ABSTRACT
With globalization, financial markets the world over became more open, transparent, flexible, responsive, and sensitive to changes and the smallest policy moves from the central banks (and more particularly, the Federal Reserve, the world’s largest central bank and the supplier of global liquidity). Increasing integration of the markets following the process of financial liberalization and deregulation globally also compounded the influence of the demonstration effect of interest changes. The floating exchange rates offered greater freedom and maneuverability to monetary authorities in the supply of liquidity and its cost. The fast-changing financial environment also meant more frequent changes in the monetary stance of the central banks. The world’s largest and strongest controller of liquidity and interest rates, the Federal Reserve, was quick in adapting to the new rules of the game. In the late 1970s, the Chairman of the Federal Reserve, Paul Volcker, abandoned interest rates as a tool of monetary control to switch over to monetary targeting. Nevertheless, during the era of record asset price inflation, which the US experienced in the 1980s and more particularly in the 1990s, Alan Greenspan, who succeeded Paul Volcker in August 1987 – only a few months before the October 1987 stock market crash – had to revert to the weapon of the discount rate and more particularly the Fed Funds rate as the primary tool of monetary management with much greater frequency than at any time in the US monetary history.
