In “How Fiction Works” James Wood explains the use of Free Indirect Style as a defining characteristic of modern literature. Let’s understand how it works, and works so well to the modern ear and eye.
Wood gives this example, approximately:
Reported Indirect Style
She looked at her husband. He looked so unhappy, she thought. She wondered what to say.
Free Indirect Style (FIS)
She looked at her husband. Yes, he was tiresomely unhappy. What the hell should she say?
Hear how intimate the second treatment sounds? The writer hovers nearby to nudge us, to whisper what he knows (selectively). The first sentence is a familiar reported fact of behavior, the second is an opinionated declaration (a tell, not a show), and the third is an odd convergence of the writer’s voice and the character’s. It sounds like natural language.
Natural language, as used orally and understood internally, is messy. It has implied line breaks, like poetry, and run-on streams. It contains implied meanings, the kind linguists use to decipher languages. Ordinary conversation is full of such emotional and intellectual shorthand, and modern fiction (and literary non-fiction) has incorporated these truncations, interstitials, and juxtapositions to stunning effect. They only seem odd when compared to older, more rigid and formulaic prose forms.
Reported Indirect Style
Then one day I made a face. He un-hooked his belt, pulled it from the loops, doubled it in his fist, and shook it at me. "You want the belt?" he said, and grinned. He looked bored.
I would never say yes, I thought.
Free Indirect Style (FIS)
Then one day I made a face and all he did was un-hook, snick it from the loops, double it in his fist, and shake it at me twice. "Want the belt?" His half-grin, already thinking about something else.
Like I would ever say yes.
FIS lets us say it as if across the kitchen table, to add a colloquial music and flow. In this somewhat flamboyant example the narrator is a character, and the sensation of intimacy is even stronger. We avoid quotation marks around thoughts, too. In both of the examples above we have an instance of direct speech in quotes, though; FIS permits this mix, and it can have subtle and intensifying power to favor one character over another as the “quoted” one. FIS is inherently fluid about tense, and suggests stylistic liberties (“There came a day...”).
Naturally enough, free indirect is also referred to as close writing, close third person, and even “going into character” though this is a mis-cue, because in a peculiar way FIS can and usually must include the authorial voice, too. If not speaking from the page, then evident in the shifting choices for Voices. Depending on the style, the page is a tumult of peering, muttering, wise-cracking, whispering and declaring. Jostling larks on the page.
Odd, how the character is more real and vivid, more distinctively Other, when the writer blurs her omniscience line in this creative way.
There can be a larger intention at work with free indirect speech. In Frank Conroy’s memoir “Stop-Time”, we travel chronologically from his first experiences living at a private school, through a childhood disrupted by difficult moves and ever-changing emotional circumstances. He finds and invokes the Voice of that younger self, but we never quite lose the adult perspective. With deft touches, connecting sardonic childhood with wry adulthood, he inserts perspectives and insights that are tailored to the details. Just enough perspective, in a brisk, throwaway tone, to frame what happened, to move the reader forward and to build the characters. If Wood's example is on the micro level, between and even within sentences, Conroy's is at the macro level in the flow of story, in the style of a close encounter with a sad, thoughtful, and wise raconteur.

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What is Free Indirect Discourse Now? : Comparative Literature
Comparative Literature Professor Dora Zhang gives us a brief overview excerpted from her presentation at the November 29 symposium on the subject.
The origins of free indirect discourse are disputed. Cases in classical and medieval literature have been proposed but they are usually subject to debate. The history of the style, however, seems to gain greater clarity as it goes on. A number of critics cite La Fontaine's Fables as an early example of the style (sometimes along with Pascal and Fanny Burney), ...