This kind of shock to the economy will have consequences

The rich, but largely forgotten, history of people protesting high interest rates at the Federal Reserve seems crazy today, when Americans used to have easy access to borrowed money.

We’re talking about the late ’70s and early ’80s, when hyperinflation so engulfed the American psyche that killing it shocked the system – resulting in daily interest rates on par with credit card fees today.

The anti-inflation drug started a double-dip recession — one followed by a short recovery and then another — and put millions of Americans out of work.

The architect of that shock, the former Federal Reserve Chairman Paul VolckerToday, he is lauded for doing the politically difficult thing and creating the environment for decades of subsequent economic growth.

But it has withstood criticism as inflation eases.

The president who appointed Volcker in charge of the Federal Reserve, Jimmy Carter, lost his job amid a crisis of confidence and voter annoyance. Ronald Reagan was renominating Volcker for a second four-year term before the two separated.

Volcker shock. This week, people remember the “Volcker shock”, which changed the course of the US economy at that time, as the Federal Reserve today forces interest rates to rise for the second time in a row.

Read these articles from CNN Business for the full story on Wednesday’s rally:

Now, back to Volcker.

What kind of rates were they looking at as Volcker took on inflation?

Mortgage rates have risen dramatically. Let’s look at Fixed mortgage rates for 30 yearswhich tracks close to Fed-controlled rates.
The 30-year average flat rate was already excessive and approached 12% in October 1979, even before Volcker Dramatic ad of strict anti-inflation measures. Within months average price It may reach more than 16%. The average 30-year fixed-rate mortgage rate was over 18%, its highest level in October 1981.
Today we are still Far from the highs of the 80s; Flat rates for 30 years have nearly doubled in a year to nearly 6%.

Volcker’s legacy is majestic. Every story you read about Volcker will mention that he was tall, 6 feet 7 inches. But he has a huge legacy to match.

In addition to introducing the harsh medicine that ended the hyperinflation of the 1970s, he was credited with the “Volcker Rule,” which for some time prevented banks from trading their own assets.

Chris Isidore books CNN’s obituary to Volcker Back in 2019. I asked him how Volcker would see today’s fight against inflation.

He made these important points clear:

Volcker was willing to make tough choices. Volcker believes the Fed should do whatever it takes to get rates back on track. Under his leadership, the central bank raised the benchmark interest rate to 19% in January 1981.

There were consequences. His high interest rate policy caused not just one recession, but two recessions in a short time: one from January 1980 and lasting until July 80, which was soon followed by a recession that began in July 81 and lasted until November 1982.

By November 1982, the unemployment rate had reached 10.8%, almost a full percentage point higher than it had reached in the aftermath of the Great Recession 12 years earlier.

It was much worse inflation than we have today. Volcker had much more serious inflationary pressures, as the rate of increase in the CPI was 14.8% in March 1980, well above the current rate of 8.3%.

Volcker faced a wage spiral. Many workers had more union contracts than they do today, and many of those contracts had cost-of-living adjustments, or COLA clauses, which automatically raise wages when prices rise. This is not the case today.

Today, the Federal Reserve has less control. Many factors in today’s high inflation are beyond the Fed’s control, including the sharp rise in oil and food prices caused by the war in Ukraine, and supply chain problems caused by the Covid-19 pandemic, which continues to raise the cost of production for many products and cause Shortage in the face of strong demand.

Inflation can become a self-fulfilling prophecy

A large part of the Fed’s job in taming inflation is to convince people to tame inflation, according to former Fed official David Wilcox, now a senior fellow at the Peterson Institute for International Economics.

Written before this latest price hike Opinion article for CNN BusinessHe presented two routes to the United States:

The optimistic view is that people believe inflation is under control. “If households and businesses maintain the view that inflation will return to 2% in the not-too-distant future, the Fed’s job of achieving that outcome will be much easier,” Wilcox wrote.

The pessimistic view is that people think they are here to stay. “The experience of rising prices at the gas pump and the grocery store over the past year has made families and businesses expect more of the same,” Wilcox wrote. “In that case, the Fed will need to raise its policy rate much higher – and the next economic slowdown will be much deeper.”

Wilcox said Volcker was trying to get Americans out of public acceptance of very high inflation. Today, Wilcox is optimistic and expects inflation to be lower within a year and in the 2% target area 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 Chairman Jerome Powell invokes Volcker’s name frequently.

Usually in glowing terms. This spring, Powell praised Volcker for fighting on two fronts, “killing, as he called it, the ‘inflationary dragon’ and dismantling the public’s belief that high inflation was an unfortunate but constant fact of life.”

Let’s hope that is not the case and that these rate increases will not have the same unintended consequences that Volcker suffered more than 40 years ago.