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posted on 11 January 2018

The Evolution Of U. S. Monetary Policy

from the Richmond Fed

Since the creation of the Federal Reserve System, the goal of policymakers has been economic stability. Policymakers’ strategies for achieving that goal have evolved with their understanding of how the world works. An overview of that understanding and of its consequences for monetary policy provides an approximation to a laboratory for understanding what constitutes a stabilizing monetary policy. As an institution, when has the Fed been a major contributor to economic stability and when has it been a major source of instability?

This laboratory provides guidance in the construction of a model that allows for identification of the forces that drive prices and the business cycle. A model allows one to go beyond the correlations of monetary and macroeconomic variables in order to assign causation. It explains how “exogenous" forces, that is, forces emanating from outside the working of the price system, move markets away from stable outcomes. The historical overview here suggests that monetary policymakers still have not settled on a model and a rule for policy that satisfactorily distills the lessons from historical experience. Much work remains in order to achieve consensus on the design of a rule that will make monetary policy into a consistently stabilizing influence.

Section 1 poses the questions, “What is a central bank and how does the systematic behavior of a central bank create the monetary regime?" Section 2 summarizes the pre-World War II monetary regime, while sections 3 summarizes the era of stop-go monetary policy. Section 4 reviews the post-disinflation Volcker-Greenspan era and the intellectual sea change that it entailed. Section 5 reviews the monetary regime created during the Volcker-Greenspan tenures as FOMC chairmen. Section 6 reviews monetary policy during the Great Recession. (The narrative summarizes Hetzel (2008 and 2012). Section 7 examines the reasons why the Fed regularly missed its inflation target on the downside after the Great Recession. Section 8 offers concluding comments.

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Source publications/research/working_papers/2018/ pdf/wp18-01.pdf

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