INTRODUCTION

During the past 10 years the U.S. inflation rate has been on a roller-coaster ride. Twice, during 1973–75 and again during 1979–81, the inflation rate rose dramatically, giving rise to fears of unstoppable hyperinflation, only to drop again almost as dramatically. In addition, during these episodes, output fell and unemployment rose. This unfortunate combination of inflation and recession has been dubbed “stagflation.” Monetary policy played a prominent role in this stagflationary decade, and it is the purpose of this chapter to review and analyze the part played by the Federal Reserve's conduct of monetary policy in greater detail than was possible in previous chapters. It is not intended merely to record the events since 1972 but instead to fit them into the analytical framework formulated in Chapters 2–7. From the IS-LM-AS model it is possible to make a number of predictions about the macroeconomic consequences of policy changes or unpredictable shocks; these predictions will then be tested against the evidence of the time to see how.useful the IS-LM-AS model is in such a turbulent period.

In a sense, this is a case study; it is an attempt to use the macro model to analyze a specific real-world situation. At the same time, it should not be construed as the final word on the events that transpired during this period; there is not enough historical perspective for that.