bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

MONETARY POLICY IN THE USA 435
• the long-run is quite distant and
• short-run gains in employment and output are well worth having.
We return in these circumstances to simple Keynesian truths:
• if unemployment is rising and people fear for their jobs, they will
reduce their spending
• if consumers reduce their spending, profits will fall and firms will
reduce their output
• as profits fall, firms will cut investment
• as output and investment fall, firms will lay off workers.
The role of monetary policy in these circumstances is to encourage people
to spend and firms to invest by lowering the cost of doing so. These
points were made throughout 2001 in FOMC statements.
The decade of the 1990s had started with interest rates relatively high.
At the beginning of July 1990, the target Fed funds rate stood at 8.25 per
cent. The early 1990s, however, saw a downturn in all developed
economies and the Fed set out on a long series of interest cuts, which saw
the target rate fall sharply. In 1991, the Fed was extraordinarily active, making
10 cuts in the intended Fed funds rate, bringing it down from 7 per cent
to 4 per cent. That is, the FOMC not only cut the interest rate at each of its
8 regular meetings, but also made further reductions in two special telephone
linkups. Three more cuts followed in 1992, bringing the rate to 3 per
cent by September, but this was as far as the Fed was prepared to go and the
rate was then left unchanged for seventeen months until February 1994, by
which time the US economy had started on a long period of rapid growth.
The Fed, worried now about developing inflationary pressure, then pushed
the rate up sharply. It made six increases in the target rate in 1994, two of
fifty basis points and one (November) by the unusually large amount of 75
basis points. A further 50-basis-point increase in February 1995 meant that
the rate had doubled from 3 per cent to 6 per cent in just twelve months.
Perhaps this had been too far and too fast. In the following twelve months,
three 25-point cuts had restored the target to 5.25 per cent.
Then came a period of extraordinary calm. Almost nothing happened
from January 1996 until September 1998. In a period of two and three-quarter
years, there was only a small increase in March 1997 as the economy
kept growing but without generating serious concerns of inflation. Towards
the end of 1998, a crisis developed in Asian financial markets and spread to