Abstract
This paper offers an alternative explanation for the great inflation of the 1970s by measuring a novel source of monetary policy time inconsistency. In the presence of asymmetric preferences, the monetary authorities generate a systematic inflation bias through the private‐sector expectations of a larger policy response in recessions than in booms. The estimated Fed's implicit target for inflation has declined from the pre‐ to the post‐Volcker regime. The average inflation bias was about 1% before 1979, but this has disappeared over the last two decades, because the preferences on output stabilization were large and asymmetric only in the former period.
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