17.3 Shifts in monetary and fiscal policies

The 1970s saw the U.S. economy grappling with stagflation, a mix of high inflation and slow growth. The Federal Reserve used tools like open market operations and interest rate adjustments to balance inflation control with economic growth, facing the challenge of addressing both high unemployment and rising prices.

Fiscal policy shifted during this period, with initial expansionary measures giving way to concerns about growing deficits. Presidential administrations, from Nixon to Carter, tried various approaches to combat stagflation, including wage-price freezes and energy conservation measures. The decade ended with a renewed focus on monetary policy to tackle inflation.

Monetary Policy and Stagflation

Role of Federal Reserve in stagflation

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• Federal Reserve utilized open market operations bought and sold securities to influence money supply and interest rates
• Discount rate adjustments changed cost of borrowing for banks impacting overall lending activity
• Reserve requirement changes altered amount of deposits banks must hold in reserve affected money multiplier
• Fed faced challenge of balancing inflation control with economic growth required delicate policy adjustments
• Addressing high unemployment and rising prices simultaneously presented conflicting policy objectives
• Implemented contractionary monetary policy raised interest rates to curb inflation and reduce money supply to slow economic growth
• Volcker's aggressive monetary tightening dramatically increased federal funds rate (reached 20% in 1981) caused short-term economic pain but aimed for long-term stability

Effectiveness of monetary policy tools

• Interest rate adjustments impacted borrowing costs and consumer spending reduced demand for loans and big-ticket purchases
• Higher rates affected business investment and expansion increased cost of capital for firms
• Money supply control influenced inflation expectations tighter supply aimed to reduce inflationary pressures
• Relationship between money growth and price levels followed monetarist theory (Milton Friedman)
• Limitations of monetary policy in stagflation included time lag between implementation and economic effects (6-18 months)
• Potential for unintended consequences such as recession or credit crunch
• Volcker's monetary tightening eventually broke inflationary spiral inflation rate dropped from 14.8% in March 1980 to 3% by 1983
• Restored credibility to the Federal Reserve as inflation fighter enhanced central bank's reputation

Fiscal Policy and Presidential Approaches

Shift in fiscal policy during 1970s

• Initial expansionary fiscal policies increased government spending on social programs (Great Society initiatives)
• Tax cuts implemented to stimulate economic growth (Revenue Act of 1971)
• Growing budget deficits resulted from increased spending and reduced tax revenues
• National debt increased from $371 billion in 1970 to$908 billion in 1980
• Nixon imposed temporary freeze on wages and prices in 1971 aimed to curb inflation
• Wage and price controls created economic distortions led to shortages and black markets
• Energy crisis response included creation of Strategic Petroleum Reserve in 1975
• Promoted energy conservation measures introduced fuel efficiency standards for vehicles

Economic philosophies of presidential administrations

• Nixon administration introduced "New Economic Policy" in 1971 included wage-price freeze and import surcharges
• Temporarily abandoned gold standard ended dollar's convertibility to gold (August 15, 1971)
• Ford administration launched "Whip Inflation Now" (WIN) campaign focused on voluntary measures to combat inflation
• Introduced public education initiatives to promote personal savings and energy conservation
• Carter administration initially emphasized fiscal stimulus increased government spending on job creation programs
• Later shifted towards anti-inflationary policies as inflation worsened prioritized price stability
• Appointed Paul Volcker as Federal Reserve Chairman in 1979 signaled commitment to monetary tightening
• Administrations shared struggle to effectively address stagflation gradual recognition of monetary policy importance
• Differences in approach included varying degrees of government intervention (Nixon more interventionist, Ford less so)
• Shifts in priority between unemployment and inflation Carter initially focused on unemployment later prioritized inflation control