“Gautti Eggertson has an interesting post where he compares current economic conditions to those that prevailed leading up to the recession of 1937-1938. Here is his description of developments in 1937:
(1) Signs indicate that the recession is finally over. (2) Short-term interest rates have been close to zero for years but are now expected to rise. (3) Some are concerned about excessive inflation. (4) Inflation concerns are partly driven by a large expansion in the monetary base in recent years and by banks’ massive holding of excess reserves. (5) Furthermore, some are worried that the recent rally in commodity prices threatens to ignite an inflation spiral.
The Federal Reserve responded at this time by tightening monetary policy. Fiscal policy also was tightened. These policy moves turned what had been a robust recovery between 1933 and 1936 into the second recession of the Great Depression. As a result, a full economic recovery was postponed several more years.
Eggertson explains the surge in commodity prices was the galvanizing force then behind the concerns over inflation and, thus, the tightening of policy. Though these developments sound eerily similar to today’s environment, Eggertson is confident that Fed officials will not make the same mistake:
It is unlikely, however, that a modern economist put in the same position would respond to the commodity price rise in the same way… Fed economists today typically monitor various components of the CPI that are not influenced strongly by temporary supply disruptions. For example, one common measure tracked is “core CPI,” which excludes volatile food and energy prices from the overall CPI basket.
He then goes on to claim the Fed’s response in 2008 proves his point: ….”
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