I see three key parallels between the economic situation in 1979 and the economic situation in 2013. First, just like in 1979, the Federal Open Market Committee faces a challenging macroeconomic problem—although this time, the problem is stubbornly low employment as opposed to stubbornly high inflation. Second, there is a widespread perception that monetary policymakers lack either the tools or the will to solve this problem.
And third, the perception of monetary policy ineffectiveness is itself a key factor in generating the problem… If the public thinks that monetary policy is ineffective, then it will expect relatively weak macroeconomic conditions in the future. But these expectations about the future have a direct impact on current macroeconomic outcomes…
We’ve seen how the FOMC dealt with its problems in 1979 by adopting a goal-oriented approach to monetary policy. Given the parallels between 1979 and 2013, I believe that a goal-oriented approach would be useful again…
But, as Paul Volcker said in his 1979 speech, it is not enough to formulate or communicate a goal. The Committee has to stick to its formulated approach—that is, it must do whatever it takes to achieve its communicated goal. In the early 1980s, doing whatever it took meant being willing to keep money tight, even though interest rates and the unemployment rate rose to unusual heights. By doing whatever it took to achieve its goal, despite these short-term costs, the FOMC was able to bring down inflation and inflation expectations.