The Research On How Fed Solve The Problem Of Stagflation In The Period Of Paul Volcker

Stagflation crisis erupted in the United States in the1970s. Its main reason is theconsequence of long-term implementation of expansionary fiscal policy. After the SecondWorld War, the U.S. government in economic policy has been guided by the Keynesian,expanding aggregate demand to spur economic growth. By cutting taxes, increasing socialwelfare and starting the Vietnam War at the same time, Johnson administration took the rapidincrease of fiscal deficit which resulted in the stagnation of the economic development andserious inflation. In order to curb inflation, the Nixon administration imposed price regulationto curb inflation temporarily, but as long as the regulation canceled, the rate of inflationrebounded terribly. In addition, the lack of new economic point of growth of economy, andthe decline of industrial productivity, which have been the reasons for stagnant economydevelopment since the late1960s. The oil crisis and the food crisis which broke out in1973had become a high inflation rate of external cause. Under the leadership of Arthur Burns andWilliam Miller in the1970s，America’s central bank which called the Federal Reservesubjected to political pressure without independence. When the presidential election or themid-term elections occurred, the Fed adopted loose monetary policy, increased monetarysupply, which resulted in more and more serious inflation in the US.The U.S. government’s measures were not good enough to deal with stagflation crisis.Nixon, Ford or Carter, no matter who tried to use tighten fiscal policy, would be againstAmericans’ willingness. Americans had enjoyed material comforts brought by the rapideconomic development for a long time, and they could not stand the pain of the recession.Facing the pressure of the voters, the government had to take a bigger fiscal spending tostimulate economic development. In1981, Ronald Reagan became the president of theAmerica. By using Supply-side economics theory and monetary theory as the policy, theReagan administration tried to slash the marginal tax rates for improving the economic growth,and to increase the money supply for reducing the rate of inflation at a fixed money supplygrowth rate. However, there was controversy between Supply-side economics theory of taxcuts and monetarism. Slashing the marginal tax rates resulted in the US government hugebudget deficits, and increasing the money supply at a fixed money supply growth rate did notwork. In1979, Jimmy Carter appointed Paul Volcker as chairman of the Federal Reserve.Volcker took the price stability as the Fed’s monetary policy within a priority objective, theFed nominally solved the inflation in monetarism, according to the data on the marketindicators and other sources of information, the Fed actually chose monetary policy flexibly,so that it could avoid too rigid absolute control target for money supply. These policiesenabled the fed to adhere to high interest rates monetary policy to reshape the fed’s credibility,which solved the problem of inflation. However, in the process of solving the problem ofstagflation, the fed met many problems. Monetary policy being without sustainability, theFederal Reserve lost the confidence of the financial markets at the pre Volcker period. Inaddition, that the Fed tightened monetary policy made the American economy slowdown,which caused the Americans and the government’s dissatisfaction. Facing the question fromthe various parties, The Fed’s policy in1980second and the third quarter once deviated fromthe predetermined scheme, which made the rate of inflation soared. Under the leadership ofVolcker, The Fed corrected errors in time, implemented high interest rate tightening monetarypolicy toughly. Facing political pressures from the president and Congress, Volcker adoptedpolitical means flexible with the president and the Congress to reach a compromise on thepremise of maintaining the independent of the Federal Reserve, which achieved lowerinflation target. The good economic development cannot leave the monetary policy and fiscalpolicy. The Reagan administration executed tax cuts and fiscal expansion at the same time,which made U.S. government a huge fiscal deficit. Therefore, the finance market formed theinflation expectations, so long-term interest rates were staying high all the time. In order tomake the United States government to moderate fiscal policy, the Federal Reserve continuedto adopt high interest rates policy, which forced the United States government to implementthe tax increase bill, it had laid a foundation for the Clinton administration balance the budget.Fed in Volcker era successfully solved the inflation, though it had paid the heavy price.High interest rates prompted strong dollar in the international market, which causedagriculture and manufacturing more damage. Service industry and financial industry gainedthe opportunity to develop. American bank accommodated Latin American countries with aloan with high interest rates, as a result of it, Latin American countries could not repay theloan owning to the high interest rates, which caused Latin American the debt crisis. Also, thathigh interest rates promoted foreign capital investment in U.S. financial markets supplied the U.S. economic recovery with enough money, therefore the United States was in huge debt.Reagan’s tax cuts increased the gap between the rich and the poor. Lending consumption whichformed in the period of stagflation became the main future American consumption patterns.It is so visionary that the Fed in Volcker era aimed at price stability and long-termeconomic development, and guided fiscal policy with monetary policy, which made the USeconomy realize a high-speed development of low inflation eventually. After, the FederalReserve status rise, chairman of the Federal Reserve became the man of great importance.Otherwise, Volcker established the monetary policy objective of price stability for the future.Nowadays, maintaining low inflation has become Europe and the United States central bankmonetary policy another important criterion. Those created a good reputation for the centralbank, which enabled the government to implement economic policy with great operationalspace. In summary, it has guiding significance to the economic development of our country onthe Fed solving the stagflation crisis. The government should reduce the fiscal expenditureand the money supply, seek new economic point of growth, which create the steady economicdevelopment.