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The incredible Volcker disinflation

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  • Goodfriend, Marvin
  • King, Robert G.

Abstract

The reduction in inflation that occurred in the early 1980s, when the Federal Reserve was headed by Paul Volcker, is arguably the most widely discussed and visible macroeconomic event of the last 50 years of U.S. history. Inflation had been dramatically rising, but under Volcker, the Fed first contained and then reversed this process. Using a simple modern macroeconomic model, we argue that the real effects of the Volcker disinflation were mainly due to its imperfect credibility. In our view, the observed upward volatility and subsequent stubborn elevation of long-term interest rates during the disinflation are key indicators of its imperfect credibility. Studying transcripts of the Federal Open Market Committee recently released to the public, we find — to our surprise — that Volcker and other FOMC members likewise regarded the long-term interest rates as indicative of inflation expectations and of the credibility of their disinflationary policy. Drawing from the transcripts and other contemporary sources, we consider the interplay of monetary targets, operating procedures, and credibility during the Volcker disinflation.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 52 (2005)
Issue (Month): 5 (July)
Pages: 981-1015

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Handle: RePEc:eee:moneco:v:52:y:2005:i:5:p:981-1015

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Web page: http://www.elsevier.com/locate/inca/505566

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  1. Milton Friedman, 1957. "A Theory of the Consumption Function," NBER Books, National Bureau of Economic Research, Inc, number frie57-1, May.
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  3. McCallum, Bennett T., 1981. "Price level determinacy with an interest rate policy rule and rational expectations," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 319-329.
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  13. Ball, Laurence, 1994. "Credible Disinflation with Staggered Price-Setting," American Economic Review, American Economic Association, vol. 84(1), pages 282-89, March.
  14. Christopher J. Erceg & Andrew T. Levin, 2001. "Imperfect credibility and inflation persistence," Finance and Economics Discussion Series 2001-45, Board of Governors of the Federal Reserve System (U.S.).
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