IN October 1979, inflation was running at more than 10 percent a year, and the Federal Reserve’s gradual interest rate increases weren’t solving the problem. So Paul Volcker, the Fed chairman, dramatically changed how monetary policy was conducted. Today, an equally intractable unemployment crisis demands that Ben S. Bernanke, the current Fed chairman, stage a quiet revolution of his own.
What did Mr. Volcker do? He reasoned that because inflation depends on growth in the money supply, inflation would fall if he brought that growth down. And he believed that by backing up his commitment to lower inflation with a new policy framework, he would break people’s inflationary expectations. So the Fed began to explicitly target the rate of money growth.
Hitting that target required pushing interest rates to unprecedented levels. Unemployment rose past 10 percent, and Mr. Volcker was pilloried. At one point, farmers on tractors blockaded Fed headquarters to protest the high rates.
But the policy worked. Inflation fell from 11 percent in 1979 to 3 percent in 1983, and unemployment returned to normal levels. Even my father, who lost his job as a chemical plant manager in the 1981 recession, views Mr. Volcker as a hero. His bold moves ushered in an era of low inflation and steady output growth.
Today, inflation is still low, but unemployment is stuck at a painfully high level. And, as in 1979, the methods the Fed has used so far aren’t solving the problem.