Title: The Phases of U.S. Monetary Policy: 1987 to 2001
Abstract: Inflation was relatively well behaved in the 1990s in comparison with preceding decades, yet Federal Reserve monetary policy was no less challenging. The Fed took painful actions in the late 1970s and early 1980s to reverse rising inflation and bring it down, and inflation fell from over 10 percent to around 4 percent by the mid-1980s. The worst economic ills stemming from high and unstable inflation were put behind us. Yet central bankers and monetary economists recognized that more disinflation was needed to achieve price stability. I he transition to price stability was expected to be comparatively straightforward. Monetary policy promised to become more routine. Although the 1990s saw the longest cyclical expansion in U.S. history, the promised tranquility did not materialize. In many ways the period to be chronicled here proved to be about as difficult for monetary policy as the preceding inflationary period. My account of Fed monetary policy divides the period since 1987 into six distinct phases. This division is natural because in each phase the Fed was confronted with a different policy problem. Phase 1 begins with rising inflation in the aftermath of the October 1987 stock market crash and ends with the start of the Gulf War in August 1990. Phase 2 covers the 1990-1991 recession, the slow recovery, and the disinflation to the end of 1993. Phase 3 tells the story of the Fed's preemptive tightening against inflation in 1994-- 1995. Phase 4 deals with the long boom to 1999, the near full credibility for low inflation, and rising trend productivity growth. Phase 5 addresses the tightening of monetary policy to slow the growth of aggregate demand in 1999 and 2000. The sixth phase chronicles the collapse of investment in late 2000 and the recession in 2001. The article presents a relatively compact account of the interaction between interest rate policy and the economy since 1987. It provides the minimum of descriptive detail needed to understand monetary policy during the period. The situations that confronted the Fed were remarkably varied. Nevertheless, the Fed's policy actions can be understood and interpreted as supporting the primary objectives of monetary policy, which were the same throughout. First of all, the Fed aimed to achieve and maintain credibility for low inflation. Second, the Fed managed interest rate policy so that the economy could attain the full benefits of rising trend productivity growth. Third, the alleviation of financial market distress dictated interest rate policy actions on occasion. Fourth, the Fed steered real short-term interest rates sharply lower when economic stimulus was needed. The story of how monetary policy pursued these objectives follows. 1. OCTOBER 1987-JULY 1990: RISING INFLATION AND THE STOCK MARKET CRASH From Wednesday, 14 October 1987, through the close of trading on Monday, 19 October, the Dow Jones Industrial Average lost about 30 percent of its value. On Monday alone, the Dow lost 23 percent. Not since October 1929, when the Dow lost around 25 percent in two consecutive days, had a sudden collapse of equity values been so great.1 The Fed responded to the October 1987 stock market crash in a number of ways. For our purposes, its most important responses were these. The Fed accommodated the increased demand for currency and bank reserves with extensive open market purchases. It also dropped its federal funds rate target from around 7.5 percent to about 6.75 percent. Central bankers now know that sufficiently stimulative monetary policy might well have averted the deflation and depression of the 1930s. The Fed made sure that monetary policy was sufficiently stimulative to avert another catastrophe. The Fed was concerned about the resulting risks to price stability, noting that its actions should not be seen as inflationary.2 As it turned out, inflation rose in 1988, 1989, and 1990 in spite of the fact that the Fed had put the economy through a severe recession in the early 1980s to restore price stability. …
Publication Year: 2002
Publication Date: 2002-10-01
Language: en
Type: article
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Cited By Count: 12
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