From the Great Depression to the Great Inflation: Path dependence and monetary policy

There is substantial narrative evidence that the shadow of the Great Depression may have influenced the conduct of U.S. monetary policy during the 1970s. In this paper, we estimate central bank reaction functions for the United States and 12 other countries over the 1970s to examine the relationship between the magnitude of the Great Depression and the response of central banks to output gaps and inflation during the Great Inflation. The main finding is that countries which suffered the most during the 1930s had monetary policy reaction functions that responded substantially more aggressively to output gaps during the 1970s.