Thursday, December 13, 2012

FRB - The Reform of October 1979: How It Happened and Why

Finance and Economics Discussion Series
Divisions of Research & Statistics and Monetary Affairs
Federal Reserve Board, Washington, D.C.

David E. Lindsey, Athanasios Orphanides, and Robert H. Rasche


"This study offers a historical review of the monetary policy reform of October 6, 1979, and discusses the influences behind it and its significance. We lay out the record from the start of 1979 through the spring of 1980, relying almost exclusively upon contemporaneous sources, including the recently released transcripts of Federal Open Market Committee (FOMC) meetings during 1979. We then present and discuss in detail the reasons for the FOMC’s adoption of the reform and the communications challenge presented to the Committee during this period. Further, we examine whether the essential characteristics of the reform were consistent with monetarism, new, neo, or oldfashioned Keynesianism, nominal income targeting, and inflation targeting. The record suggests that the reform was adopted when the FOMC became convinced that its earlier gradualist strategy using finely tuned interest rate moves had proved inadequate for fighting inflation and reversing inflation expectations. The new plan had to break dramatically with established practice, allow for the possibility of substantial increases in short-term interest rates, yet be politically acceptable, and convince financial markets participants that it would be effective. The new operating procedures were also adopted for the pragmatic reason that they would likely succeed."

"Do we have the wit and the wisdom to restore an environment of price stability without
impairing economic stability? Should we fail, I fear the distortions and uncertainty
generated by inflation itself will greatly extend and exaggerate the sense of malaise and
caution...Should we succeed, I believe the stage will have been set for a new long period
of prosperity."

—Paul Volcker


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