Tuesday 261020
Mostly summarized from Gregory Mankiw’s Principles of Economics, 5th Ed.
PART 10 Money and Prices in the Long Run
Chapter 29 of 36 Money Growth and Inflation
Section 15 of 27
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Mostly from article: Volcker’s Handling of the Great Inflation Taught Us Much.
William Poole President and CEO, Federal Reserve Bank of St. Louis, January 2005
On October 6, 1979, Fed Chairman Paul Volcker took dramatic steps, greatly increasing interest rates, to rein in the runaway inflation that had been sapping the strength of our economy since the mid-1960s.
Volcker was Chairman of the Federal Reserve System (the Fed) from August 1979 to August 1987.
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Without his bold change in monetary policy and his determination to stick with it through several painful recession years, the U.S. economy would have continued its downward spiral.
By reversing the misguided policies of his predecessors, Volcker set the table for the long economic expansions of the 1980s and 1990s.
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How bad was the period of the Great Inflation?
A mere one percent in 1965, the inflation rate hit 14 percent by 1980.
Unemployment hit 9.7 percent in 1982, up from a low of 3.5 percent annual average in 1969.
The high inflation and high unemployment was labeled “stagflation.”
The stock market was in the dumps.
Oil prices jumped off the charts.
Presidents Richard Nixon and Jimmy Carter became desperate enough to tinker with price controls, the results being disastrous.
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In 1979 Volcker began increasing interest rates, see Figure A.
As interest rates are increased, consumers tend to save as interest earned from savings are higher.
Higher interest rates also mean there is less borrowing for investment in plants and equipment and other business assets.
Because increased interest rates result in less consumer spending and less business investment, the economy slows and inflation decreases.
The prime lending rate reached 19% in July 1981.
The unemployment rate reached 11% in December 1982.
The dollar depreciated significantly in world foreign exchange markets. Volcker’s tough medicine led to two recessions before prices finally stabilized.
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We’ve learned a lot from that period.
Bad economic advice, much of it from economists, contributed greatly to policy mistakes in the pre-Volcker days.
Keynesian economics had been in vogue by then for decades.
This school argued the government could tax and spend its way to full employment.
Inflation was acceptable if it put more people to work.
Thankfully, such thinking has been discredited today.
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The Fed also learned to be effective it must have the confidence of the markets and the public.
During the 1960s and early 1970s various Fed chairmen made rumblings about fighting inflation, but they always backed down when the complaints about the higher interest rates grew loud.
For example Fed Chairman William McChesney Martin was no match for President Lyndon Johnson, who depended on low interest rates to finance the Vietnam War and his Great Society.
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Because the markets observed the Fed’s lack of fortitude, they had no expectations the Fed would conquer inflation.
It is extremely difficult to bring inflation down if inflation expectations don’t come down first.
Not until Volcker showed the Fed could take the heat did the markets believe the Fed was serious this time.
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Another lesson from the Great Inflation is the Fed can achieve its goal of maximum sustainable employment only if it is successful in achieving price stability.
The idea we can let down our guard on inflation to increase employment is unwise in the long term because higher inflation eventually destroys rather than creates jobs.
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another lesson
betsu no ressun
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To CGPT: Add line showing U.S. unemployment rate to Figure A.
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