158
*
BARSKY & KILIAN
the
part
of the
Federal
Reserve:
first,
a
miscalculation of full
employment
in
the wake of the
productivity
slowdown and of structural
changes
in
the
labor
market
(see
Orphanides,
2000;
Orphanides
et
al.,
1999);12
and,
second,
an
increased
tendency
to attribute
inflation to
"special
factors"
rather than the
underlying monetary
environment.13
A
third
element
was the
exploitation
of
the
newly
unconstrained
policy
environment in
the service of electoral
politics.14
A
number
of
authors
(see
McKinnon, 1982;
DeLong,
1997;
Mundell,
2000)
have
suggested
that the
collapse
of the
gold exchange
standard
associated
with
Bretton
Woods
played
a
key
causal
role
in
the
creation of
the
inflationary monetary
environment of the
1970s.15
Although
it is
widely accepted
that
the eventual
collapse
of the Bretton
Woods
system
was
inevitable due to fundamental
structural flaws
(see
the
papers
in
Bordo
and
Eichengreen,
1993),
the
timing
of its demise was influenced
by
the same factors
that also
launched the
initial
wave
of
inflation
in
the
mid-1960s to
1970.
The
collapse
was
triggered
by
an
excess
supply
of
U.S. dollars
resulting
both from the
expansion
of the U.S.
monetary
base
and
a
reduction
of the demand for dollars abroad driven
by
the
expecta-
12.
Orphanides
(2000)
documents
that
the measurements of real
output
available to the
Fed
following
both the 1970 and
1974
recessions were
substantially
lower
than
the
output
data
now available.
At
the same
time,
official estimates
of
potential
real
output
were
in
retrospect
far
too
optimistic, resulting
in
excessively high
estimates
of the
output gap,
defined
as the shortfall of actual
output
relative to
potential.
Drawing
on
evidence from
simulated
real-time
Taylor
rules and on the Fed minutes
and
the recollec-
tions of the
policymakers
involved,
Orphanides
concludes
that
the increase
in
the
natural rate
of
unemployment
and the
productivity
slowdown
in
the
late
1960s and
1970s were
two
major
factors
in
explaining
the
inflationary
outcomes
of
the
period.
13.
For
example,
Hetzel
(1998)
makes
the
case
that then chairman Arthur Burns adhered
to
a
special-factors
theory
of inflation
which attributed
increases
in
inflation
to a
variety
of
special
circumstances
ranging
from unions and
large corporations
to
government
defi-
cits and
finally
food
and
oil
price
increases.
Hetzel
argues
that Bums
systematically
discounted
any
direct effects from increases
in the
money
supply
on inflation
and did
not
appear
to
be
overly
concerned
about the extent of the
monetary expansion
in the
early
1970s.
For a similar
view
see Christiano
and Gust
(2000).
14.
For
example,
DeLong
(1997)
stresses
that the inflation of the
early
1970s
was fueled in
addition
by
Arthur
Bums's efforts
to
facilitate
Nixon's
reelection
through expansionary
monetary policy.
Christiano
and Gust's
(2000)
narrative
evidence that
Burns was
not
intimidated
by
Nixon
does not contradict this
interpretation,
because
Burns's conserva-
tive economic
views were
closer to Nixon's than
to
those
of his
Democratic
opponent.
15.
The
temporal
coincidence
is
indeed
an
impressive
one. The
breakdown
of
the
Bretton
Woods
system
was foreshadowed
by
the introduction
in 1968 of
a
two-tiered
system
of
convertibility
with
significantly higher
prices
for
private
than for
official
transactions,
in
response
to the
declining private-sector
confidence
in
the
dollar
peg.
It became
official when
President Nixon
announced
the
"closing
of
the
gold
window"-ending
the
convertibility
of dollars into
gold
in
August
1971.
The relaxation of the convertibil-
ity
constraint coincided
with a dramatic
increase
in
U.S.
monetary growth
(see
Figure
3a)
and
a
period
of
expansionary monetary policy
between mid-1970
and late
1972,
as
indicated
by
the Bernanke-Mihov
index.