The Journey of the Fed rate through a false natural level of real GDP

The story of how the Fed controlled inflation after the 1970’s is long. Below I present a perspective that you probably have never seen. I have never seen it presented.

The story uses the monetary model of effective demand to show how the Fed lost control of inflation in 1978 and then was able to bring inflation back under control by 1995. In the process, the Fed manufactured a false lower natural level of real GDP with an unnatural real interest rate of 6%. They maintained that false lower level until inflation was under control.

In the end, the Fed brilliantly coordinated the Fed funds rate into perfect balance with their original targets.

Part 1

Part 2

Will the Fed now try to create a higher unnatural level of real GDP in order to reach full employment? As Larry Summers says, they would have to target a negative natural real interest rate. But would the effective demand limit allow real GDP to pass its natural level? That has never happened in the US at least since the 1960’s.

Further analysis to come…