A bit of history I only recently learned.
I recently read Inside the Economist’s Mind, which is a collection of interviews by famous economists of even-more-famous economists. The book was edited by Paul Samuelson and William Barnett, and even has its own blog– talk about niche blogging!
One of the most interesting for me was an interview conducted in April 2000 by Perry Mehrling of Paul Volcker. Volcker chaired the Federal Reserve from August 1979 through August 1987, during which period the U.S. inflation rate was brought down from 12% to 4%. The Volcker regime has sometimes been characterized as one in which the traditional notion of interest-rate targeting was replaced by a focus on controlling the growth of the money supply, as a consequence of which interest rates were initially allowed to reach unprecedented high levels:
In the interview, Volcker explained to Mehrling how he became a “practical monetarist” primarily in order to cultivate the necessary intellectual and political support for allowing interest rates to get so high:
It always seemed to me that there is a kind of commonsense view that inflation is too much money chasing too few goods. You could oversimplify it and say that inflation is just a monetary phenomenon. There are decades, hundreds of years, of economic thinking relating the money supply to inflation, and people to some extent have that in their bones. So I think we could explain what we had to do to stop inflation better that way than simply by saying that we’ve got to raise interest rates. It was also true that we had no other good benchmark for how much to raise interest rates in the midst of a volatile inflationary situation.
At least as important was the idea to discipline ourselves. People in the Federal Reserve don’t like to raise interest rates. So the danger is you’re always too little too late. I think that would apply to the current situation [April 2000]. So, when inflation really had the upper hand, it was, I think, very important to put something out there so you could discipline yourself. For that kind of a commitment, you’ve got to know what’s at stake, and it does make some broad sense if you have that much inflation [pp. 178-179].
Volcker related that the critical decisions came in February 1980:
What really propelled me to make the change was when we raised the discount rate for the second time, when I was first down there. The vote was 4-3. I thought it was a reasonably strong move and we’d get a favorable reaction in the market, but we didn’t. The response was, “Well, gee, the Federal Reserve is behind the curve anyway, the vote was 4-3, and that’s the last increase of the discount rate we’ll see.” So the market reacted very badly, which surprised me. I guess I was a little naive. I remember very clearly, I didn’t bend over backwards to try to twist the arms of the three people who voted the other way. I knew I had four votes. If we had to increase the discount rate again, we’d have another 4-3 vote. But that’s not the way the market read it. Then I realized that we had this credibility problem worse than I thought. That got me off and really thinking operationally about the other approach [basing policy on target growth for the monetary aggregates]. But when it was sprung on them, everybody was very much in favor, even those who were voting against the increases in interest rates [pp. 178-179].
The rest, as they say, is history. But, if you can become a practical monetarist as a technical expedient to achieve your short-run objective, you can drop the intellectual baggage just as easily when being a monetarist no longer seems to be all that practical:
Then in October , or whenever it was, the money supply (by some measures) was increasing again rather rapidly. We had a tough explanation to make, but I thought we had come to the point that we were getting boxed in by money supply data that was, in any event, strongly distorted by regulatory changes and bank behavior. We came to the conclusion that it was not very reliable to put so much weight on the money supply any more, so we backed off that approach [p. 183].
It really wasn’t a matter of choosing sides in the debates between academic economists about how to bring inflation down. Instead, it was simply whether the Fed had the will to stick with the program until inflation was brought under control. Volcker proved to be the man for the job.