alan greenspan : monetary policy twenty - five years after october 1979 remarks by mr alan greenspan, chairman of the board of governors of the us federal reserve system, to the conference on reflections on monetary policy 25 years after october 1979, federal reserve bank of st louis, st louis, missouri, ( via videoconference ), 7 october 2004. * * * a defining moment may shape the direction of an institution for decades to come. in the modern history of the federal reserve, the action it took on october 6, 1979, stands out as such a milestone and arguably as a turning point in our nation ’ s economic history. the policy change initiated under the leadership of chairman paul volcker on that saturday morning in washington rescued our nation ’ s economy from a dangerous path of ever - escalating inflation and instability. as i noted in congressional testimony before the joint economic committee on november 5 of that year : we are here … to evaluate the moves of chairman volcker and his colleagues last month, implying that some alternate policies were feasible at that time. however, given the state of the world financial markets, had the fed not opted to initiate a sharp interest rate increase in this country, the market would have done it for us. 1 in a democratic society such as ours, the central bank is entrusted by the congress, and ultimately by the citizenry, with the tremendous responsibility of guarding the purchasing power of money. it is now generally recognized that price stability is a prerequisite for the efficient allocation of resources in our economy and, indeed, for fulfilling our ultimate mandate to promote maximum sustainable employment over time. but the importance of price stability has sometimes been insufficiently appreciated in our central bank ’ s history, and, as allan meltzer will soon point out, such episodes have had unfortunate consequences. far from being a bulwark of stability in the 1970s, the federal reserve conducted policies that, in the judgment of many analysts, inadvertently contributed to an environment of macroeconomic instability. we should strive to retain in the collective memory of our institution the ensuing lessons of that period. it may be the most fruitful and proper way to commemorate the events of october a quarter - century ago. tracing the roots of the 1970s inflation brings us to an earlier era. the keynesian revolution of the 1930s and its subsequent empirical application led many economists to accept the view that through regulation, state intervention, and the macroeconomic management of aggregate demand, government policies, including those of our nation ’ s central

rate of 4. 8 percent, inflation is 2 percent, the nominal federal funds rate is 3 percent, the 10 - year treasury bond rate is 3. 5 percent, and potential output growth is 2 percent. except as otherwise noted, tax rates are held fixed at their baseline levels for four years, after which fiscal policy is allowed to respond by gradually adjusting the federal personal income tax rate to stabilize the ratio of federal government fiscal deficits to gross domestic product ( gdp ) at its assumed baseline target level. in all instances, monetary policy is assumed to be governed by the ( non - inertial ) taylor ( 1999 ) rule, with an intercept shift where applicable. table a. 1 summarizes the effects of several shocks on the long - run equilibrium real federal funds rate in the frb / us model. the details of how these shocks were implemented follow. labor force. the growth rate of the u. s. population ( variable n16 in the frb / us model ) is assumed to climb over the course of a year to a pace that is 1 percentage point faster than in the baseline, with commensurate effects on the labor force, employment, potential output, and actual output. the elevated pace of population growth lasts for 20 years before returning to baseline rates over the succeeding 5 years. productivity. the growth rate of total factor productivity ( hmfpt ) is increased 0. 7 percentage point, which implies an acceleration in labor productivity ( output per worker hour ) of 1. 0 percentage point. the shock lasts for 40 years before fading out at a moderate pace. - 4investment. sequences of shocks to the frb / us model ’ s three equations for business fixed investment - - producer durables ( epd ), intellectual property ( epi ), and nonresidential structures ( eps ) - - are constructed such that the total increase in gross fixed capital investment equals 1 percent of gdp for 25 years. thereafter, the shocks fade at a moderate rate over time. the shocks are scaled such that the split between the three components is about equal to their relative shares of gdp since 2001. cost of capital. relative to its average over the period from 2000 to 2007, the financial cost of capital ( rpd ) has declined by about two percentage points, according to the frb / us model database. that should have produced a boom in investment, which seems not to have happened. this shock computes the magnitude of this “ missing effect ”