The Case for Gradualism in Policies to Reduce Inflation
Allan H. Meltzer rejects as myth the view that the current inflation has its roots in the Vietnam War era deficits. Instead, Meltzer states that the proximate source of the current inflation is the monetary policy of the early 1960s and that inflation persists because monetary policy continues to sustain anticipations of future inflation. Meltzer then develops the rationale for a policy of “gradualism”—pre-announced, gradual, sustained declines in the rate of growth of money. Meltzer emphasizes the importance of conducting monetary policy in a way that permits individuals to quickly recognize permanent shifts in the rate of monetary growth. If monetary growth is volatile, individuals have difficulty in inferring from observed money supply figures what direction the Federal Reserve is likely to take in the future. This situation results in a slow adjustment of expectations about future monetary growth and inflation to a permanent decline in the rate of monetary growth—and, as a consequence, a serious cumulative output loss. By announcing its target and reducing the variance of actual monetary growth around its target, the Fed promotes more rapid revision in inflation expectations and minimizes the cumulative output loss associated with anti-inflation policy.