA: Edward Elgar Publishing, 1999. ix + 151 pp  
$70.00 (cloth), ISBN: 1-85898-953-1.   
 
Reviewed for EH.NET by Stephen J. Perez, Department of  
Economics, Washington State University. <[log in to unmask]>   
 
 
Why did inflation rise to such frightening levels in the U.S. during  
the 1970s? In his book, _Monetary Policy and the Great Inflation_,  
Thomas Mayer analyzes and describes a vast amount of largely  
narrative evidence regarding the formulation of monetary policy from  
1965-1979. He uses a maintained hypothesis that the Great  
Inflation was caused by monetary policy and takes as his charge  
explaining the Federal Reserve's willingness to accommodate the  
high inflation rates. According to Thomas Mayer, "[t]here are  
several villains, and the biggest one turns out to be then prevailing  
views of economists, and not malicious political interference with  
the central bank, or cartel-imposed supply shocks. We have met  
the enemy and he is (or rather was) us" (p. 117).   
 
Professor Mayer uses sources ranging from the minutes of Federal  
Open Market Committee (FOMC) meetings to economic textbooks  
of the time to interviews with policy makers conducted in 1996 to  
try and sort through several possible explanations for why the  
Federal Reserve pursued an expansionary policy during the Great  
Inflation. The possible explanations include: bad forecasting by the  
Federal Reserve, poor control over the money supply, cognitive  
errors, political pressure, wage, price, dividend, and interest rate  
controls (Nixon's incomes policies), and poor economic advice.    
 
As a graduate student at UC Davis, I had the distinct pleasure of  
taking two classes in monetary theory and policy from Professor  
Mayer. I am heartened to know that he continues to attack  
problems with the methodical and intellectual style with which he  
taught. Professor Mayer systematically evaluates the possibility  
that each of the above reasons could have lead to the Federal  
Reserve's role in the Great Inflation. In each case, he makes great  
use of the minutes and interviews he conducted detailing evidence  
both for and against each explanation.   
 
Is it possible that the Federal Reserve was simply misled by poor  
forecasts of future economic performance? It is true that the  
Federal Reserve staff systematically underestimated future inflation  
and overestimated potential output. However, Professor Mayer  
attributes a maximum of 3 to 10% of the inflation to these  
misestimates. Did poor control over the money supply lead to  
excessive monetary growth? Although there may have been an  
accommodative policy bias, poor control of the money supply  
should have led to mistakes towards accommodative _and_  
restrictive policy. Professor Mayer attributes a small possible role  
to cognitive errors such as vagueness of policy, procrastination, a  
short run bias, the role of expectations, etc. But, the most  
interesting analysis lies in chapters regarding political pressure,  
price controls, and the influence of economists.   
 
Professor Mayer looks very carefully for evidence that the Federal  
Reserve experienced pressure from the administration or Congress  
to follow an accommodative policy. Other than a few instances, the  
following excerpt summarizes the role of political influence: "The  
political pressures the Fed actually experienced appear to have  
played only a relatively minor role in the Great Inflation, so that  
direct cause of the Great Inflation was primarily the Fed's own  
inflationary proclivity. But if the Fed had been much less inclined to  
tolerate inflation, political pressures might well have forced it to do  
so" (p. 81).   
 
The possibility of political pressure also plays a role in the  
discussion of the role of how the Nixon wage and price controls  
affected the formulation of monetary policy. Professor Mayer finds  
evidence that the FOMC may have been influenced by the specter  
of interest rate controls if it became too contractionary. The wage  
and price controls may have also lead the FOMC to become more  
expansionary with the belief that the incomes policies would hold  
down inflationary expectations.   
 
Professor Mayer finds the main cause of the expansionary  
monetary policy to be the correlation of the FOMC's attitudes  
towards inflation with those of academic economists. In particular,  
both the FOMC and academic economists felt that monetary policy  
should play a reduced role in fighting cost-push inflation, that the  
cost of fighting cost-push inflation was very high, and that the  
NAIRU was relatively low and both failed to fully realize the lack of  
a tradeoff between inflation and unemployment in the long run. In  
summary, Professor Mayer states: "My own ranking [of causes of  
the Great Inflation] is to put the intellectual atmosphere in first  
place, and cognitive errors, political pressures and the wish to  
avoid interest-rate fluctuations, in second, third and fourth place  
respectively,  Well behind these come inadequate operating  
procedures, and even further behind, the pressures exerted from  
the imposition of wage and price controls" (p. 120).   
 
_Monetary Policy and the Great Inflation in the United States_ is a  
very enlightening description of how monetary policy lead to the  
Great Inflation. Professor Mayer displays his typically thorough  
analytical skills and clear writing style while describing a wealth of  
source level evidence regarding the thought process of monetary  
policy makers.   
 
 
Stephen J. Perez is Assistant Professor of Economics at  
Washington State University. He is author of numerous works  
including "Data Mining Reconsidered: Encompassing and the  
General-to-Specific Approach to Specification Search."  
_Econometrics Journal_, Vol. 2, (with Kevin D. Hoover); "Causal  
Ordering and the 'Bank Lending Channel'." _Journal of Applied  
Econometrics_, (Nov.-Dec. 1998); "Testing for Credit Rationing: An  
Application of Disequilibrium Econometrics." _Journal of  
Macroeconomics_, (Fall 1998); "Post Hoc Ergo Propter Hoc Once  
More: An Evaluation of 'Does Monetary Policy Matter?' in the Spirit  
of James Tobin." _Journal of Monetary Economics_, (August 1994)  
(with Kevin D. Hoover).   
 
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