A Consistent Characterization of a Near-Century of Price Behavior

Abstract

This paper develops a single econometric equation that can explain most of i the variation in the aggregate U.S. rate of inflation during the period between 1892• and 1978.Unlike previous studies that have omitted the Depression and World War II years, the present equation can explain the 1929-1945 period as well as other years.The equation is derived from a simple aggregate supply equation and makes the rate of price change depend on the rate of change of nominal GNP, the level of detrended real GNP, and on expected price change; the latter, in turn, depends on lagged values of price change and nominal GNP change.Four additional factors are identified that have had a significant impact on the price-setting process: the National Recovery Act (1933-1936), World War II price controls (1943-1947), the Nixon-era controls (1972~1975), and the relative prices of food and energy.The most surprising result is that the contemporaneous elasticity of price change to nominal GNP change has been roughly one-third for almost a century, both in a single equation fitted to the whole period and in equations fitted to three sub-periods.The formation of price expectations changed completely after 1950 from regressive expectations appropriate under a gold standard to extrapolative inertia-dominated expectations appropriate under a fiat money standard and postwar long-period wage contracts.The results also imply that restrictive aggregate demand policy would have a much greater immediate impact in slowing inflation than implied by other econometric work on postwar data.

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