Economists generally give credit to chairman Paul Volcker of the Federal Reserve for ensuring the recession's end. Last summer the Federal Reserve decided to abandon the monetarism that was perpetuating the recession by keeping a tight rein on the money supply. Mr. Volcker and his board contrived a growth in the money supply big enough to bring interest rates down from the high level that had been killing off housing starts. When Henry Kaufman, the fallible wizard of Wall Street, recognized the Fed's shift in strategy, his announcement of this fact initiated the great bull market of last August. Bonds soared upward in price. Common stocks chased up after them.
Again in October, when Volcker and the Federal Reserve signaled that they were determined to make credit easier in order to promote home construction and auto sales, American and European investors took this to be a good thing and bid up further the prices of securities. This behavior was in direct contrast to what the Chicago School monetarists had predicted to be the effects of letting the money supply grow faster: The monetarists had said that investors in the markets would regard any increase in money as portending a reacceleration of inflation, and would in consequence dump bonds and raise interest rates.
The significant drop in nominal interest rates engineered by the Fed led, in the standard textbook way, to a strong snapback of the housing industry. Then, early this year, it led also to a snapback in auto sales. Although Reaganomics had been pushing tax programs designed, it was said, to stimulate saving and reduce consuming, it is an ironical truth that so far the recovery has been sparked by strong consumer spending and by cessation of inventory reduction. As yet, there has been no measurable increase in spending on machinery and plant, which true supply-side economics teaches us is the way that long-term productivity of labor gets increased.