# 28.4: Historical Federal Reserve Policies

## Volcker Disinflation

Paul Volcker, the 12th Chairman of the Federal Reserve, became known for lowering the inflation rate and achieving price stability.

learning objectives

• Evaluate the benefits and consequences of Paul Volcker’s actions as chairman of the Federal Reserve Board of Governors

### Paul Volcker

Paul Volcker is an American economist who was appointed by President Carter in 1979 to be the 12th Chairman of the Federal Reserve of the United States (the Fed). He was reappointed by President Reagan and served as chairman until August of 1987. During his time as the Chairman of the Fed, Volcker is credited with ending the high levels of inflation that the United States experienced during the 1970s and early 1980s. Volcker was also appointed as the chairman of the Economic Recovery Advisory Board under President Obama from 2009 to 2011.

Paul Volcker: Paul Volcker was the 12th Chairman of the Federal Reserves. He became known for decreasing inflation during the early 1980s.

### Benefits During Volcker’s Tenure

During his time as chairman, Paul Volcker led the Federal Reserve board and helped to end the stagflation crisis of the 1970s. The inflation rate had remained high throughout the 1970s, while the growth rate was slow and the unemployment was high. When he became chairman in 1979, inflation was high and peaked in 1981 at 13.5%. However, due to the work of Volcker and the rest of the board, the inflation rate dropped to 3.2% by 1983.

Volcker raised the federal funds target rate from 11.2% in 1979 to 20% in June of 1981. The unemployment rate became higher than 10% during this time as well. The economy was restored by 1982 as a result of the tight-money policy put in place by the Fed. Volcker chose to enact a policy of preemptive restraint during the economic upturn which increased the real interest rates. Volcker’s policy also pushed the President and Congress to adopt a plan to balance the budget. Volcker’s tenure as the chairman of the Federal Reserve resulted in sound monetary and fiscal integrity that achieved the goal of price stability.

### Consequences From Volcker’s Tenure

Despite his level of success in certain areas, Volcker’s Federal Reserve board drew some of the strongest political attacks and protests in the history of the Federal Reserve. The protests were a result of the negative effects that the high interest rates had on the construction and farming industries. Nobel laureate Joseph Stiglitz explained “Paul Volcker, the previous Fed Chairman known for keeping inflation under control, was fired because the Reagan Administration didn’t believe he was an adequate deregulator. ”

Despite the protests, Paul Volcker was respected for the work that he did while he was the chairman of the Federal Reserve. Congressman Ron Paul was a harsh critic of the Fed, but he commented about Volcker by saying, “If I had to name a Federal Reserve chairman that did a little bit of good, that would be Paul Volcker. ” Volcker received the U.S. Senator John Heinz Award for Greatest Public Service by an elected or Appointed Official in 1983.

## Greenspan Era

Alan Greenspan was Chairman of the Federal Reserve from 1987 to 2006.

learning objectives

• Summarize the actions taken during Alan Greenspan’s tenure as chairman of the Federal Reserve Board of Governors

### Alan Greenspan

Alan Greenspan is an American economist who served as the Chairman of the Federal Reserve of the United States from 1987 to 2006. He had the second longest tenure in the position. He was appointed by Ronald Reagan in 1987 and reappointed in four-year intervals, finally retiring on January 31, 2006.

Alan Greenspan: Alan Greenspan was the 13th Chairman of the Federal Reserve. He held the position from 1987 until 2006. His tenure as the chairman was marked by low interest rates which eventually were blamed for the 2007 mortgage crisis in the United States.

### Chairman of the Federal Reserve

The stock market crashed in 1987 shortly after Greenspan became Chairman of the Federal Reserve (the Fed). He stated the the Fed was ready “to serve as a source of liquidity to support the economic and financial system. ” Throughout his early years as chairman, Greenspan impacted all the presidencies in various ways. President George H.W. Bush blamed federal policy when he was not reappointed for a second term.

During President Clinton’s terms in office, Greenspan was consulted regarding economic affairs and assisted in the 1993 deficit reduction program. As a whole, the 1990s saw healthy economic growth.

