Choosing the Federal Reserve Chair: Lessons from History

Abstract

This paper demonstrates that the key determinants of policy success have been policymakers' views about how the economy works and what monetary policy can accomplish. In the first major section of the paper, the authors analyze the narrative record of the Federal Reserve to discover what policymakers believed and why they chose the policies they did. The authors find that the well-tempered monetary policies of the 1950s and of the 1980s and 1990s stemmed from a conviction that inflation has high costs and few benefits, together with realistic views about the sustainable level of unemployment and the determinants of inflation. In contrast, the profligate policies of the late 1960s and 1970s stemmed initially from a belief in a permanent tradeoff between inflation and unemployment, and later from a natural rate framework with a highly optimistic estimate of the natural rate of unemployment and a highly pessimistic estimate of the sensitivity of inflation to economic slack. And the deflationary policies of the late 1930s stemmed from a belief that the economy could overheat at low levels of capacity utilization and that monetary ease could do little to stimulate a depressed economy.