Lacker

At the Fed Bank of Richmond, Federal Reserve Bank President Jeffrey M. Lacker presents his Economic Outlook, January 2013:

My economic outlook presumes that the FOMC will not allow monetary instability to disrupt economic growth, as arguably took place in the 1970s. But beyond avoiding the economic damage associated with high and variable inflation, I believe it is unlikely that the Federal Reserve can push real growth rates materially higher...

Out of context, for sure. But Fed Bank President Lacker is saying that high and variable inflation disrupted economic growth in the 1970s, and I don't think that's right.

First of all, it wasn't the inflation that disrupted economic growth. It was the Fed's response to inflation that disrupted growth. Trying to halt inflation, the Fed created the recession of 1970, the recession of 1974, and the recessions of 1980 and 1982.

Graph #1: The interest rate (blue) rises repeatedly, each time driving the red line (GDP) down.

Notice: At the Gray bars, the blue line is above the red, and the red is going down.

Again and again the Fed pushed interest rates (blue) up until GDP (red) fell and a recession (gray bar) was created. It was the Fed that disrupted growth!

However, despite the Fed's persistent choking-off of growth, inflation-adjusted GDP grew better during the inflationary years than at any other time:

Graph #2, source: Marcus Nunes

On Marcus's graph, the blue line shows inflation-adjusted GDP. The red line is the straight-line trend path for the blue line. For the years 1965 to 1980 there is a gray background, and these years are labeled "G.I." for the Great Inflation.

Notice that the blue line, real (inflation-adjusted) GDP is well above the trend line for the whole of the Great Inflation period. Oh -- the 1970 and 1974 recessions pull the blue line briefly down to trend, and the 1980 and '82 recessions ended the inflationary period. Sure.

But nowhere else on the graph do we see the blue line so significantly above trend for such an extended period, as during the Great Inflation.

The inflationary years were years of very good economic growth, by Marcus's graph. And remember, the blue line has the inflation stripped out of the numbers. That's real growth we're looking at.

Despite the Fed's creation of three recessions during that decade, real GDP growth was at its best in the inflationary 1970s.

Marcus's graph uses a log scale, so his trend line comes out like a straight line. I looked at the same data, without the log scale. So my graph shows upward-curving lines. Real (inflation-adjusted) GDP, shown in red on Graph #3, closely follows the exponential trend line shown in black:

Graph #3: Real GDP (Quarterly) 1947-2007 and Exponential Trend

Graph #3 doesn't look like Graph #2. But both graphs show inflation-adjusted GDP significantly above trend for the full period of the Great Inflation.

Conclusion: Inflation is good for real growth.

Now, what was it Jeffrey Lacker said? Inflation disrupts economic growth.

That's not right.