The most notable actions taken during Greenspan’s tenure as chairman began in 2000. He raised interest rates several times in 2000 which was likely this cause of the bursting of the dot-com bubble. In 2001, Greenspan and the Fed initiated a series of interest cuts that brought the Federal Funds rate down to 3% following the September 11, 2001 terror attacks. The Federal Funds rate continued to drop until it was 1% in 2004. Greenspan believed that a group in rates would lead to a surge in home sales and refinancing. In February of 2004, Greenspan suggested that homeowners should consider taking out adjustable-rate mortgages (ARMS) where the interest rate adjusts to the current interest rate in the market. A few months later, Greenspan began raising the interest rates. Interest rate funds increased to 5.25% about two years later.

### The Housing Bubble

In 2007, only months after Greenspan retired, the subprime mortgage crisis occurred in the United States. It is suggested that Greenspan’s easy-money policies were the leading cause of the mortgage crisis. When homeowners took out subprime ARMS in 2004, the interest rates were set much higher than what the homeowners paid the first few years of the mortgages. In 2009, Robert Reich explained that the lower interest rates in 2004 allowed banks to borrow money for free. As a result, the banks borrowed large amounts of money, lent it out to borrowers, and earned substantial profits. Without government oversight for lending institutions, banks lent money to unfit borrowers. Greenspan did not think the oversight was necessary. He trusted that the market would weed out bad credit risks, but it did not. In 2008, Greenspan admitted during Congressional testimony that he had put too much faith in the self-correcting power of free markets. He had not anticipated the self-destructive power of irresponsible mortgage lending. Greenspan did not accept responsibility for creating the housing bubble that led to the mortgage crisis. He simply stated that he did not believe in deregulation as strongly following the crisis.

## Bernanke Era

The Bernanke Era has included challenges faced by the Federal Reserve such as the financial crisis, strengthening federal policy, and reducing the deficit.

learning objectives

• Review the challenges faced by Ben Bernanke during his time as chairman of the Federal Reserve Board of Governors

### Ben Bernanke

Ben Bernanke is an American economist and chairman of the Federal Reserve (the Fed) through January 2014. He was appointed chairman by President Bush and reappointed by President Obama. During his tenure as chairman, Bernanke has been responsible for overseeing the Federal Reserve’s response to the financial crisis.

Ben Bernanke: Ben Bernanke (right) was appointed chairman of the Federal Reserve by President Bush and he was reappointed by President Obama. Throughout his time as chairman, Bernanke has influenced the financial crisis, the Wall Street bailout, and the economic stimulus.

### The Great Moderation

Ben Bernanke was one of the first individuals to discuss “the Great Moderation” which is the theory that traditional business cycles have declined in volatility in recent decades because of structural changes that have occurred in the international economy. The primary structural changes include increases in the economic stability of developing nations and the diminished influence of monetary and fiscal policy.

The Great Moderation is important because while Bernanke was chairman of the Federal Reserve, it is speculated the the economic and financial crisis in the later-2000s brought the period of the Great Moderation to an end. The period was known for predictable policy, low inflation, and modest business cycles.

### The Bernanke Doctrine

Ben Bernanke gave a speech in 2002, before he became chairman of the Federal Reserve. He emphasized that Congress gave the Fed responsibility for preserving price stability – avoiding inflation and deflation. He also identified seven specific measures for the Fed to reduced deflation. These seven measures were:

1. Increase the money supply
2. Ensure liquidity makes its way into the financial system
3. Lower interest rates all the way down to 0%
4. Control the yield on corporate bonds and other privately issued securities
5. Depreciate the U.S. dollar
6. Execute a de facto depreciation
7. Buy industries throughout the U.S. economy with “newly created money”

### Chairman of the Federal Reserve

As Chairman of the Federal Reserve, Bernanke sits on the Financial Stability Oversight Board and is also Chairman of the Federal Open Market Committee, the Fed’s principal monetary policy making body. One of Bernanke’s first main challenges was balancing his comments and how they were influenced by the media. As an advocate for more transparent federal policy, Bernanke stated clearer inflation goals, but his public statements negatively impacted the stock market. As a result, he did not continue to make public statements about the direction of the Federal Reserve.

