778PART TWELVESHORT-RUN ECONOMIC FLUCTUATIONSTHE COST OF REDUCING INFLATIONIn October 1979, as OPEC was imposing adverse supply shocks on the world’seconomies for the second time in a decade, Fed Chairman Paul Volcker decidedthat the time for action had come. Volcker had been appointed chairman by Presi-dent Carter only two months earlier, and he had taken the job knowing that infla-tion had reached unacceptable levels. As guardian of the nation’s monetarysystem, he felt he had little choice but to pursue a policy of disinflation—a reduc-tion in the rate of inflation. Volcker had no doubt that the Fed could reduce infla-tion through its ability to control the quantity of money. But what would be theshort-run cost of disinflation? The answer to this question was much less certain.THE SACRIFICE RATIOTo reduce the inflation rate, the Fed has to pursue contractionary monetary policy.Figure 33-10 shows some of the effects of such a decision. When the Fed slows therate at which the money supply is growing, it contracts aggregate demand. The fall
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