Inflation Or Slow Growth?

By the late 1980s and early 1990s, inflation had not disappeared, but Americans were enjoying a level of inflation that was relatively low and stable compared with the 1970s. This resulted in large part from the severe recessions and ">tight monetary policy of the early1980s. But many Americans were not totally convinced that the problem of inflation had been permanently solved. They suffered a scare in 1990 when, as a result of an outbreak of war in the oil-rich Gulf, the price of petroleum rose sharply on the world market. It declined again after a few months, and after hostilities had ceased the incident appeared not to have left lingering inflationary after-effects.

But the incident showed how vulnerable the U.S. economy is to sudden shocks. The 1990 oil shock appeared to help tip the U.S. economy into recession in 1991. By then, the major concern of many Americans was gradually shifting from fears of renewed inflation to questions about how soon there would be an economic recovery, how robust the recovery might be, and whether after an initial upswing the economy might suddenly slide downward -- a phenomenon known as a "double-dip" recession.

High interest rates inhibit economic growth, and interest rates were already high, in part because of large U.S. budget deficits and the prospect that they might continue indefinitely. In addition, economists anticipated demands for large amounts of capital for Eastern Europe -- a part of the world that was desperately trying to cast off the shackles of socialist controls and convert to market-based economies.

There were other reasons for concern about the robustness of an economic recovery. As a result of the lending excesses of the 1980s, which left a legacy of heavy indebtedness and crippled financial institutions, U.S. banks and other lenders had tightened lending standards in the 1990s. Indeed, the entire financial sector was under strain, as banks, savings and loans, and some insurance companies, hobbled by portfolios of poor-quality debt, struggled to remain afloat by getting injections of capital or merging. But more than a few toppled into bankruptcy, and some became insolvent.

Partly as a result of these problems, Americans were raising more and more questions about whether the structure of the U.S. financial system was suitable to global competition in the waning years of the 20th century. Only a few decades earlier U.S. money-center banks had been prominent in the ranks of the world's biggest banks; by 1991, there were none left among the top 20. While bigness is no assurance of strength, it was clear that the structure of American banking was obsolete, dominated by earlier-era thinking about the need for many small-town banks to lend money to farmers, as well as the imposition of numerous restrictions on banks during the Great Depression. But efforts to get agreement on a package of reforms proved difficult.