Introduction to Finance

World War II and the Postwar Period 
The government used fewer infl ationary 
policies to fi nance World War II. Nevertheless, the banking system still took up large sums 
of bonds. By the end of the war, the debt of the federal government had increased by $207 
billion. Bank holdings of government bonds had increased by almost $60 billion. Prices went 
up by only about one-third during the war because they were held in check after the fi rst year 
by price and wage controls. They then rose rapidly when the controls were lifted after the war. 
In 1948, wholesale prices had risen to 236 from a level of 110 in 1939.

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8.5 Inflation Premiums and Price Movements
209
Wholesale prices increased during the Korean War and again during the 1955–1957 
expansion in economic activity as the economy recovered from the 1954 recession. Consumer 
goods prices continued to move upward during practically the entire postwar period, increas-
ing gradually even in those years in which wholesale prices hardly changed.
Recent Decades 
Figure 8.3
shows changes in the consumer price index (CPI) for all 
items, and a related consumer price measure when food and energy are excluded, beginning 
with 1980. Although not depicted, wholesale consumer goods prices increased substantially 
when the Vietnam War escalated after mid-1965. Prices continued upward after American 
participation in the Vietnam War was reduced in the early 1970s. After American participa-
tion in the war ended in 1974, prices rose at the most rapid levels since World War I. Infl ation 
was worldwide in the middle 1970s; its eff ects were much worse in many other industrial 
countries than in the United States.
As the 1970s ended, economists realized the full impact of a philosophy based on a high 
infl ation rate. Many economists thought high infl ation could keep unemployment down per-
manently, even though history shows that it does not. The government’s eff orts to control 
interest rates by increasing the money supply created doubts that such policies would reduce 
infl ation and high interest rates. By October 1979, the Federal Reserve System abandoned this 
failed approach to interest rate control and adopted a policy of monetary growth control. The 
result was twofold. First, there was a far greater volatility in interest rates as the Federal Reserve 
concentrated on monetary factors. Second, during the fi rst three quarters of 1980, some mon-
etary restraint was exercised. This monetary restraint depressed production and employment. 
The Federal Reserve System quickly backed off from this position of restraint, and by the end 
of 1980 a far greater level of monetary stimulus had driven interest rates to new peaks.
By this time, the prime rate had risen to 21.5 percent and three-month Treasury bills had 
doubled in yield from their midyear lows. These high interest rates had a profound negative 
eff ect on such interest-sensitive industries as housing and automobiles. The Fed reversed the 
rapid growth of money supply throughout 1981 and until late in 1982. Unemployment climbed 
as the eff ects of monetary restraint were imposed on the economy, but the back of infl ation 
was broken. By the end of 1982, economic recovery was in place, along with an easing of 
monetary restraint.
Figure 8.3 shows that infl ation stayed at moderate levels beginning in 1983 and continu-
ing through most of the remainder of the 1980s until near the end of the decade. After peaking 
in 1990 above a 6 percent annual rate, changes in the CPI stayed at about 3 percent until 1997, 
when the infl ation rate dropped even further. In early 1994, the Fed moved toward a tighter 
monetary policy in an eff ort to keep infl ation from rising. As the country fi nished the 1990s 
and moved into the early twenty-fi rst century, infl ation rates remained at relatively low levels. 
For 2007, the rate of infl ation using changes in the CPI for all items was 4.1 percent, refl ect-
ing record high oil prices. Using the alternative CPI measure, adjusted to exclude food and 
energy, the rate of infl ation was 2.4 percent for 2007. Since then, changes in the all items CPI 
3
0
6
9
12
15
Percent Change from
Year Ago
80 81 82 83 84 85 86
90 91 92 93 94 95 96
87 88
97 98 99 00 01
89
All Items
Excluding Food
and Energy
02
06 07 08 09 10 11 12 13 14 15
03 04 05