NCPA - National Center for Policy Analysis

A Closer Look At Fed Policy

August 7, 1997

The Federal Reserve Board's policy of "pre-empting" inflation by boosting interest rates in small increments periodically has worked, according to a study by Cleveland Federal Reserve Bank economist John Carlson.

The Fed has sought to reduce long-term interest rates by controlling the level of short-term rates, through the federal funds rate, and dampening investors' expectations of inflation.

  • Carlson notes that the Fed lost its credibility as an inflation fighter in the 1970s, then sought to re-establish it starting in 1982 by acting before inflation got out of hand.
  • He identifies three specific periods after 1982 when the Fed acted pre-emptively to short-circuit inflation -- August 1982 to August 1984, April 1988 to March 1989, and February 1994 to February 1995.
  • One important consequence has been that since 1982, U.S. output growth has exceeded 3 percent a year -- compared to average annual growth of only 2.3 percent over the previous 15 years.

During the later period there has been only one recession, ending six years ago, and inflation is substantially below the 1980s trend.

Source: Perspective, "The Fed's Success?" Investor's Business Daily, August 7, 1997.


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