St Louis Fed, Report: The COVID-19 Pandemic and Inflation, Lessons from Major US Wars

“The fiscal and monetary policies adopted in the “war” on COVID-19 were indeed like past wars. Sharp increases in government spending with substantial monetary accommodation promoted a rapid recovery from the severe, but brief, recession in the second and third quarters of 2020. However, as in past wars, those fiscal and monetary policies also contributed to a significant increase in inflation. Whether price stability will be restored quickly (as it was after the Civil War and World War I or soon after the removal of price controls at the end of World War II) or persist for several years (as it did after the Vietnam War) remains to be seen. The era of modern central banking shows that central banks are capable of achieving low inflation, though the evidence from US wars suggests that the extent of govern­ment spending and the means used to finance that spending (e.g., monetizing the debt) can have a sig­nificant impact on inflation outcomes. Further, the historical record reveals that postwar periods can be disruptive, with sharp fluctuations in economic activity and inflation, and that a quick restoration of price stability requires a recalibration of monetary policy that cannot always be taken for granted.”