For Jerome H. Powell, chairman of the Federal Reserve, Paul Volcker is more than a predecessor. He is one of his professional heroes of him.
“I knew Paul Volcker,” Mr. Powell said during his testimony in Congress this month. “I think he was one of the great civil servants of the time, the greatest economic civil servant of the time.”
Now, if rapid inflation proves more stubborn than politicians expect, Mr. Powell may find himself in a situation where he has to follow Mr. Volcker’s example. The towering former Fed chairman is best remembered for leading an aggressive – and painful – assault on the rapid rise in prices that plagued America in the early 1980s.
Mr. Volcker’s Fed launched policies that pushed a key short-term interest rate to nearly 20% and pushed unemployment to nearly 11% in 1981. Car dealers sent Fed keys from unsold vehicles, builders sent two-by-four from unbuilt vehicles to homes and farmers drove tractors around the Fed building in Washington in protest. But the approach worked, eliminating the rapid price inflation that had worsened in the 1970s.
This month, Mr. Powell was asked if the Fed was ready to do whatever it takes to control inflation, even if it meant hurting growth, as Mr. Volcker did.
“I hope history will record that the answer to your question is yes,” replied the Fed chairman.
Few, if any, economists think the 2022 Fed will have to repeat Volcker’s policies to the same extent, in part because the central bank is acting much faster. The Fed is expected to start raising interest rates near zero at this week’s meeting, and is likely to signal that it plans to make a number of moves this year as it seeks to cool the economy and control inflation.
Price hikes had been high for more than a decade when Mr. Volcker became president in 1979, making them a part of everyday life. Buyers were expecting prices to rise, companies knew it, and both acted accordingly.
This time around, inflation has been anemic for years (until recently) and most consumers and investors still expect costs to return to lower levels in a short time, according to surveys and market data. While inflation has been rapid over the past year, it is a relatively short period and it may not fuel the same kind of expectations for higher prices that plagued the Volcker era.
And while today’s inflation is taking a bite off household balance sheets, it’s slower than in previous periods: while it climbed to 7.9 percent in February, the fastest pace since 1982, it’s still well below the peak. 14.6 percent in 1980. Economists expect price gains to begin to moderate this year rather than soar to such high levels.
But in other ways, the background that Mr. Powell faces is starting to look eerily similar to what Mr. Volcker faced.
Understanding inflation in the United States
Wages are rising rapidly, and employers report raising prices to cover their larger labor bills, posing the possibility of a more subdued version of the wage-price spiral that helped keep inflation high during Mr. Volcker.
Oil prices are rising as Russia declares war on Ukraine, mirroring the oil price shocks that shook the economy in the years before Volcker’s ascension to the chair. The 1973-74 Arab oil embargo and the 1979 Iranian revolution reduced supply and drastically increased pump prices.
And geopolitical instability is fueling uncertainty about what will happen next, just as it did in the 1970s, when the Vietnam War raged.
“This is the appropriate historical reference for what we are trying not to replicate,” Mr. Powell said of the 1970s during separate remarks to Congress this month. “One of the things that is different now is that central banks, including the Fed, are openly taking responsibility for inflation.”
When inflation was taking off in the 1960s and 1970s, Fed officials were arguing over how much to raise rates because they feared it would damage the job market too much. Many economic historians now think their reluctance to act faster has allowed those price gains to get stuck until they demanded a more draconian response.
“The one big difference – huge difference, consequential difference – is that the Fed and the country have lived through the 1970s,” Donald Kohn, former Fed Vice President, said in an interview. “I think the Fed is determined to do not let us arrive “.
The inflation challenge facing Mr. Powell, who has been renamed by President Biden for a second term as president and awaits confirmation from the Senate, is the latest economic test he has had to contend with during his term.
Powell, 69, began his first four years as Fed chairman in early 2018. By Christmas, the central bank’s campaign of steady rate hikes to fend off inflation collided with the president’s trade war. Donald J. Trump to bring down the markets.
