During the 1970s, inflation expectations were very poorly anchored. There was very little confidence that the Fed would keep inflation low and stable. When oil prices rose, those price increases fed through quickly into other prices and began to raise the general rate of inflation quite quickly.

The Fed responded somewhat in a panicked way by raising interest rates enormously, which then contributed to the deep recessions of 1975 and 1981-'82.

In a more recent episode, we've had extensive increases in energy prices, but outside of the energy sector, if you look at core inflation, core inflation remains very well controlled. And as a result, the Fed Reserve has been able to raise interest rates from its low accommodative level, but to only 4 percent at this point. And the economy is growing strongly.

So I think this is an enormously good illustration of why keeping inflation low, stable and keeping expectations well-anchored is of tremendous benefit, not just on the inflation side, but also on the employment and growth side.

From the Q&A session

Today, the average price of crude oil, despite its recent surge, is still in real terms below the price peak of February 1981. Moreover, since oil use, as I noted, is only two-thirds as important an input into world GDP as it was three decades ago, the effect of the current surge in oil prices, though noticeable, is likely to prove significantly less consequential to economic growth and inflation than the surge in the 1970s.

Thus far at least, the growth effects of energy price increases appear relatively modest. The economy is much more energy-efficient today than it was in the 1970s, when energy shocks contributed to sharp slowdowns, and real energy prices remain below the peaks attained in the 1970s and early 1980s. Well-controlled inflation and inflation expectations have also moderated the effects of energy price increases, since those increases no longer set off an inflation spiral and the associated increases in interest rates, as they did three decades ago.

If people begin to expect higher inflation because of the current impact of oil prices, we could face a kind of scaled down version of the devastating wage-price spiral we lived through in the 1970s. The good news is that evidence from financial market indicators, surveys, and recent patterns of labor compensation all indicate that long-term inflation expectations have been extremely stable. Presumably, this reflects the market’s view that the Fed will continue to demonstrate that it’s willing to do what’s necessary to ensure U.S. price stability.

What got us into trouble in the '60s was overly expansionary fiscal policy due to the Vietnam War. Everybody knows that. A large part of the trouble of the 1970s was due to supply shocks -- food, oil. It wasn't the only thing, but it was a very major shock. It wasn't due to monetary policy errors. I don't mean to say the Fed was flawless. The goal is to get the unemployment to around the natural rate and not to overshoot. If you do that, you're not going to make an inflationary error. Mistakes will be made. We're not tuning a precision instrument here. Sometimes you'll accidentally be too tight. Sometimes you'll accidentally be too loose. That doesn't lead to any secular creep in inflation.