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The Greenspan Era

The Greenspan Era

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Published by ClassOf1.com
In October 1979, as Organization of Petroleum Exporting Countries (OPEC) was imposing adverse supply shocks on the world’s economies for the second time in a decade, Fed Chairman Paul Volcker decided that the time for action had come. Volcker had been appointed chairman by President Carter only two months earlier, and he had taken the job knowing that inflation had reached unacceptable levels.
In October 1979, as Organization of Petroleum Exporting Countries (OPEC) was imposing adverse supply shocks on the world’s economies for the second time in a decade, Fed Chairman Paul Volcker decided that the time for action had come. Volcker had been appointed chairman by President Carter only two months earlier, and he had taken the job knowing that inflation had reached unacceptable levels.

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Published by: ClassOf1.com on Jun 26, 2013
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Economics
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Sub: Economics Topic: Disinflation
*
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
The Greenspan Era
 
In October 1979, as
Organization of Petroleum Exporting Countries
(OPEC) was imposing adverse
supply shocks on the world’s economies for the second time in a decade, Fed Chairman Paul Volcker
decided that the time for action had come. Volcker had been appointed chairman by President Carteronly two months earlier, and he had taken the job knowing that inflation had reached unacceptable
levels. As guardian of the nation’s monetary system, he felt he had little choice but to pursue a policy
of 
disinflation
a reduction in the rate of inflation. Since the
Organization of Petroleum ExportingCountries
(OPEC) inflation of the 1970s and the Volcker disinflation of the 1980s, the U.S. economyhas experienced relatively mild fluctuations in inflation and unemployment. This period is called the
Greenspan era
, after Alan Greenspan who in 1987 followed Paul Volcker as chairman of the FederalReserve. This period began with a favorable supply shock. In 1986, OPEC members started arguingover production levels, and their long-standing agreement to restrict supply broke down. Oil prices fellby about half. This favorable supply shock led to falling inflation and falling unemployment. Sincethen, the Fed has been careful to avoid repeating the policy mistakes of the 1960s, when excessiveaggregate demand pushed unemployment below the natural rate and raised inflation. Whenunemployment fell and inflation rose in 1989 and 1990, the Fed raised interest rates and contractedaggregate demand, leading to a small recession in 1991. Unemployment then rose above mostestimates of the natural rate, and inflation fell once again.The rest of the 1990s witnessed a period of economic prosperity. Inflation gradually drifteddownward, approaching zero by the end of the decade. Unemployment also drifted downward,leading many observers to believe that the natural rate of unemployment had fallen. Part of the creditfor this good economic performance goes to Alan Greenspan and his colleagues at the FederalReserve, for low inflation can be achieved only with prudent monetary policy. But as the followingcase study discusses, good luck in the form of favorable supply shocks is also part of the story. What
 
 
Sub: Economics Topic: Disinflation
*
The Homework solutions from Classof1 are intended to help students understand the approach to solving the problem and not forsubmitting the same in lieu of their academic submissions for grades.
does the future hold? Macroeconomists are notoriously bad at forecasting, but several lessons of thepast are clear. First, as long as the Fed remains vigilant in its control over the money supply and,thereby, aggregate demand, there is no reason to allow inflation to heat up needlessly, as it did in thelate 1960s. Second, the possibility always exists for the economy to experience adverse shocks toaggregate supply, as it did in the 1970s. If that unfortunate development occurs, policymakers willhave little choice but to confront a less desirable tradeoff between inflation and unemployment.

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