##minants of credibility and its link to policy outcomes. in 1977, however, finn kydland and edward prescott published a classic paper, entitled “ rules rather than discretion : the inconsistency of optimal plans ” ( kydland and prescott, 1977 ), that provided the first modern analysis of these issues. 3 specifically, kydland and prescott demonstrated why, in many situations, economic outcomes will be better if policymakers are able to make credible commitments, or promises, about certain aspects of the policies they will follow in the future. “ credible ” in this context means that the public believes that the policymakers will keep their promises, even if they face incentives to renege. in particular, as one of kydland and prescott ’ s examples illustrates, monetary policy - makers will generally find it advantageous to commit publicly to following policies that will produce low inflation. if the policymakers ’ statements are believed ( that is, if they are credible ), then the public will expect inflation to be low, and demands for wage and price increases should accordingly be moderate. in a virtuous circle, this cooperative behavior by the public makes the central bank ’ s commitment to low inflation easier to fulfill. in contrast, if the public is skeptical of the central bank ’ s commitment to low inflation ( for example, if it believes that the central bank may give in to the temptation to overstimulate the economy for the sake of short - term employment gains ), then the public ’ s inflation expectations will be higher than they otherwise would be. expectations of high inflation lead to more - aggressive wage and price demands, which make achieving and maintaining low inflation more difficult and costly ( in terms of lost output and employment ) for the central bank. providing a clear explanation of why credibility is important for effective policymaking, as kydland and prescott did, was an important step. however, these authors largely left open the critical issue of how a central bank is supposed to obtain credibility in the first place. here is where rogoff ’ s seminal article took up the thread. 4 motivated by the example of carter and volcker, rogoff ’ s paper showed analytically why even a president who is not particularly averse to inflation, or at least no more so than the average member of the general public, might find it in his interest to appoint a well - known “ inflation hawk ” to head the central bank. the benefit of appointing a hawkish central banker is the

ben s bernanke : panel discussion : what have we learned since october 1979? remarks by mr ben s bernanke, member 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, 8 october 2004. the references for the speech can be found on the board of governors of the federal reserve system ’ s website. * * * the question asked of this panel is, “ what have we learned since october 1979? ” the evidence suggests that we have learned quite a bit. most notably, monetary policy - makers, political leaders, and the public have been persuaded by two decades of experience that low and stable inflation has very substantial economic benefits. this consensus marks a considerable change from the views held by many economists at the time that paul volcker became fed chairman. in 1979, most economists would have agreed that, in principle, low inflation promotes economic growth and efficiency in the long run. however, many also believed that, in the range of inflation rates typically experienced by industrial countries, the benefits of low inflation are probably small - particularly when set against the short - run costs of a major disinflation, as the united states faced at that time. indeed, some economists would have held that low - inflation policies would likely prove counterproductive even in the long run, if an increased focus on inflation inhibited monetary policy - makers from responding adequately to fluctuations in economic activity and employment. as it turned out, the low - inflation era of the past two decades has seen not only significant improvements in economic growth and productivity but also a marked reduction in economic volatility, both in the united states and abroad, a phenomenon that has been dubbed “ the great moderation. ” recessions have become less frequent and milder, and quarter - to - quarter volatility in output and employment has declined significantly as well. the sources of the great moderation remain somewhat controversial, but as i have argued elsewhere, there is evidence for the view that improved control of inflation has contributed in important measure to this welcome change in the economy ( bernanke, 2004 ). paul volcker and his colleagues on the federal open market committee deserve enormous credit both for recognizing the crucial importance of achieving low and stable inflation and for the courage and perseverance with which they tackled america ’ s critical inflation problem. i could say much more about volcker ’ s achievement and