Volcker indeed sent a powerful message of policy regime change in his first press conference. “If we are going to progress and prosper, we need a sense of confidence that we are moving toward price stability at home,” he said. Rate hikes brought inflation down to 3 percent in 1983, but the “tough medicine” would put the U.S. into a recession, with the unemployment rate rising from 6 percent in the summer of 1979 to nearly 11 percent in 1982.
President Carter lost the election in 1980, but President Ronald Reagan kept Volcker as Fed chairman. In August 1982, with the unemployment rate at 10.8 percent, Volcker lowered rates and the economy began to gain strength while the secular bull market was launched.
Alan Greenspan: The “Great Moderation”
Alan Greenspan’s tenure as Federal Reserve Chairman (1987 – 2006), made him the second-longest serving Fed chairman. The period was labeled the “Great Moderation”—even though the 1987 Black Monday crash occurred two months after he began, a series of rate hikes in 1994 led to losses in fixed income portfolios, and the tech bubble crash led to a low interest rate environment with easy access to subprime mortgages that ultimately led to the financial meltdown in 2008.
Interest rate cuts helped soften the shock of the 1987 crash as Greenspan asserted that the Fed “affirmed today its readiness to serve as a source of liquidity to support the economy and the financial system.”
In 1994, a strong economy, along with a strong stock market, was followed by a series of rate hikes. Critics worried that Greenspan was seeing “imaginary inflationary pressures.” On February 4, 1994, the FOMC decided to raise rates slightly for the first time in many years. The statement following the meeting said, “The decision was taken to move toward a less accommodative stance in monetary policy in order to sustain and enhance the economic expansion.” The public statement was unusual in that the Fed didn’t historically announce changes in the federal funds rate. It explained that Greenspan sought to “avoid any misunderstanding of the committee’s purposes, given the fact that this is the first firming of reserve market conditions by the committee since early 1989.”
The Dow sold off. Analysts agreed that markets were facing a more difficult reality. Rates were raised again in between meetings. Following the series of rate hikes, Orange County, California, the richest county in the U.S., came under pressure as the county’s funds, which had bet on the direction of interest rates, suffered major losses leading to bankruptcy. Fixed income portfolios lost money in 1994 although the stock market managed a positive return.
In 1996, Greenspan delivered his famous “irrational exuberance” speech, although the stock market paid little attention to his warning. Greenspan was adamant that it wasn’t the Federal Reserve’s job to puncture bubbles; rather, the Fed could help after the bubble burst. Criticism aimed at Greenspan focused on his use of monetary policy to create a boom-and bust cycle that included the 2008 financial collapse.
Ben Bernanke: To the Rescue … With $4.5 Trillion
As the Great Recession unfolded, Fed Chairman Ben Bernanke (2006 – 2014), suggested that the subprime mortgage crisis was contained. Without realizing that subprime mortgages were the basis for highly leveraged derivatives that spread their toxicity across portfolios and balance sheets globally, Bernanke would preside over the collapse of major financial institutions, including Bear Stearns and Lehman Brothers. The ensuing fallout led to an absence of confidence, a withdrawal of market liquidity and a deep recession.
Bernanke lowered rates to nearly zero, which was called zero-interest- rate policy. In addition, Quantitative Easing, or the Fed’s buying of bonds, was implemented. Mortgage-backed securities were also purchased by the Fed.
On October 4, 2010, Bernanke wrote an op-ed piece published in the Washington Post that explained the Fed’s plan and defended spending an additional $600 billion for purchasing long-term Treasury securities. Bernanke outlined a “virtuous circle” in which easier financial conditions promote economic growth. This in turn leads to lower mortgage rates, more affordable housing, and refinancing. Lower corporate bond rates should encourage increased investment, while higher stock prices bolster consumer wealth and confidence. Spending results, and as spending increases, so will incomes and profits move higher.