donald l kohn : comments on “ understanding the evolving inflation process ” by cecchetti, hooper, kasman, schoenholtz, and watson remarks by mr donald l kohn, vice chairman of the board of governors of the us federal reserve system, at the u. s. monetary policy forum, washington, dc, 9 march 2007. * * * this was an interesting paper with an important objective – to contribute to our understanding of inflation dynamics, with a particular focus on the so - called great inflation of the 1970s. 1 the better we understand history, the less likely we are to repeat it, even on a reduced scale. of course, the basic problem in tackling the inflation of the 1970s is that we have one observation and many competing theories. the authors ’ approach is to consider the experiences of other major industrial countries during that period with the hope that cross - country differences will provide a way to discriminate among the potential causes. the authors ’ principal empirical finding is that the onset and, to a lesser degree, the end of the great inflation were closely synchronized across a number of countries. on the basis of this timing and other findings, they reject many of the theories about why inflation rose in the period from the late 1960s through the end of the 1970s. according to the authors, the great inflation did not stem solely from adverse structural changes to the economy, or from policymaker misunderstandings about the nature of the inflation process, or from errors in gauging aggregate resource utilization. instead, they say, changes in monetary policy preferences, perhaps accentuated by political influences, are the key part of the story. i certainly agree with the authors that high inflation could not have emerged and then persisted without an accommodative policy regime and that a period of tight policy was required to produce the sustained moderation in inflation that followed. however, their conclusions do not fit easily with my premise, which is that policymakers did not seek the result they obtained. in thinking about the story told by the paper, i also wonder why political forces and central - banker preferences would necessarily shift at the same time in so many countries. so i am left with the question of why policy was conducted the way it was. my impulse when it comes to selecting from the list of causative factors in the paper is to say “ all of the above. ” policymakers in the 1970s – the federal reserve among them – were dealt a very bad hand that,

##ility – we should always keep in mind how little we know about the economy. monetary policy operates in an environment of pervasive uncertainty – about the nature of the shocks hitting the economy, about the economy ’ s structure, and about agents ’ reactions. the 1970s provide a sobering lesson in the difficulty of estimating the level and rate of change of potential output ; these are quantities we can never observe directly but can only infer from the behavior of other variables. we cannot effectively implement policy without some reference to the likely level of potential, given that demand - supply pressures are an integral part of the monetary transmission mechanism. but we must be realistic about the accuracy of our estimates of potential while always doing our best to improve them. even today, we face a number of sources of uncertainty about the nature of the inflation process. interestingly, we can draw several examples from the paper. first, any estimate of the persistent component of inflation is inherently uncertain. comparing the trend inflation estimates for the gross domestic product of the united states in the current study with related estimates based on stock and watson ’ s recent paper on the topic reveals an important difference : in the latter, the standard deviation to the innovation of the permanent component of inflation from 1997 onward is not zero but rather permits a small but significant amount of drift in the trend from its late - 1990s trough. 2 other trend - extraction exercises imply either a stable trend or a trend that has drifted up over the past several years ; likewise, the behavior of estimated trend inflation over this period differs according to the inflation concept used. although these differences are small relative to the overall variation in the trend over the past forty years, they are assuredly large enough to be meaningful to a monetary policy maker. in addition, we do not yet have a consensus structural model of inflation dynamics that satisfactorily explains all the important aspects of the empirical data. as the paper demonstrates, a standard workhorse model – a sticky - price business cycle model with a drifting inflation target and a new keynesian phillips curve – cannot mimic one important feature of the inflation process. i will leave it to the modelers to debate the seriousness of this deficiency and to propose how it might be rectified. however, it is clear to me that our understanding of the inflation process still has far to go. the issue of expectations illustrates our ignorance. as i have already indicated, inflation expectations are among the most important variables policymakers monitor, but we do not have answers to