NCPA - National Center for Policy Analysis

Fed Led American Economic Recovery

February 14, 2000

Financial specialists believe the U.S. owes much of its current prosperity to the Federal Reserve, the central bank that controls America's money supply -- even if the Fed took a while to correct its own easy money policies which led to inflation.

There were two causes of the great inflation of the 1970s:

  • The U.S. went off the Bretton Woods Agreement which tied the dollar to gold.
  • And monetary policy was inflationary ("easy") under Presidents Johnson and Nixon -- Johnson to fund his guns and butter program of vast domestic spending while fighting the Vietnam war, Nixon to reassure his re-elected in 1972.

These policies opened the monetary floodgates with the inevitable rise in inflation following. After a downturn in inflation under Gerald Ford, Jimmy Carter appointed G. William Miller as head of the Fed, and the easy money-inflation bandwagon was rolling again.

Finally, in 1979, Carter surrendered to pressure from the financial markets and appointed as Fed Chairman Paul Volcker, who emphasized controlling the money supply.

  • The tightening of the money supply sent the prime interest rate to an unprecedented 15.5 percent by year's end.
  • A recession followed in early 1980, along with a 21.5 percent prime rate in late in the year.
  • The new president, Ronald Reagan, agreed with the tight money policy, and despite the predicted recession (July 1981 through November 1982) stuck with it.
  • Under Volcker's successor, Alan Greenspan (appointed in 1987), inflation came down to around two percent from the four to five percent of the late 1980s.

Squeezing out inflation, economists note, much more than balancing the federal budget, has led to a significant decline in interest rates. Even Bill Clinton, a liberal Democrat who many observers felt might otherwise have favored a free-spending Fed policy, left Greenspan alone and was rewarded with lower inflation and interest rates than have been seen in a generation.

Source: Bruce Bartlett (NCPA), "Thank You Federal Reserve," The American Enterprise, March 2000.


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