I.O.U.S.A. by Addison Wiggin, Kate Incontrera, Dorianne Perrucci
afford that much without raising taxes, and they didn ’ t want to raise taxes because then they wouldn ’ t be reelected. So they had this big problem. And what resulted from that was a run on America ’ s money. ”
Other countries, especially the French, led by Charles de Gaulle, noticed that the dollar was weakening. So de Gaulle told then - President Nixon that he wanted to exchange the dollars France had for gold. Nixon examined the situation and realized that if France took all of that gold, the United States would not have much gold left, and in turn decided to close the gold window. That was August 15, 1971, and since then, no foreign government could trade dollars for gold.
Money Supply:
Money Supply and Infl ation
The amount of
money (coins,
Now, with the Bretton Woods System a thing of the past, paper currency, and when the Fed determines that the economy needs a stimu-checking accounts)
lus, interest rates are lowered, borrowing becomes easier, and that is in circulation more money fl ows into the economy. This is known as openin the economy.
ing the Fed window, and the result is an increase in the money supply. If the money supply is increasing, consumers are feeling wealthier and more money is changing hands as they buy goods and services.
This puts a chain of events into motion. Businesses see increased sales and therefore order more materials and increase production. This, in turn, increases the demand for labor and goods. What happens after that, in a buoyant economy, is that prices of stocks rise and fi rms issue equity and debt. If the money supply continues to expand, the c03.indd 48
8/26/08 8:43:54 PM
Chapter 3 The Savings Defi cit 49
prices for these goods and services begin to rise, especially if output growth reaches capacity limits — in other words, a bubble is formed. As the public begins to expect infl ation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.
When infl ation is rising, the dollar is quickly losing value, and the Fed raises interest rates, which means borrowing becomes more expensive and money eventually fl ows out of the economy.
When the supply of money falls, or when its rate of growth declines, economic activity declines and either disinfl ation (reduced infl ation) or defl ation (falling prices) results.
Closing the Fed window decreases the money supply.
In a worst - case scenario, the economy can become stagnant and infl ation can rise simultaneously, a situation called stagfl ation. The Fed is then faced with an extremely diffi cult choice, because it can ’ t raise interest rates and lower them at the same time. It must choose either to stimulate the economy or to fi ght infl ation. This last happened in the United States in the late 1970s, and it proved to be a very diffi cult time for the country.
The forces of infl ation had been picking up steam throughout the 1970s, and the prices of just about everything were hitting record highs. Pete Peterson, then secretary of Commerce under the Nixon Administration, remembers this period in U.S. history clearly. “ I was in the Nixon White House, ” Peterson recalls,
“ fi rst as an economic adviser to
President Nixon and then as secretary of Commerce. History will record that the Federal Reserve was part of the problem.
They let money supply get out of control. When Paul Volcker took over he realized he had to take truly courageous action.
And he did. ”
Dr. Volcker
’ s offi ce in New York City is adorned with poster - size caricatures depicting the former Fed chairman as a warrior, battling runaway infl ation. And these cartoons are hardly exaggerating. Over the din of the ice skaters enjoying c03.indd 49
8/26/08 8:43:54 PM
50 The
Mission
themselves at Rockefeller Center, 20
- odd stories below,
Dr. Volcker told us of the tough medicine he had to spoon -
feed the United States when he took the helm of the Federal
Other countries, especially the French, led by Charles de Gaulle, noticed that the dollar was weakening. So de Gaulle told then - President Nixon that he wanted to exchange the dollars France had for gold. Nixon examined the situation and realized that if France took all of that gold, the United States would not have much gold left, and in turn decided to close the gold window. That was August 15, 1971, and since then, no foreign government could trade dollars for gold.
Money Supply:
Money Supply and Infl ation
The amount of
money (coins,
Now, with the Bretton Woods System a thing of the past, paper currency, and when the Fed determines that the economy needs a stimu-checking accounts)
lus, interest rates are lowered, borrowing becomes easier, and that is in circulation more money fl ows into the economy. This is known as openin the economy.
ing the Fed window, and the result is an increase in the money supply. If the money supply is increasing, consumers are feeling wealthier and more money is changing hands as they buy goods and services.
This puts a chain of events into motion. Businesses see increased sales and therefore order more materials and increase production. This, in turn, increases the demand for labor and goods. What happens after that, in a buoyant economy, is that prices of stocks rise and fi rms issue equity and debt. If the money supply continues to expand, the c03.indd 48
8/26/08 8:43:54 PM
Chapter 3 The Savings Defi cit 49
prices for these goods and services begin to rise, especially if output growth reaches capacity limits — in other words, a bubble is formed. As the public begins to expect infl ation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.
When infl ation is rising, the dollar is quickly losing value, and the Fed raises interest rates, which means borrowing becomes more expensive and money eventually fl ows out of the economy.
When the supply of money falls, or when its rate of growth declines, economic activity declines and either disinfl ation (reduced infl ation) or defl ation (falling prices) results.
Closing the Fed window decreases the money supply.
In a worst - case scenario, the economy can become stagnant and infl ation can rise simultaneously, a situation called stagfl ation. The Fed is then faced with an extremely diffi cult choice, because it can ’ t raise interest rates and lower them at the same time. It must choose either to stimulate the economy or to fi ght infl ation. This last happened in the United States in the late 1970s, and it proved to be a very diffi cult time for the country.
The forces of infl ation had been picking up steam throughout the 1970s, and the prices of just about everything were hitting record highs. Pete Peterson, then secretary of Commerce under the Nixon Administration, remembers this period in U.S. history clearly. “ I was in the Nixon White House, ” Peterson recalls,
“ fi rst as an economic adviser to
President Nixon and then as secretary of Commerce. History will record that the Federal Reserve was part of the problem.
They let money supply get out of control. When Paul Volcker took over he realized he had to take truly courageous action.
And he did. ”
Dr. Volcker
’ s offi ce in New York City is adorned with poster - size caricatures depicting the former Fed chairman as a warrior, battling runaway infl ation. And these cartoons are hardly exaggerating. Over the din of the ice skaters enjoying c03.indd 49
8/26/08 8:43:54 PM
50 The
Mission
themselves at Rockefeller Center, 20
- odd stories below,
Dr. Volcker told us of the tough medicine he had to spoon -
feed the United States when he took the helm of the Federal
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