Money
Matters: An IMF Exhibit -- The Importance of Global Cooperation
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Reinventing
the System (1972-1981)
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Part
7 of 7
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War
on Inflation
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Debt
& Transition |
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Desperate
times called for desperate measures. Governments around the world
fought inflation in 1979 and the early 1980s by raising interest
rates to record highs in order to tighten the money supply and
reduce pressure on prices.
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How
Do Higher Interest Rates Reduce Inflation?
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Central banks control interest
rates on funds that they lend to individual banks and on funds
loaned between banks. If the central bank raises these interest rates,
individual banks are forced in turn to raise the rates they charge
their customers. Borrowing money becomes more expensive, so less is
borrowed. Economic activity slows, less money is earned, and less
money is spent. Demand for goods and services falls. To revive shrinking
demand, providers of goods and services lower their prices, and inflation
slows.
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credits
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Cost
of the War on Inflation
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Stopping
inflation came at great cost. In addition to decreasing the money
supply, high interest rates reduced spending, output, and employment.
The world economy was pulled into the deepest recession since the
1930s. World Trade fell in 1981 for the first time since World War
II.
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credits |
Stabilizing
the Dollar
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To
slow inflation and stop the fall of the dollar, the U.S. government
adopted a dramatic anti-inflationary policy in October 1979.
It made borrowing money more difficult and more expensive.
The policy worked, interest rates soared. By the end of 1981,
inflation had been brought under control and the value of
the dollar had stabilized. But the anti-inflationary policy
also plunged the U.S. economy into recession.
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Chain
Reaction
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Since
capital now flowed across borders with ease, higher interest
rates in one country attracted capital away from others. U.S.
anti-inflationary policies pushed interest rates to record
levels. As the high U.S. rates attracted capital, other countries
were forced to raise their interest rates to compete. High
interest rates around the world caused spending to contract
sharply, throwing the global economy into recession.
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Debt
& Transition |
