Americans today need to understand that, despite being presumably necessary, efforts to rein in runaway inflation can have actual negative effects. A lot.
Not so long ago, there was a period when:
Farmers drove to Washington, DC in tractors to protest at the Federal Reserve in order to stop foreclosures brought on by excessive interest rates.
Because individuals could no longer afford to borrow money to buy cars, auto dealers gave the Fed coffins filled with car keys from unsold autos to symbolize the death of sales.
To tell the Federal Reserve chairman that his efforts to control inflation were stifling the construction industry, builders sent chunks of 2×4 wood to him.
When Americans are so accustomed to having such easy access to borrowed money, the rich but largely forgotten history of people protesting excessive interest rates at the Federal Reserve sounds crazy today.When high inflation became ingrained in the American psyche in the late 1970s and early 1980s, eradicating it required a shock to the system, resulting in daily interest rates comparable to those charged by credit cards today.
Millions of Americans lost their jobs as a result of the medication to treat inflation, which caused a double-dip recession, in which one downturn was followed by a brief upturn.Former Federal Reserve Chairman Paul Volcker, the mastermind behind that surprise, is now praised for taking the politically risky course and fostering the conditions that led to decades of economic expansion afterward.
But once the inflation subsided, he handled criticism well.
Jimmy Carter, the president who appointed Volcker as head of the Fed, was ousted amid a voter unrest and crisis of confidence. Before the two had a falling out, Ronald Reagan would nominate Volcker for a second four-year term.
Volcker's shock This week, as the Federal Reserve imposes its second significant rate hike in a row, people are thinking back to the "Volcker shock," which changed the direction of the US economy at the time.What types of rates were being considered as Volcker fought against inflation?
Mortgage interest rates soared. Let's examine 30-year fixed mortgage rates, which are almost identical to the rates that the Fed regulates.
Even before Volcker made his dramatic announcement of harsh anti-inflation measures in October 1979, the typical 30-year fixed rate was already excessive and close to 12 percent. The average rate skyrocketed to more than 16 percent in a matter of months. In October 1981, the 30-year fixed mortgage rate average reached a record high of over 18 percent.
Today, 30-year fixed rates have nearly doubled in a year to close to 6 percent, showing that we are still a very long way from those 1980s highs.
The legacy of Volcker is strong. Every account of Volcker you read will highlight his height of 6 feet 7 inches. But he also leaves behind a huge legacy.
He is recognized with creating the "Volcker rule," which for a while prevented banks from trading their own assets, in addition to administering the harsh medicine that put a halt to the galloping inflation of the 1970s.
In 2019, Chris Isidore penned the CNN obituary for Volcker. I enquired as to how Volcker may perceive the current battle against inflation.
He stressed these crucial points:
Volcker was prepared to make challenging decisions. Volcker said the Fed had to take whatever action was necessary to get prices back in check. In January 1981, under his direction, the central bank increased its benchmark rate to a maximum of 19 percent.
There were repercussions. His high interest rate policies sparked not just one, but two recessions in quick succession: the first from January 1980 to July 1980, which was swiftly followed by the recession from July 1981 to November 1982.
The unemployment rate rose to 10.8% by November 1982. That was nearly a full percentage point higher than the low point it reached following the Great Recession of 12 years ago.
The inflation was significantly worse than it is now. Inflationary pressures were much more severe under Volcker's watch; in March 1980, the Consumer Price Index increased at a rate of 14.8 percent, which is much higher than the current rate of 8.3 percent.
A wage-price spiral was facing Volcker. Compared to today, a lot more workers had union contracts, and many of those contracts included COLA clauses, which automatically increased wages as prices increased. The situation is different now.
The Fed has less power now. The Fed has little control over many of the factors causing today's high inflation, such as increases in food and oil prices brought on by the conflict in Ukraine and supply-chain issues brought on by the Covid-19 pandemic, which are still driving up the cost of manufacturing a number of goods and resulting in shortages in the face of high demand.
A self-fulfilling prophecy about inflation may occur.
According to David Wilcox, a former Fed employee who is currently a senior fellow at the Peterson Institute for International Economics, a large part of the Fed's work in managing inflation is persuading people that inflation has been contained.
He provided two options for the US in an opinion post he penned for CNN Business just before this most recent rate hike:
The optimistic perspective is that people think inflation is in check. "The Fed's task in achieving that result will be much easier if families and businesses maintain the assumption that inflation will return to 2 percent in the not-too-distant future," Wilcox wrote.
According to the gloomy perspective, people believe it will continue. Wilcox stated that the experience of rising petrol and food store prices over the previous year "may have conditioned people and businesses to expect more of the same." In that scenario, the Fed would have to raise its policy interest rate much more, which would result in a considerable worsening of the coming economic downturn.
Wilcox contended that Volcker was attempting to shake Americans out of their collective acceptance of excessive inflation. Although it's impossible to anticipate what will happen with the epidemic and the situation in Ukraine, Wilcox seems hopeful today and projects inflation will be lower within a year and in the goal region of 2 percent within two to three years.
Volcker is referred to as "the patron saint of inflation management" by Wilcox, who also points out that current Fed Chair Jerome Powell frequently uses Volcker's name.
Typically, it is positive. Powell praised Volcker this spring for fighting on two fronts, "slaying the inflationary monster," as he put it, and debunking the public's notion that high inflation was a regrettable but unavoidable aspect of life.
Hopefully, this won't be the case and these interest rate increases won't have the unexpected effects Volcker's did more than 40 years ago.
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