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Who’s Right on Inflation?

As in the 1970s, a severe economic shock has forced governments to pursue massive fiscal and monetary expansion, thereby sowing fears of future inflation. But not all shocks are the same, and the key question now is whether we can be confident that the current state of exception will end.

PRINCETON/PARIS – The specter of inflation has returned. For two decades, central banks across industrialized economies were confident that they had banished it for good. Then came the 2008 financial crisis, which occasioned a brief return of inflation anxiety on both sides of the Atlantic. In the United States, congressional Republicans ushered in austerity in 2010, and the European Central Bank started tightening its interest-rate policy in 2011. But then policymakers started to worry that inflation was too low, and that it might be impossible to reignite.

Now, the inflation chatter is back. But how seriously should one take it? After all, we have been here before, and not just in 2010.

The current debate reprises the confused policy environment of the 1970s, when inflation doves argued that the decade’s oil shocks – prices tripled in 1973-74, and again in 1979, after Iran’s Islamic Revolution – would not produce higher inflationary expectations or an inflationary spiral. Some prominent economists, like the British Keynesian Roy Harrod, even argued that growth-boosting monetary and fiscal policies would lower prices, because output and abundance would increase.

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