Academic journal article Review - Federal Reserve Bank of St. Louis

Editors' Introduction

Academic journal article Review - Federal Reserve Bank of St. Louis

Editors' Introduction

Article excerpt

On October 6, 1979, the Federal Reserve implemented a monetary policy reform of profound significance for the U.S. economy, marking the beginning of the end of the inflationary malaise that permeated the economy at the time. Starting with its policy actions that Saturday afternoon, the Federal Reserve reaffirmed its responsibility to restore and maintain an environment of price stability in the economy, thereby restoring confidence and setting the stage for a period of lasting economic prosperity. This prosperity has been interrupted only by two mild and shallow recessions over the past two decades.

A conference held in St. Louis on October 7 and 8, 2004, provided the opportunity to reflect on the history of monetary policy in the United States 25 years after the events of that October. Over the two-day period, three papers were presented and discussed, followed by two panel discussions revisiting and distilling the policy lessons surrounding the events of October 1979 and those that can be drawn to safeguard good policy practice going forward. This conference volume is a compilation of the conference proceedings as well as personal reflections commemorating October 6,1979.

With the passage of time, the significance of that moment for our nation's economic history and continuing prosperity will surely fade. Nonetheless, we hope that this conference volume will help preserve the lessons from the October 1979 episode. As Chairman Greenspan noted in his introductory remarks: "We should strive to retain in the collective memory of our institution the ensuing lessons of that period. It may be the most fruitful and proper way to commemorate the events of October a quarter-century ago."

ORIGINS OF THE GREAT INFLATION

In the first conference paper, Allan Meltzer offers a historical analysis of the economic and political forces that generated and sustained the Great Inflation of the 1960s and 1970s and necessitated the forceful disinflationary actions of October 1979. Various explanations have been advanced as possible causes of the policy errors of that period. Some are based on the political business cycle and dynamic consistency problems relating to the limited independence of the Federal Reserve at the time from the political process. Other explanations stress the role of misinformation or misinterpretation of economic theories, models, and/or data.

Meltzer reviews these explanations and discusses their limitations in providing a complete account of the historical experience. His analysis leads to his conclusion that not one but multiple elements must be identified as critical to understand the policy errors of the 1960s and 1970s. Meltzer stresses the role of leadership and beliefs of Federal Reserve policymakers, particularly the Chairman. According to Meltzer, during the 1960s, Chairman Martin placed excessive emphasis on reaching consensus among Federal Open Market Committee (FOMC) members before changing policy, a factor that contributed to unfortunate delays in taking prompt anti-inflationary action at the early stages of the Great Inflation, allowing it to gather momentum. second, adherence to apparently flawed theories of inflation adversely influenced policy deliberations. Over many years, disregard of the fundamental long-run relationship between money growth and inflation steered analysis toward nonmonetary explanations of inflation. Meltzer argues that for many years Federal Reserve staff and policymakers denied that inflation had either begun or increased: They believed instead that inflation was the consequence of transitory factors that did not require a forceful policy response. Third, and perhaps most important, the presence of institutional arrangements that stressed policy coordination between fiscal and monetary policy compromised the independence of the Federal Reserve during the 1960s and 1970s. This, according to Meltzer, hindered the Federal Reserve from taking timely and effective disinflationary action throughout the period and is arguably the most significant factor in his analysis. …

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