The main controversies surrounding Bernanke’s terms as chairman include how he handled the financial crisis, particularly failing to see the crisis, for bailing out Wall Street, and for injecting $600 billion into the banking system to give the slow economic recovery a boost. Two areas that received prominent attention include: • The Merrill Lynch merger with Bank of America: New York state Attorney General Andrew Cuomo wrote a letter to Congress in 2009 accusing Bernanke and the treasury secretary of fraud concerning the acquisition of Merrill Lynch by Bank of America. Cuomo stated that the extent of Merrill Lynch’s losses were not disclosed to Bank of America by Bernanke or the treasury secretary. Bernanke was questioned in Congressional hearings as to whether he bullied individuals when the merger was invoked. Bernanke stated that the Fed did nothing illegal when they tried to convince Bank of America to not end the merger. • AIG bailout: It was stated that Bernanke had overruled recommendations from his staff regarding the AIG bailout. The question arose as to whether it had been necessary to bailout AIG. Senators from both parties supported Bernanke and said that the AIG bailout averted worse problems. They stated that act of averting worse problems outweighed any responsibility that he had for the financial crisis. In 2010, Bernanke also expressed his views regarding deficit reduction and reforming Social Security / Medicare. He favored reducing the U.S. budget deficit. He stated that reforming Social Security and Medicare entitlement programs would help reduce the deficit. He believed that a credible plan needed to be developed in order to address the funding crisis that is pending. He explained that without reform, the U.S. will not have financial stability or healthy economic growth. His comments were directed at Congress and the President since reform in fiscal exercise is not in the power of the Federal Reserve. He emphasized that deficit reduction would need to consist of raising taxes, cutting entitlement payments, and reducing government spending. ## Key Points • During his time as the chairman of the Fed, Volcker is credited with ending the high levels of inflation that the United States experienced during the 1970s and early 1980s. • When he became chairman in 1979, inflation was high and peaked in 1981 at 13.5%. However, due to the work of Volcker and the rest of the board, the inflation rate dropped to 3.2% by 1983. • Volcker raised the federal funds rate from 11.2% in 1979 to 20% in June of 1981. The unemployment rate became higher than 10% during this time as well. • Volcker chose to enact a policy of preemptive restraint during the economic upturn which increased the real interest rates. • Despite his level of success, Volcker’s Federal Reserve board drew some of the strongest political attacks and protests in the history of the Federal Reserve. The protests were a result of the negative effects that the high interest rates had on the construction and farming industries. • In 1987, Greenspan stated that the Fed was ready “to serve as a source of liquidity to support the economic and financial system” following the stock market crash. • Greenspan influenced each presidency during his tenure as chairman. He provided economic consultation for President Clinton and assisted in the deficit reduction program in 1993. • He raised interest rates several times in 2000 which was likely this cause of the bursting of the dot-com bubble. In 2001, Greenspan began to lower interest rates. By 2004, the Federal Funds rate was 1%. • In 2004, Greenspan urged homeowners to take out ARMS. Over the next two years, the interest rates increased to 5.25% which contributed to the mortgage crisis in 2007. • During his tenure as chairman, Bernanke has been responsible for overseeing the Federal Reserve ‘s response to the financial crisis. • Ben Bernanke was one of the first individuals to discuss “the Great Moderation” which is the theory that traditional business cycles have declined in volatility in recent decades because of structural changes that have occurred in the international economy. • The financial crisis in the later-2000s brought the period of the Great Moderation to an end. • The main controversies surrounding Bernanke’s terms as chairman include how he handled the financial crisis, particularly failing to see the crisis, for bailing out Wall Street, and for injecting$600 billion into the banking system to give the slow economic recovery a boost.
• Bernanke also focused on the importance of reducing the deficit and reforming entitlement programs in order to achieve financial stability and economic growth.

## Key Terms

• stagflation: Inflation accompanied by stagnant growth, unemployment, or recession.
• inflation: An increase in the general level of prices or in the cost of living.
• interest rate: The percentage of an amount of money charged for its use per some period of time (often a year).
• financial crisis: A period of serious economic slowdown characterized by devaluing of financial institutions often due to reckless and unsustainable money lending.
• deflation: A decrease in the general price level, that is, in the nominal cost of goods and services.