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What is the monetary standard, or, how did the Volcker-Greenspan FOMCs tame inflation?

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Author Info
Robert L. Hetzel
Abstract

A consensus now exists that central banks, which possess a monopoly over the creation of fiat money (the monetary base), control trend inflation. But how do they exercise this control, especially given that their use of the interest rate as the policy instrument renders money endogenous (determined by market forces)? This paper considers two alternatives. First, central banks control inflation through the way that they manipulate the unemployment rate (subject to a trade-off between changes in inflation and the amount of excess unemployment as summarized in a Phillips curve). Second, and alternatively, central banks control inflation by following consistent procedures that combine two characteristics. Through their consistency, these procedures provide for a nominal anchor by causing the public to expect low trend inflation that is stable in the sense of being unaffected by inflation and recession shocks. Also, they allow the price system to work in the sense of allowing market forces to determine real variables such as the unemployment rate.

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Publisher Info
Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

Volume (Year): (2008)
Issue (Month): Spr ()
Pages: 147-171
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Handle: RePEc:fip:fedreq:y:2008:i:spr:p:147-171:n:v.94no.2

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Related research
Keywords: Monetary policy ; Inflation (Finance);

References listed on IDEAS
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  1. Bennett T. McCallum, 1986. "Some Issues Concerning Interest Rate Pegging, Price Level Determinacy, and the Real Bills Doctrine," NBER Working Papers 1294, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," NBER Working Papers 13580, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Hetzel, Robert L & Mehra, Yash P, 1989. "The Behavior of Money Demand in the 1980s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 21(4), pages 455-63, November. [Downloadable!] (restricted)
  4. Nelson, Edward, 2001. "What Does the UK's Monetary Policy and Inflation Experience Tell Us About the Transmission Mechanism?," CEPR Discussion Papers 3047, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  5. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond. [Downloadable!]
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  6. Sargent, Thomas J & Wallace, Neil, 1975. ""Rational" Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 83(2), pages 241-54, April. [Downloadable!] (restricted)
  7. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
    Other versions:
  8. repec:bep:macadv:v:5:y:2005:i:1:p:1297-1297 is not listed on IDEAS
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  9. repec:fip:fedreq:y:1987:i:jul:p:3-16:n:v.73no.4 is not listed on IDEAS
  10. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 1007-1057.
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  11. Athanasios Orphanides, 2002. "Monetary-Policy Rules and the Great Inflation," American Economic Review, American Economic Association, vol. 92(2), pages 115-120, May. [Downloadable!]
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  12. Robert L. Hetzel, 2006. "Making the systematic part of monetary policy transparent," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 255-290. [Downloadable!]
  13. repec:fip:fedreq:y:1987:i:may:p:3-16:n:v.73no.3 is not listed on IDEAS
  14. repec:fip:fedreq:y:1990:i:may:p:3-12:n:v.76.no.3 is not listed on IDEAS
  15. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August. [Downloadable!] (restricted)
  16. Marvin Goodfriend, 2004. "Monetary policy in the new neoclassical synthesis : a primer," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 21-45. [Downloadable!]
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  17. Robert L. Hetzel, 1999. "Japanese monetary policy: a quantity theory perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-26. [Downloadable!]
  18. repec:fip:fedreq:y:1974:i:may:p:2-19:n:v.60no.3 is not listed on IDEAS
  19. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
  20. Robert L. Hetzel, 2004. "How do central banks control inflation?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 46-63. [Downloadable!]
  21. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April. [Downloadable!] (restricted)
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  22. Marvin Goodfriend & Robert G. King, 2005. "The Incredible Volcker Disinflation," Boston University - Department of Economics - Macroeconomics Working Papers Series WP2005-007, Boston University - Department of Economics. [Downloadable!]
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  23. Robert L. Hetzel, 1998. "Arthur Burns and inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 21-44. [Downloadable!]
  24. repec:fip:fedreq:y:1983:i:sep:p:12-21:n:v.69no.5 is not listed on IDEAS
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This page was last updated on 2009-11-13.

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