In 2019, Trump publicly pushed for lower rates and approached Mr. Powell – whom the president had chosen to lead the central bank – in interviews and on Twitter, calling him a “bonehead”, an “enemy” and a player of golf that could not putt.
Then came the start of the pandemic in 2020, and Mr. Powell and his colleagues pushed the boundaries and overturned the rules to save the markets and the economy. They averted a financial crisis, but 2021 brought with it a new challenge: rapid inflation.
Now, critics are wondering if the monetary aid Powell’s Fed has released to protect the pandemic-stricken economy – by lowering rates close to zero and buying trillions of dollars in government bonds – combined with massive fiscal stimulus for overload the demand and unleash an inflationary genius that may prove difficult to trap.
The Fed has already begun to remove some of that support, halting bond purchases and communicating plans to raise interest rates by a quarter of a point this month and steadily throughout the rest of the year. Mortgage rates have already started to rise in anticipation of such actions.
But some wonder whether the Fed, which wanted to see full employment return before slashing its support, was too slow to react to changing conditions.
This moment “represents a decade of economic experience in the late 1960s and 1970s, compressed into one year,” said Lawrence H. Summers, a former Treasury Secretary who spent the past year warning that inflation would be took off when the government overstimulated the economy.
Frequently asked questions about inflation
“The question is, is this the time for the Fed’s Paul Volcker, or is this the time for the Fed’s Arthur Burns?” He said.
Mr. Burns preceded Mr. Volcker as Fed chairman and arrived late to react to rapid inflation, fearing slowing the labor market and damaging Republicans politically. Mr. Summers warned that today’s situation so far looked more Burns than Volcker, because the Fed spent 2021 only slowly adjusting to the reality of inflation and is now only planning on constant policy adjustment.
While White House and Fed officials expected inflation to fade away last year, optimistically labeling it as “transient,” their hopes were dashed as rapid consumer demand for diapers, cars and other goods collided. with supply chains limited by the pandemic. The rise in prices has accelerated rather than slowed down.
“Transitional” has now become a dirty word in political circles. While officials continue to anticipate moderation in inflation, they more clearly recognize how uncertain that is.
“We never froze our economy and then thawed it,” said Megan Greene, a senior fellow at a Harvard Kennedy School center and chief global economist for the Kroll Institute. “And we haven’t had a war in continental Europe for a while.”
War in Ukraine threatens to keep costs high for longer. Gas prices have already risen, raising headline inflation as consumers pay more at the pump. Disruptions to supply chains – and shortages of Russian and Ukrainian exports such as neon, palladium and wheat – could reduce automobile and food production and freight transport, exacerbating the global shortage.
Now, new coronavirus restrictions in Shanghai and Shenzhen, China, a major technology manufacturing hub and port city, are increasing the risk of supply chains remaining agitated in the coming months. These external shocks come as price pressures have already begun to spread to categories like rent, another development that could make inflation last.
Whether these factors will keep inflation drastically higher is unclear, but Fed officials will watch with caution.
If the Fed raises interest rates to painful levels to cool the economy and put a brake on prices, it could bring down financial markets, wiping out equity and real estate wealth. It could also slow wage increases and kick people out of jobs as companies downsize, reducing investment and hiring.
But even the Fed’s inaction – or lack of action – would carry risks. The high prices that affect consumers’ purchasing power year after year would make it difficult for households and businesses to plan for the future. It could particularly hurt people who are unemployed and living on savings, or the poor, who devote a large chunk of their budget to necessities and have less room to cut if costs get out of control.
Mr. Volcker, Mr. Powell’s predecessor, one of his professional idols and, potentially, if things go wrong, his inspirational muse, passed away in 2019. But he had thoughts about compromise.
Maintaining the confidence that a dollar will be able to buy tomorrow what it can today “is a fundamental responsibility of monetary policy,” Volcker wrote in his 2018 memoir. “Once lost, the consequences can be severe and stability. difficult to restore “.