THE MONETARY POLICY REGIME SHIFT IN OCTOBER 1979
We find a different set of empirical regularities for post-October 1979 than we find for the pre-October
1979 period. It is useful to make a distinction between changes in the way the monetary policy decisions are made at Federal Open Market Committee (FOMC) meetings and changes in the way FOMC decisions are implemented by the Open Market Desk (Desk) at the Federal Reserve Bank of
New York. In October 1979, both types of changes were made. After October 1979, the FOMC appeared to make policy decisions with more concern about deviations of inflation from the implied objective than they had before October 1979. The FOMC also changed the procedures the Desk used to implement the decision made at the meeting.
FOMC Decision Making
The FOMC sets the target for the policy instrument at FOMC meetings. This is a decision about where to locate the money supply function. The decision, both before and after the October 1979 policy change, was to supply reserves to lead to desired outcomes for inflation and output growth. Each decision was also expected to result in particular outcomes for the federal funds rate and the growth in the targeted monetary aggregates, particularly M1. A combination of theory, econometric models, and judgment went into these decisions. Before October 1979, monetary policy resulted in a high and variable outcome for inflation. After October 1979, the FOMC appeared to put relatively more weight on controlling money growth and inflation. Gavin and Kydland (1999) show that shifts of this sort would be expected to lead to significant shifts in the cyclical properties of nominal variables. This is the case whether or not the FOMC changes the way it implements the policy decision (its operating procedure).
The Operating Procedures
At the same time that it announced a new commitment to reducing money growth and inflation, the FOMC announced a change in the way the Desk would implement the decisions made at FOMC meetings. Prior to October 1979, the FOMC decided on a target for the federal funds rate the
market interest rate on overnight lending between banks. The FOMC would direct the manager of the System Open Market Account to buy and sell securities to maintain the interest rate near the target level.
At each FOMC meeting, the staff of the Board of Governors would present the committee with estimates of how much money growth to expect from the alternative federal funds target choices. During the inter-meeting period, surprises in the demand for reserves would be accommodated so that surprises in money demand showed up as variability in the quantity rather than the price of reserves.
On October 6, 1979, Fed Chairman Paul Volcker announced that the procedure would be changed so that the manager of the Desk would be required to adjust the Fed’s portfolio of securities to achieve weekly targets for non-borrowed reserves, rather than the federal funds rate. The policy change led to a dramatic, tenfold increase in the volatility of the federal funds rate and a high correlation among changes in interest rates across the term structure and across national boundaries. The increased interest rate volatility caught the attention of the markets and the public. It probably helped Paul Volcker achieve credibility for the disinflation policy.
Although inflation fell to around 4 percent at the end of 1982, M1 demand became more unstable, so the Fed shifted to borrowed reserves and returned to an operating procedure that was an indirect form of interest rate targeting. In Alan Greenspan’s first term as Fed Chairman (which began in 1987), the FOMC returned to an explicit interest rate targeting procedure.
(the rest of article is a useless attempt to get scientific which only gets scientimistic)
stls.frb.org |
