Indeterminacy and learning: An analysis of monetary policy in the Great Inflation

Abstract

The Great Inflation of the 1970s can be understood as the result of equilibrium indeterminacy in which loose monetary policy engendered excess volatility in macroeconomic aggregates and prices. The Federal Reserve inadvertently pursued policies that were not anti-inflationary enough because it did not fully understand the economic environment it was operating in. Specifically, it had imperfect knowledge about the structure of the economy and was subject to data misperceptions. The combination of learning about the economy and the use of mis-measured data resulted in policies, which the Federal Reserve believed to be optimal, but when implemented led to equilibrium indeterminacy.