Read That ‘70s Show, a Wall Street Journal op-ed essay by Allan H. Meltzer.
The writer is a distinguished economics professor at Carnegie-Mellon University and the author of A history of the Federal Reserve : Volume 1, 1913—1951, a highly recommendable book.
Professor Meltzer observes:
Surely Mr. Bernanke and his colleagues remember what happened in the 1970s. They console themselves with the belief that they will respond to any inflation that occurs by promptly raising interest rates. That repeats the commitments made repeatedly in the 1970s, which the Fed was unwilling to keep. The blunt fact is that there is rarely a popular time to raise interest rates. And with the growing streak of populism in the country, it will become more difficult.
Unfortunately,the Fed has chosen to forget the most important empirical lesson from the stagflation of the 1970s: after inflation takes hold, raising interest rates is ineffective in stemming it.
Only once has the Fed actually stopped inflation. In the early 1980s, under President Ronald Reagan, Fed Chairman Paul Volcker let interest rates find their own level and concentrated on reducing the money supply.
Had that course been followed earlier, the nation would have had a shallow and quickly ended recession. Instead, by seeking to manipulate the economy by ballooning the money supply to fund more Federal spending, as Keynes recommended, the Fed gave us the prolonged agony of stagflation: a severe economic recession, while prices rose at the fastest rate in United States history.
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