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Americans must recognize today that efforts to tame runaway inflation, while necessary, have real consequences that can hurt. A lot of.
It was not so long ago when:
- A small army of farmers protesting foreclosures due to high interest rates drove to Washington, DC in tractors to protest the Federal Reserve.
- Auto dealers sent the Fed Coffins full of car keys from unsold vehicles symbolized the death of the sale because people could no longer borrow money for cars.
- Builders sent 2×4 sticks to the Federal Reserve Chairman to remind him that his efforts to curb inflation were stifling the construction industry.
The rich but largely forgotten history of people protesting high interest rates at the Federal Reserve seems crazy today, when Americans are so used to having such easy access to borrowed money.
We’re talking about the late ’70s and early ’80s, when high inflation was so etched into the American psyche that the system went into shock killing it – leading to everyday interest rates on par with those charged on credit cards today to demand.
The anti-inflation medicine triggered a double-dip recession – in which one recession was followed by a brief rebound and then another recession — putting millions of Americans out of work.
The architect of that shock, former Federal Reserve Chairman Paul Volcker, is now being hailed for doing the politically difficult and setting the stage for decades of economic growth to follow.
But he weathered the criticism as inflation eased.
The president who put Volcker at the helm of the Fed, Jimmy Carter, lost his job amid a crisis of confidence and voter unease. Ronald Reagan would nominate Volcker for a second four-year term before the two fell out.
The Volcker shock. People are remembering the “Volcker shock” this week that changed the course of the US economy back when today’s Federal Reserve implemented its second massive rate hike in a row.
For the full story on Wednesday’s walk, read these articles from CNN Business:
Now back to Volcker.
Mortgage rates skyrocketed. Let’s look at 30-year fixed-rate mortgage rates, which are close to Fed-controlled rates.
The average 30-year fixed rate was already inflated, approaching 12% in October 1979, even before Volcker announced dramatic measures to combat inflation. The average rate within months skyrocketed to over 16%. The average interest rate on 30-year fixed-rate mortgages peaked in October 1981 at over 18%.
Today we are still a long way from those heights of the 80s; 30-year fixed rates have nearly doubled to nearly 6% in a year.
Volcker’s legacy is impressive. Every story you read about Volcker will mention that he was tall, 6 feet 7 inches. But he has an outsized legacy to match.
As well as providing the hard medicine that ended the runaway inflation of the 1970s, he is credited with the “Volcker Rule” which for a time prevented banks from trading their own assets.
Chris Isidore wrote CNN’s obituary for Volcker back in 2019. I asked him how Volcker would see today’s fight against inflation.
He made these important points:
Volcker was willing to make tough decisions. Volcker believed the Fed must do whatever it takes to bring prices back into line. In January 1981, under his leadership, the central bank increased its key interest rate to as much as 19%.
There were consequences. His high interest rate policy caused not one, but two recessions in a short space of time: one in January 1980 that lasted through July ’80, which was quickly followed by the recession that began in July ’81 and lasted through November 1982.
In November 1982 the unemployment rate reached 10.8%. That was almost a percentage point more than after the Great Recession 12 years ago.
It was much worse inflation than today. Volcker has faced far more serious inflationary pressures, with CPI inflation peaking at 14.8% in March 1980, well above the current rate of 8.3%.
Volcker faced a wage-price spiral. Many more workers had union contracts than today, and many of those contracts included cost-of-living adjustment clauses, or COLA, that automatically increased wages when prices rose. That is not the case today.
Today the Fed has less control. Many of the factors behind today’s high inflation are beyond the Fed’s control, including oil and food price spikes caused by the war in Ukraine and supply chain problems caused by the Covid-19 pandemic, which are still pushing up production costs for many products and causes bottlenecks in the face of strong demand.
Much of the Fed’s job in taming inflation is convincing people that inflation has been tamed, according to former Fed official David Wilcox, now a senior fellow at the Peterson Institute for International Economics.
Shortly before this latest rate hike, he wrote an opinion piece for CNN Business, offering two avenues for the US:
The optimistic view is that people believe inflation is under control. “If households and businesses hold onto the view that inflation will return to 2% in the not too distant future, the Fed’s task of achieving that outcome becomes much easier,” Wilcox wrote.
The pessimistic view is that people think it’s here to stay. “The experience of rising prices at the pump and in the grocery store over the past year may have caused households and businesses to expect more of it,” Wilcox wrote. “In that case, the Fed will have to raise its interest rate much higher — and the coming economic downturn will be much deeper.”
Wilcox argued that Volcker was trying to get Americans out of the general acceptance of inflation being too high. Today, Wilcox sounds optimistic, forecasting that inflation will be lower within a year and close to the 2% target within two or three years – although who knows what will happen with the pandemic and the war in Ukraine.
Wilcox refers to Volcker as “the patron saint of inflation control” and notes that current Fed Chair Jerome Powell frequently invokes Volcker’s name.
It’s usually in glowing terms. That spring, Powell praised Volcker for fighting on two fronts, “slaying what he called ‘the ‘inflationary dragon,’ and debunking the public’s belief that elevated inflation was an unfortunate but unchanging fact of life.”
Let’s hope that’s not the case and that these rate hikes don’t have the same unintended consequences that Volcker had more than 40 years ago.
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