A defining moment
may shape the direction of an institution for
decades to come. In the modern history of the
Federal Reserve, the action it took on October
6, 1979, stands out as such a milestone and arguably
as a turning point in our nation's economic history.
The policy change initiated under the leadership
of Chairman Paul Volcker on that Saturday morning
in Washington rescued our nation's economy from
a dangerous path of ever- escalating inflation
and instability. As I noted in congressional testimony
before the Joint Economic Committee on November
5 of that year:
We are here … to evaluate the moves of Chairman
Volcker and his colleagues last month, implying
that some alternate policies were feasible at
that time. However, given the state of the world
financial markets, had the Fed not opted to initiate
a sharp interest rate increase in this country,
the market would have done it for us. 1
In a democratic society such as ours, the central
bank is entrusted by the Congress, and ultimately
by the citizenry, with the tremendous responsibility
of guarding the purchasing power of money. It
is now generally recognized that price stability
is a prerequisite for the efficient allocation
of resources in our economy and, indeed, for fulfilling
our ultimate mandate to promote maximum sustainable
employment over time. But the importance of price
stability has sometimes been insufficiently appreciated
in our central bank's history, and, as Allan Meltzer
will soon point out, such episodes have had unfortunate
consequences.
Far from being a bulwark of stability in the 1970s,
the Federal Reserve conducted policies that, in
the judgment of many analysts, inadvertently contributed
to an environment of macroeconomic instability.
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.
Tracing the roots of the 1970s inflation brings
us to an earlier era. The Keynesian revolution
of the 1930s and its subsequent empirical application
led many economists to accept the view that through
regulation, state intervention, and the macroeconomic
management of aggregate demand, government policies,
including those of our nation's central bank,
could improve on earlier efforts to achieve and
maintain “full employment.” By the
1960s, policymakers seemed to concentrate their
short-run objectives on maintaining a “high
pressure” economy in the belief that such
a recipe could virtually thwart economic contractions
at little or no risk to long-run stability and
growth. If this high-pressure management inadvertently
carried the economy beyond its productive potential,
some cost in terms of inflation could be expected,
but such costs appeared tolerable in light of
the employment gains that came with them. Furthermore,
policymakers hoped that additional tools at their
disposal--so-called incomes policies enforced
by “jawboning,” guideposts, and price
and wage controls--were ready to combat and control
any resulting upcreep in inflation with minimal
macroeconomic cost. By the turn of the 1970s,
the ugly reality of stagflation forced an overhaul
of this policy framework. The corrosive influence
of inflation on our nation's productive potential
was beginning to take hold. Policymakers slowly
came to recognize the adverse long-term consequences
of compromising the purchasing power of our currency
for economic well being. Indeed, by the late 1970s,
a consensus gradually emerged that inflation destroyed
jobs rather than facilitating their creation.
Unfortunately, a legacy of failed attempts during
the decade to restore stability with gradualist
plans and with various incarnations of incomes
policies took its toll on business and household
attitudes toward inflation and toward the prospects
of our nation. By the end of the decade, an inflationary
psychology had become well entrenched and complicated
efforts to restore a sense of stability in the
national psyche.
Little leeway for policy was left before the Federal
Reserve took decisive action on October 6, 1979.
In retrospect, the policy put in place on that
day was the obvious and necessary solution to
the nation's troubles. As events unfolded, however,
the Federal Reserve did not escape criticism,
and for a time it was not entirely obvious that
the System could maintain the necessary public
support to see its disinflationary efforts come
to fruition. Though widely anticipated even before
the actions of October, the recession and retrenchment
in employment that followed those actions resulted
in pressures on the Federal Reserve to reverse
course. The fiftieth anniversary of the beginning
of the Great Depression--the crash of 1929--was
observed later during that same month, October
1979. I recall that this anniversary not only
rekindled the question of whether such an event
could recur but also inflamed sensitivities regarding
the effects on unemployment that might stem from
the new anti-inflationary action. Judging from
the fate of earlier attempts during the 1970s
to tame inflation in the face of a weakening economy,
when short-run considerations appeared to trump
policies oriented toward longer horizons, such
fears of rising unemployment could have also derailed
the reforms of October. In the event, they did
not. We owe a tremendous debt of gratitude to
Chairman Volcker and to the Federal Open Market
Committee for their leadership and steadfastness
on that important occasion and for restoring the
public’s faith in our nation's currency.
By the time that I arrived at the Federal Reserve,
in 1987, the task of the Federal Open Market Committee
had become easier precisely because of the perseverance
and success of our predecessors in the turbulent
years following October 1979. Maintaining an environment
of stability is simpler than restoring the public’s
faith in the soundness of our currency. The task
is easier still as we remind ourselves of the
stark difference between the long-term prospects
of our economy now, in our current environment
of stability, and then, a quarter-century ago,
before the reforms of that October.
In closing, I applaud President Poole and his
colleagues for organizing this event to reflect
upon that critical episode in our nation’s
economic history. An appreciation of our history
is, after all, an invaluable guide to sound policies
for a better future.
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