Volcker vs Powell — how the US Fed once handled low inflation
Inflation peaked in March 1980. Wage growth peaked in January 1981. Both fell sharply over the next five years, though interest rates were slower to come down
New York — US Federal Reserve chair Jerome Powell has called low inflation the great problem of our time, but it wasn’t always so. Paul Volcker, the legendary Fed chief who died on Sunday, will be remembered for the extraordinary interest rates he imposed to vanquish high inflation four decades ago.
Inflation averaged 7.1% in the 1970s, more than double the previous decade’s level, and mortgage rates — the most important borrowing costs for American households — were above that level for most of those years. The soaring cost of living was a national preoccupation, so president Jimmy Carter called in “Tall Paul”.
Volcker, whose height of 200cm made him a towering presence in more ways than one, took the Fed’s helm in 1979 and immediately began tightening monetary policy to the most restrictive levels of the post-war era. The benchmark federal funds rate — the level at which banks borrow cash reserves from each other overnight — rose as high as 20% in 1980 and 1981.
Inflation peaked at 14.8% in March 1980. Wage growth peaked at 9.4% in January 1981. Both fell sharply over the next five years, though interest rates were slower to come down.
While the inflationary conditions of the 1970s were defeated, the campaign came at a cost. US inflation has been low ever since, but unemployment has also been higher.
The jobless rate peaked at 10.8% in November and December of 1982, the highest since the Great Depression. And while unemployment averaged about 5.1% in the roughly three-decade period between the end of the Second World War and the Volcker shock, it has been about 6.2% on average in the four decades since.
Unionisation rates have also been on a steady decline since Volcker. In a 2000 PBS interview, he cited president Ronald Reagan’s fight with the air traffic controllers union in 1981 as a watershed moment, calling it “one of the major factors in turning the tide on the inflationary situation”, which “had a profound effect on the aggressiveness of labour at that time, in the midst of this inflationary problem and other economic problems”.
That period also marked a turning point for many measures of income and wealth inequality, which have become important political issues since the 2008 financial crisis. The post-Volcker era of low inflation has afforded strong protection to savings, and tax cuts for top earners that began under Reagan have increasingly concentrated wealth in fewer hands.
Between 1947 and 1979, the share of income taken home by the top 20% of American households averaged about 41%. That measure began climbing in the early 1980s and reached a record 49% in 2018.
Now, Fed officials themselves are increasingly talking about inequality; wage growth is outpacing mortgage rates for the first time since Richard Nixon occupied the White House, and policy makers are more often heard fretting about the possibility of inflation staying too low than getting too high.
The world facing them in 2019 looks very different from the one Volcker inherited in the 1970s, and the policy regime they’ve put in place — one of low interest rates — is therefore widely expected to prevail at least for the foreseeable future.