Essay/Term paper: U.s monetary policy in 1995

Essay, term paper, research paper:  Economics

U.S Monetary Policy in 1995

When Alan Greenspan presented the Federal Reserve's semi-annual report
on monetary policy to the Subcommittee on Domestic and International Monetary
Policy, the Committee on Banking and Financial Services, and the U.S. House of
Representatives on February, Dr. Greenspan touted a cautionary yet favorable
view of the U.S. economy. He states that "With inflationary pressures
apparently receding, the previous degree of restraint in monetary policy was no
longer deemed necessary, and the FOMC consequently implemented a small reduction
in reserve market pressures last July." (Greenspan, 1996, Speech)
During the Summer and Fall of 1995, the economy experienced a
strengthening of aggregate demand growth. According to Greenspan, this increase
in aggregate demand brought finished goods inventories and sales into near
equilibrium. The Fed's fine tuning of the economy seemed to be paying off.
Greenspan had a positive outlook for the economy for the rest of 1995. He
states "the economy, as hoped has moved onto a trajectory that could be
maintained--one less steep than in 1994, when the rate of growth was clearly
unsustainable, but one that nevertheless would imply continued significant
growth and incomes." (Greenspan, 1996, Speech)
Towards the end of the year, the economy showed signs of slowing.
Fearing a prolonged slowdown or even a recession in the economy, and with
inflationary expectations waning, Chairman Greenspan and the Federal Reserve cut
rates again in December. (Greenspan, 1996, Speech)
There are, of course, critics of 1995's monetary policy. Most of the
criticism came in the early part of 1995 when the Fed raised rates again.
In the article "Are We Losing Altitude Too Fast" from the May 1, 1995
issue of Time magazine written by John Greenwald, he explains that the economy
might not be coming in for a "soft landing" like the fed predicts. Trying to
sustain 2 to 3 percent growth might lead us into a recession. Mr. Greenwald
explains how the Fed's actions in 1994 and early 1995 has hurt individuals and
the economy as a whole. "Corporate layoffs are far from over," says Greenwald,
"they generally accelerate when firms find themselves in an economy that is
weakening." (Greenwald, Time, 5/1/95, p80)
Unemployment and layoffs aren't the only thing to worry about according
to Mr. Greenwald. The automobile industry and the housing markets are both
getting hit in the pocket books. Paul Speigel, owner of a New York car
dealership explains his woes by saying '"We're doing our best to keep up the
volume by discounting, working on our customers, but the Fed's rate hikes have
dampened the ability of many Chevrolet customers to buy that new vehicle."'
John Tuccillo, chief economist for the National Association of Realtors states
that the market (for new housing) "fell apart as mortgage rates rose above 9%
last fall (1994), and still have not yet recovered." (Greenwald, Time, May 1,
1995. p81)
Another outspoken, and cynical opponent to the Fed's monetary policy is
Dr. Michael K. Evans, who is president of Evans Economics, Inc. and Evans
Investment Advisors, Boca Roton, Fla. Dr. Evans wote an article in the Aug. 21,
1995 issue of Industry Week entitled "The Gang that Wouldn't Shoot Straight:
Fed's Trample Over Their Own Rate Cut." Dr. Evans contends that lowering the
federal funds rate in July was a mistake because the economy was already
starting to recover without tampering by the Fed. He claims Greenspan knew full
well that the economy was on the upswing, but cut rates anyway to try to ensure
his reappointment come March 1996. Dr. Evans claims that vice-Chairman Alan
Blinder also knew of the recovery but "he could not face his collegues at
Princeton when he returned, unless he pushed for a rate cut." (Evans, Industry
Week, Aug. 21, 1995. p122)
Dr. Evans concludes that the Fed's actions in July were "purposely
misleading, cravenly political, and just plain stupid." (Evans, Industry Week,
Aug. 21, 1995. p122)
Many people applauded the actions of the Fed in 1995, and defend them
from the rampant "fed-bashing".
One of the defenders of the Fed's monetary policy and Alan Greenspan is
Rob Norton who wrote an article in the July 24, 1995 issue of Fortune entitled
"The Blaming of Dr. Greenspan. (Federal Reserve Board Chairman Alan Greenspan
Takes Blame for Economic Downturn)." Mr. Norton agrees with Greenspan that in
February 1995 it was essential to raise interest rates because of an
unsustainable rate of growth. He says that Greenspan was ahead of the game by
doing this. "The conventional wisdom crowd claimed that here was no reason to
fear that the economy was going to overheat," he goes on to say "By the fourth
quarter of last year, real GDP was growing at a 5.1% rate--twice the average
growth rate most economists consider sustainable in the U.S., given population
growth and productivity increases." (Norton, Fortune, July 24, 1995. p39)
Mr. Norton also does not believe that Alan Greenspan cut rates in July
to ensure his re-nomination in March, 1996. He points out that during the 1988
Presidential campaign, with inflationary pressures present, many economists felt
Greenspan would not raise rates because he is a loyal Republican, and he did not
want to hurt the Republican's chances in the campaign. Chairman Greenspan went
against most people's predictions and raised rates "just days before the
Republican convention." (Norton, Fortune, July 24, 1995. p39)
Another defender of the Fed's policies during 1995 is Michael Sivy, who
is a chartered financial analyst and a former Wall Street research director,
wrote an article titled "The Fed's Rate Cut Decision could Push The Dow to 4900
and Postpone a Recession," which appeared in the Aug. 1995 edition of Money
magazine. He stated that Greenspan "decided to send businesses and consumers a
clear signal: Interest rates won't go any higher." But Greenspan still was on
the lookout for any inflationary pressures, so he reduced rates by a very small
amount in July, which will be followed by more small rate cuts. Mr. Sivy states
"With the Fed fine-tuning the economy like that, we think the Dow could tack on
another 200 points to top 4900 by year-end." (Sivy, Money, Aug. 1995. p160)
Through my research on 1995 monetary policy, I feel the Fed did a good
job of monetary policy during 1995. During 1994 and early 1995 I believe the
Federal Reserve were justified in their actions in stepping up interest rates.
Inflationary pressures were definitely present at the time, and if the fed let
the inflation occur, how high would they let it go? This might also mean going
through disinflation in the future, which is a long and painful process. The
Fed did the right thing by not even letting inflation "out of the bottle."
As for the Fed's cutting of interest rates in the middle and latter
parts of the year, I believe the data suggests the economy was slowing down,
along with that, inflationary expectations were fading also. This made it
relatively easy for the Fed to lower rates. But they made sure they watched
inflationary pressures at the same time.
I still haven't made up my mind whether Greenspan based part of his
decision to cut rates on political reasons or not. Sure, he could probably make
10 times more in the private sector, but I believe more goes into it than that.
Many people see the Chair of the Federal Reserve as the 2nd most powerful person
in the U.S. right behind the President, this in itself could persuade Greenspan
into pleasing the President who reappoints him. Another point would be going
down in history. If Greenspan successfully obtains an unprecedented third term,
he will probably be highly regarded in every history book yet to be made; it's
doubtful that Greenspan would go down in history if he were the president of
the Chase Manhattan Bank. As Rob Norton defended Greenspan in saying that he
raised rates even though the Presidential election was just around the corner in
1988; Greenspan was only in the 2nd year of his 4 year term, so there wasn't any
substantial political pressure, he still had about 3 years left of his term.
At any rate, I believe that the Fed had a very successful year of
monetary policy. The stock market soared, inflation and unemployment are both
at respectable levels, so I just hope the Fed keeps it up, and President Clinton
re-appoints Alan Greenspan.