A History of the Federal Reserve, Volume 2 by Allan H. Meltzer Read Free Book Online

actions would probably end independence.

    In practice, the Federal Reserve waited for political support before making major policy changes. Although members chafed under the 2.5 percent ceiling for long-term rates before 1951, they did not challenge the restriction until they had congressional support. In 1978 polling data showed a sharp increase in concern about inflation that persisted until spring 1982. More than 50 percent of those polled listed inflation and the high cost of living as the most important problem facing the country. In October 1978, 72 percent listed inflation and only 8 percent listed unemployment. The public wanted disinflation; the political process responded and the Federal Reserve changed its policy. By October 1982, when the disinflation policy ended, 61 percent listed unemployment as the most important problem. Only 18 percent still cited inflation.
    President Nixon urged Arthur Burns to adopt more expansive policy prior to the 1972 election. Leading members of Congress agreed. The public expressed little concern about inflation. Only 20 percent listed inflation as their principal concern at election time.
    Independence should be strengthened. Responsibility for policy outcomes should not be avoided in discussions of independence. An independent central bank can cause unemployment or inflation. The public generally blames the administration and Congress for these outcomes. They may lose office. Federal Reserve officials may be criticized, but they retain their positions. Following the two major errors of the twentieth century, the Great Depression and the Great Inflation, no Federal Reserve officials had to resign.
    Responsibility and authority should be more closely aligned. At a Shadow Open Market Committee meeting in 1980, I proposed that the Federal Reserve Chairman and the Secretary of the Treasury should agree on the policy objective for the next two or three years. If the objective is not met, the president could ask for an explanation. He could then accept the explanation or ask for a resignation. Subsequently, several countries starting with New Zealand adopted variants of this proposal.
    Inflation
    The third major topic is inflation. Chapters 4 through 9 discuss four issues. Why did the Great Inflation start? Why did it take fifteen to twenty years to reduce inflation to low levels? Why did it end? Why did high inflation not return in the next twenty years?

    Modern central banks no longer claim, as the Federal Reserve did in the 1920s and even in the 1950s, that they do not control the inflation rate. They may have meant the near-term or quarterly rate but, if so, they failed to make that explicit. Academic research and experience settled the issue about the long term. It left open the practical issue of how to measure inflation and how to choose a value for an inflation target.
    Chairman Greenspan would not announce a numerical objective. He defined the absence of inflation as the point at which the public ignored inflation when making decisions. 20 President Poole of the St. Louis reserve bank favored a goal of “zero inflation properly measured” (Poole, 2005, 1). In practice, he proposed 1 percent inflation for an index that excludes “volatile food and energy prices” (ibid., 2).
    Poole’s definition recognized that in the short term, different indexes give different information. Over the longer term this is less of a problem. One reason is that one-time price changes and changes in relative prices distort inflation measures in the short term but are less troublesome over the longer term.
    Central banks that announce inflation targets choose measures of the sustained rate of price change. The price level is allowed to change in response to the many largely random changes in productivity, excise taxes, exchange rates, or other relative price changes. In economic textbooks, these problems do not appear. They are very real to central bankers.
    Otmar Issing (2003, 21) pointed to the