International Great Inflation and Common Monetary Policy

Abstract

The Great Inflation of the 1970s was an international phenomenon. We study whether monetary authorities in the G7 countries were changing their responses to inflation in a similar manner during and following the Great Inflation era. Our results suggest that the common to the G7 countries inflation pattern during the Great Inflation period is associated with a common pattern in the monetary policy response to inflation. Specifically, first, we find that until the early 1980s monetary authorities in the G7 countries responded mildly to inflation and they systematically fought it throughout the 1980s. Second, we find that the estimated Taylor-rule coefficients on inflation are cointegrated, implying the existence of a long run relationship in the responses to inflation, during and right after the Great Inflation period. We interpret these findings as suggestive of common monetary policy patterns. Third, we conduct a principal component analysis on the residuals of the estimated Taylor rules and conclude that the shocks’ structure cannot account enough for the monetary policies’ comovements. Finally, we find that the response to inflation weakens during the 2000s, indicating that after inflation stabilized in low levels, policy makers are not as concerned with it as they were during the 1980s and 1990s.