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Vol. 87, No. 2
Posted 2005-04-15

The Monetary Policy Debate Since October 1979: Lessons for Theory and Practice

by Marvin Goodfriend

Monetary theory and policy have been revolutionized in the two decades since October 1979, when the Federal Reserve under the leadership of Paul Volcker moved to stabilize inflation and bring it down. On the side of practice, the decisive factor was the demonstration that monetary policy could acquire and maintain credibility for low inflation, and improve the stability of both inflation and output relative to potential. On the theory side, the introduction of rational expectations was decisive because it enabled models of monetary policy to incorporate forward-looking elements of aggregate demand and price-setting, long known to be critically important for policy analysis, so as to understand how monetary policy achieved the favorable results found in practice.

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