Credibility allowed the FOMC to run an expansionary monetary policy in response to the international economic crises that started in summer 1997. Expansionary policy appeared initially as strong real growth not inflation.

The Fed's Response to Asia

In 1997, the FOMC debated how to reconcile strength in the economy and a falling unemployment rate with low inflation. At his July 1997 Humphrey–Hawkins testimony, Greenspan talked of a “new paradigm” where technological growth would keep capacity in line with increased demand. However, he added that growth in employment could not indefinitely exceed growth of the labor force. By fall, the unemployment rate had fallen to 4.8%. In October 1997, a hawkish Greenspan (December 1997, 965) warned Congress: “The law of supply and demand has not been repealed. … Short of a marked slowing in the demand for goods and services … the imbalance between the growth in labor demand and expansion of potential labor supply … must eventually erode the current state of inflation quiescence.”

Markets assumed that the FOMC was ready to raise the funds rate. Subsequently, the Asia crisis emerged. Although a rate hike had appeared likely at the November FOMC meeting, stock market volatility intervened. Concern over weakness in Asian equity markets produced a fall of 554 points in the DJIA on October 27, 1997. Added to the declines of the two prior days, the index fell 10.9%. Asia then came to dominate policy.