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Interest Rates: 1972 - 1982
- 1. Interest Rates 1972 - 1982
- 2. Inflation Rates: 1972 to 1982 (Effective Federal Funds Rate, 2018)
- 3. Inflation and Recession (Consumer Price Index, 2018)(Effective Federal Funds Rate, 2018)
- 6. Causal Relationship (Bank Prime Loan Rate, 2018) (Effective Federal Funds Rate, 2018)
- 7. Impacts • Got inflation? Raise interest rates! • Depression got you down? Lower interest rates! • Unemployment becoming a problem? Lower interest rates! • Low interest rates? Spend! • High interest rates? Wait!
- 8. References • Bank Prime Loan Rate. (2018). Federal Reserve Economic Database. Retrieved September 14, 2018, from https://fred.stlouisfed.org/graph/?id=MPRIME, • Brandl, M. W. (2017). Money, banking, financial markets, & institutions. Cengage Learning. Retrieved September 13, 2018, from https://ng.cengage.com/static/nb/ui/evo/index.html?deploymentId=5569002353504691003099807280&dockAppUid=16&eISBN= 9781305628632&id=352007146&nbId=903007&snapshotId=903007& • Consumer Price Index. (2018). Federal Reserve Economic Database. Retrieved September 23, 2018, from https://fred.stlouisfed.org/graph/?id=CPIAUCSL, • Data Series. (2018). Federal Reserve Economic Database. Retrieved September 23, 2018, from https://research.stlouisfed.org/useraccount/datalists/202051 • Effective federal funds rate. (2018). Federal Reserve Economic Database. Retrieved September 14, 2018, from https://fred.stlouisfed.org/graph/?id=FEDFUNDS, • Kim, T. (2018, May 17). Warren Buffett: Interest rates are the 'most important' thing in determining stock values. CNBC. Retrieved September 23, 2018, from https://www.cnbc.com/2018/05/17/buffett-interest-rates-are-most-important-thing-in-stock-valuations.html • Weise, C.L. (April 2012). Political pressures on monetary policy during the US Great Inflation. American Economic Journal: Macroeconomics 2012, 4(2): 33–64 http://dx.doi.org/10.1257/mac.4.2.33
Editor's Notes
- Hello, today I will be covering one of the most interesting periods of U.S. monetary policy in the last 50 years: 1972 to 1982 and how interest rates affect the economy.
- I chose to examine the federal funds rate from 1972 to 1982 because this was a period of uniquely high interest rates in the last 50 years in the United States. From the 1980s on, the Federal Reserve generally cut interest rates decade by decade until interest rates were virtually zero after the mortgage crisis of 2007/2008 (Effective Federal Funds Rate, 2018). Toward the end of 1973, with the oil crisis looming over the economy, the Fed dropped interest rates (Weise, 2012). A huge rise in inflation in early 1974 once again forced the Fed to use a contractionary policy (Weise, 2012). Toward the end of 1974, the Fed gradually lowered interest rates, and were able to maintain a “mildly expansionary” monetary policy until 1976 (Weise, 2012). The Fed gradually raised interest rates beginning in 1977 until 1979, which tracked an era of high economic expansion and ever-increasing inflation (Weise, 2012). By the time inflation had reached crisis levels in late 1979, the Fed began increasing the federal funds rate more aggressively (Weise, 2012). A recession in late 1980 prompted the Fed to attempt to stabilize the economy with a drop in interest rates (Weise, 2012). As the economy recovered from the recession, the Fed once again fought off inflation with a contractionary monetary policy in 1981 (Weise, 2012). Another recession created reason for the Fed to cut interest rates dramatically in 1982 (Weise, 2012).
- A leading factor contributing to the high federal funds rate during this period was the inflation rate. In an attempt to fight high inflation rates, the Federal Reserve raised interest rates to reduce liquidity, which would slow economic growth and reduce inflation (Effective Federal Funds Rate, 2018). There were three recessions during this period in which the Federal Reserve sharply cut interest rates, a policy which appears to have facilitated the end of these recessions because they all end after sharp drops in the interest rates (Effective Federal Funds Rate).
- An important economic factor that led to changes in monetary policy was the unemployment rate. As the chart shows, the federal funds rate generally went up as unemployment went down, as was the case from April 1972 to July 1974. Additionally, the federal funds rate generally went down as unemployment went up, as was the case from July 1974 to June 1975. As unemployment gradually improved toward the late 1970s, the Fed was confident enough to begin increasing interest rates. When unemployment shot up in mid-1981 through 1982, the Fed dropped interest rates.
- Interest rates must be factored into business decisions. When interest rates are low, debt is obviously cheaper, so businesses can afford to purchase more. Low interest rates equate to higher valuations for investment earnings (Kim, 2018). This is because assets can be bought at cheaper prices. So, it would be in a business’s best interest to spend more during period of lower interest rates than during period of higher interest rates. Likewise, if they can, businesses should defer undertaking large projects during periods of high interest rates.
- If a depository institution needs to borrow money to maintain their required balances at the Federal Reserve, they may borrow at the effective federal funds rate, set by the Federal Open Market Committee, from other depository institutions that have higher reserve balances than required at the Federal Reserve (Effective Federal Funds Rate, 2018). The bank prime rate is “used by banks to price short-term business loans” (Bank Prime Loan Rate, 2018). From 1972 to 1982, the bank prime loan rate tracked the federal funds rate very closely. The Federal Open Market Committee increases liquidity by buying government bonds and decreases liquidity by selling government bonds (Effective Federal Funds Rate, 2018). More liquidity makes the bonds more desirable because they are easier to turn into cash, while less liquidity makes the bonds less desirable because they are more difficult to turn into cash (Brandl, 2017). So, if the Fed wants to raise the federal funds rate, they sell government bonds, which decreases liquidity and slows down the economy, and if they want to lower the federal funds rate, they buy government bonds, which increases liquidity and boosts the economy. The bank prime loan rate generally follows the federal funds rate because more liquidity means banks have more funds to loan and less funds means the banks have less funds to loan.
- As I have alluded to, when the Federal Reserve adjusts interest rates, it holds tremendous power over the economy. When the economy is rife with inflation like it was during much of the period of 1972 to 1982, the Fed can slow down the economy by raising interest rates. We also saw how the Fed used expansionary monetary policy to fight off recession and unemployment during this period. Finally, we saw how businesses should work around the interest rates by spending more during periods of low interest rates.