But instead of getting too worked up about the prospect of inflation, the Fed is seeking a balance between the lessons of two different eras: the Great Inflation of the 1970s, when annual inflation rates soared as high as 13.5 percent, and the long but slow recovery after the 2008 financial crisis. When the Fed unleashed its bond-buying programs for years after the last recession, lawmakers such as Toomey raised concerns about inflation pressures that never took hold.
Either way, if inflation does start to really take off, the Fed should have plenty of time to react.
“It’s called the Great Inflation because it’s really like a 15, 16-year process. It’s a prolonged, gradual buildup,” said David Beckworth, a senior research fellow at the Mercatus Center at George Mason University.
Today, markets aren’t even pricing in significantly higher inflation, perhaps still expecting the Fed to flinch and raise rates at the first sign of trouble, despite its promise to hold steady until the economy reaches full employment.
Spending habits, wages and prices are all tied in part to the psychological phenomenon of whether people expect inflation to pick up, making those types of signals key to spotting the early signs of even slightly higher inflation. “I don’t even see us in the first stage of the Great Inflation,” Beckworth said.
The first stage began in the latter half of the 1960s, when inflation inched up alongside rapid economic growth and low unemployment. Before the shift to ’70s-era “stagflation” — economic stagnation plus inflation — then-Fed Chair Arthur Burns was pressured by President Richard Nixon in the lead-up to the 1972 presidential election to keep interest rates low.
“That was a great lesson of the ’60s and throughout the ’70s: policymakers, particularly at the Fed, kind of abdicated their responsibility for controlling inflation,” said Michael Feroli, chief U.S. economist at JPMorgan Chase.
The growing consensus, including within the Fed itself, is that it overcorrected in the decades after the Great Inflation by being too aggressive in trying to stave off higher price levels. After the 2008 financial crisis, the central bank raised rates before economic growth reached all corners of the labor market, even though there was no sign of inflation picking up. That’s now viewed by many economists as a policy error.