The Squeeze of '79

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It was during that meeting, reports TIME Washington Correspondent William Blaylock, that Volcker decided nothing short of decisive action would do: "Upon Volcker's return to Washington, following a brief appearance at an International Monetary Fund conference in Belgrade, he immediately instructed his staff to draw up a list of options open to the Fed. The short-term goal would be to prevent a further dollar slide abroad, but long term the objective would be to puncture the inflation psychology of the nation as a whole. As many as 20 staffers were ultimately involved in the brain-storming sessions, and economists from the Fed's New York operations were shuttling in and out daily for consultations and advice."

By week's end Volcker had the measures that he wanted and called a mid-morning meeting of the board's governors in the Fed's second-floor boardroom. There, against a backdrop of silk wall coverings and an enormous blue-and-gold map of the U.S., the governors mulled over their chairman's proposals for one hour, then two, then through lunch and on into the afternoon.

The first two items—an increase in the discount rate and the setting up of reserve requirements for offshore bank borrowings—went through smoothly enough, but the third presented a procedural problem. As a revolutionary change in Fed operations, the plan to focus day-to-day attention on actual money creation required not only board approval (which was given unanimously) but the support of the Open Market Committee, which comprises not only the board's governors but also five other representatives from the Fed's twelve regional banks. Just after lunch a conference call was arranged, unanimous support from the governors was secured, and at 2 p.m. both the White House and the Treasury were informed of the Fed's decision.

Admirers of the "Volcker package," is European central bankers are already calling the Fed's moves, praise it mainly for the promise it holds that the U.S. will be able at last to control the availability of credit, as opposed to just its cost. After a full decade of high inflation, economists are pretty much agreed that the levers that have traditionally been used to control the flow of money into the economy—namely, the key interest rates that the Fed manipulates—have failed. This is in large part because the traditional concepts of money itself are outdated.

The Fed has developed several yardsticks to gauge the supply of money. The narrowest of these is a number that is known as M-1 and is the total of currency in circulation plus other immediately accessible funds in commercial bank checking accounts. As measured by M1, the U.S. money supply at present is about $380 billion. A broader yardstick is M2, which includes all of M-1 plus savings deposits, and shows a money supply of $935 billion.