The Great Depression arguably ended with the onset of the various conflicts around the world that collectively have come to be known as World War II. As the U.S. joined other countries in getting pulled into the war, the Fed’s focus moved to supporting the war effort. This primarily meant keeping interest rates low to make it easier for the U.S. to issue debt and finance military-industrial expansion. One way the Fed accomplished this was to buy large volumes of government debt.

After the war ended, other priorities emerged. The Fed had a balance sheet brimming with government debt, while the country’s priorities shifted as it emerged as a global superpower. While veterans returned home to work and start families, the U.S. shifted to reconstruction and the realities of a Cold War. The resulting economic growth left the Federal Reserve faced with the risks of surging inflation, which at times exceeded 21%. 

Treasury and White House officials resisted Fed efforts to tighten monetary policy, even as the Fed sought to raise rates and sell off some of the government debt on its books. This conflict came to a head when then-President Harry Truman issued a unilateral statement about Fed policy to which members of the FOMC had not agreed – and in fact opposed. Marriner Eccles, who was Fed Chair at the time, responded with his own press statement directly contradicting the White House. 

Ultimately, political officials recognized that the dispute was undermining public confidence, and an accord was reached between the Treasury Department and the Fed that established the precedent for the central bank to operate largely independently, free from the political considerations of elected officials. This has proven critical to the Federal Reserve’s effectiveness in the subsequent decades.

Nevertheless, the Federal Reserve was not entirely free of geopolitical concerns. In the late 1960s, escalating U.S. military involvement in Vietnam left the Fed forced to choose between policy that could support the war effort, or policy to control inflation. President Lyndon Johnson also pressured the Fed to prioritize minimizing unemployment over controlling inflation. 

This, in turn, helped to lay the groundwork for what is known as the Great Inflation. Under Chair Arthur Burns, the Fed initially prioritized combating unemployment over price stability, giving inflation time to become anchored. Congress officially recognized the problem in 1977, when it amended the Federal Reserve Act to give the Fed a “dual mandate” to encourage the conditions necessary for both maximum employment and price stability. 

It was not until Paul Volcker took over leadership of the central bank that the Fed embarked on a draconian policy of interest-rate hikes that inflation was brought back under control. Because inflation had become anchored before this policy shift, the hikes had to be left in place long enough to cause serious economic pain for many Americans.

One of the tools that the Fed used to tame the Great Inflation was the greater use of transparency and communication. Previously the Fed frequently did not habitually announce its rate policies and decisions, or its expectations about inflation and the economy. However, faced with tarnished public credibility after years of high inflation, the Fed began to announce policy changes and objectives, and expand disclosure of the data and rationale behind its decisions. This policy has continued through the Global Financial Crisis of 2008, which spurred the Fed to play a more active role in seeking financial stability and seeking to prevent systemic risks. 

We will discuss the Federal Reserve as an organization and look at the tools the Fed uses to fulfill its responsibilities in the next chapter.