Did the Great Inflation Occur Despite Policymaker Commitment to a Taylor Rule?

James Bullard and Stefano Eusepi
Working Paper 2003-20
October 2003

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The authors study the hypothesis that misperceptions of trend productivity growth during the onset of the productivity slowdown in the United States caused much of the great inflation of the 1970s. They use the general equilibrium, sticky price framework of Woodford (2002), augmented with learning using the techniques of Evans and Honkapohja (2001). The authors allow for endogenous investment as well as explicit, exogenous growth in productivity and the labor input. They assume the monetary policymaker is committed to using a Taylor-type policy rule. The authors study how this economy reacts to an unexpected change in the trend productivity growth rate under learning. They find that a substantial portion of the observed increase in inflation during the 1970s can be attributed to this source.

JEL classification: E4, E5

Keywords: monetary policy rules, productivity slowdown, learning

This paper was presented at the Monetary Policy and Learning Conference sponsored by the Federal Reserve Bank of Atlanta in March 2003. The views expressed here are the authors' and not necessarily those of the Federal Reserve Bank of St. Louis, the Federal Reserve Bank of Atlanta, or the Federal Reserve System. Any remaining errors are the authors' responsibility.

Please address questions regarding content to James Bullard, Research Department, Federal Reserve Bank of St. Louis, 411 Locust Street, St. Louis, Missouri 63102, 314-444-8576, bullard@stls.frb.org, or Stefano Eusepi, University of Rome "Tor Vergata" and Department of Economics, New York University, 269 Mercer Street, New York, New York, 212-998-8923, se48@nyu.edu.