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

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  • Robert L. Hetzel
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    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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    Bibliographic 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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    Keywords: Monetary policy ; Inflation (Finance);

    References

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    1. 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.
    2. Lucas, Robert E, Jr, 1996. "Nobel Lecture: Monetary Neutrality," Journal of Political Economy, University of Chicago Press, vol. 104(4), pages 661-82, August.
    3. Robert L. Hetzel, 1998. "Arthur Burns and inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 21-44.
    4. Marvin Goodfriend, 1987. "Interest rate smoothing and price level trend-stationarity," Working Paper 87-03, Federal Reserve Bank of Richmond.
    5. 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.
    6. Orphanides, Athanasios, 2003. "The quest for prosperity without inflation," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 633-663, April.
    7. Goodfriend, Marvin, 2002. "Monetary Policy in the New Neoclassical Synthesis: A Primer," International Finance, Wiley Blackwell, vol. 5(2), pages 165-91, Summer.
    8. Edward Nelson, 2004. "The Great Inflation of the seventies: what really happened?," Working Papers 2004-001, Federal Reserve Bank of St. Louis.
    9. Athanasios Orphanides, 2002. "Monetary policy rules and the Great Inflation," Finance and Economics Discussion Series 2002-8, Board of Governors of the Federal Reserve System (U.S.).
    10. Thomas M. Humphrey, 1983. "Can the central bank peg real interest rates? : a survey of classical and neoclassical opinion," Economic Review, Federal Reserve Bank of Richmond, issue Sep, pages 12-21.
    11. Robert L. Hetzel, 1987. "Henry Thornton: seminal monetary theorist and father of the modern central bank," Economic Review, Federal Reserve Bank of Richmond, issue Jul, pages 3-16.
    12. Marvin Goodfriend, 2007. "How the World Achieved Consensus on Monetary Policy," NBER Working Papers 13580, National Bureau of Economic Research, Inc.
    13. Marvin Goodfriend, 2000. "Overcoming the zero bound on interest rate policy," Working Paper 00-03, Federal Reserve Bank of Richmond.
    14. Thomas M. Humphrey, 1974. "The quantity theory of money : its historical evolution and role in policy debates," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 2-19.
    15. Robert L. Hetzel, 2004. "How do central banks control inflation?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 46-63.
    16. Hetzel,Robert L., 2008. "The Monetary Policy of the Federal Reserve," Cambridge Books, Cambridge University Press, number 9780521881326, October.
    17. 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.
    18. 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.
    19. 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.
    20. Georg Rich, 1987. "Swiss and United States monetary policy: has monetarism failed?," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 3-16.
    21. 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.
    22. McCallum, Bennett T., 1986. "Some issues concerning interest rate pegging, price level determinacy, and the real bills doctrine," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 135-160, January.
    23. Robert L. Hetzel, 1999. "Japanese monetary policy: a quantity theory perspective," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-26.
    24. Robert L. Hetzel, 2006. "Making the systematic part of monetary policy transparent," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 255-290.
    25. Thomas M. Humphrey, 1990. "Fisherian and Wicksellian price-stabilization models in the history of monetary thought," Economic Review, Federal Reserve Bank of Richmond, issue May, pages 3-12.
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    Cited by:
    1. Hendrickson, Joshua R., 2012. "An overhaul of Federal Reserve doctrine: Nominal income and the Great Moderation," Journal of Macroeconomics, Elsevier, vol. 34(2), pages 304-317.
    2. Hetzel, Robert L., 2012. "Central bank accountability and independence: Are they inconsistent?," Journal of Macroeconomics, Elsevier, vol. 34(3), pages 616-625.
    3. Hendrickson, Joshua, 2010. "An Overhaul of Fed Doctrine: Nominal Income and the Great Moderation," MPRA Paper 20346, University Library of Munich, Germany.

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