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The Incredible Volcker Disinflation

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  • Marvin Goodfriend

    ()
    (Federal Reserve Bank of Richmond)

  • Robert G. King

    ()
    (Department of Economics, Boston University)

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

Paper provided by Boston University - Department of Economics in its series Boston University - Department of Economics - Macroeconomics Working Papers Series with number WP2005-007.

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Length: 51 pages
Date of creation: Jun 2005
Date of revision:
Publication status: Forthcoming in International Economic Review
Handle: RePEc:bos:macppr:wp2005-007

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Keywords: credibility; disinflation; monetary policy; Volcker;

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  1. Marvin Goodfriend & Robert G. King, 1998. "The new neoclassical synthesis and the role of monetary policy," Working Paper 98-05, Federal Reserve Bank of Richmond.
  2. Ball, Laurence, 1995. "Disinflation with imperfect credibility," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 5-23, February.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  8. Okun, Arthur M, 1978. "Efficient Disinflationary Policies," American Economic Review, American Economic Association, vol. 68(2), pages 348-52, May.
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  13. Parkin, Michael, 1978. "A Comparison of Alternative Techniques of Monetary Control under Rational Expectations," The Manchester School of Economic & Social Studies, University of Manchester, vol. 46(3), pages 252-87, September.
  14. Robert L. Hetzel, 1998. "Arthur Burns and inflation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 21-44.
  15. 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.
  16. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, May.
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