Question

1.Why did the Federal Reserve (under chairman Paul Volker) have a policy of high interest rates during a weak economy in the late 1970s/early 1980s? Explain their rationale.

2.

On October 20, 1987, stock markets in the US and other countries witnessed steep drops in value. For example, the Dow Jones Industrial Average fell by over 20%. Many in finance and economics still refer to this day as Black Monday.

(Question 2)

How did the Federal Reserve (under chairman Alan Greenspan) react to Black Monday?

3. How did the Federal Reserve (under Ben Bernanke) react to the bursting of the housing bubble in 2008/2009?

Answer 1

1. The US economy faced very high rate of inflation in the 1970s. The Fed takes up a contractionary monetary policy to reduce the money supply and reduce inflation. Maintaining a moderate inflation is one of the important goals of the Fed. The Fed contains inflation by reducing the money supply. The US economy faced a double-digit inflation in the 1970s. Therefore, the Fed adopted a highly contractionary monetary policy by raising the interest rate and decreasing the money supply.