The spirit of Paul Volcker lives on in Jackson Hole: Morning Brief

Federal Reserve Chairman Jerome Powell sent a clear message to financial markets this week: Interest rates will remain high until inflation comes down and stays low.

Powell’s message was delivered in a terse, straight-talking speech at the Jackson Hole Economic Symposium on Friday, the world’s top central bank meeting of the year. Stocks fell in response to Powell’s remarks, suggesting investors got the message.

But Powell didn’t approach the podium alone at Jackson Lake Lodge on Friday — the Fed chair brought with him the spirit and lessons of the late Paul Volcker.

Volcker, who died in December 2019, served as Fed chairman from 1979 to 1987. His tenure is remembered for one crowning achievement: breaking the inflation that plagued the US economy from the 1970s to the early 80’s.

However, these efforts did not proceed in a straight line.

Federal Reserve Board Chairman Paul Volcker stands with his hands on his hips and smokes a cigar during a meeting in Washington, D.C., in 1982.

From August ’79 to April 1980, Volcker raised interest rates from about 11% to 17.5%. Inflation during this period increased from 11.8% to 14.5%. A lull in inflationary pressures in the summer of 1980 prompted Volcker to make a mistake—the Fed cut interest rates—that Powell vowed not to make.

By July 1980, benchmark interest rates were below 9%, the lowest in two years. Inflation has been trending downward but is still running north of 12%. Another round of price hikes has begun.

In the winter of ’82, inflation was reliably below 10% for the first time in three years. The Fed funds rate was still north of 14%. Benchmark rates would not fall below 9% until December of that year. It wasn’t until 1985 that the Fed funds rate fell below 8%.

The Fed Funds rate during Paul Volcker's tenure at the Fed.  (Source: FRED)

The Fed Funds rate during Paul Volcker’s tenure at the Fed. (Source: FRED)

When Volcker was sworn in as Fed chairman, the US economy was in the midst of its second inflationary boom in six years. The fears of “stagflation” that arose during our current period of inflation were realized in the late 70’s and early 80’s.

Dramatic action was needed by the Fed – but it also needed patience and persistence to finally break inflation.

“History shows that the employment cost of deflation is likely to rise overdue as high inflation becomes more entrenched in determining wages and prices,” Powell said on Friday.

From July ’81 to the unemployment peak in December ’82, the US unemployment rate rose from 7.2% to 10.8%, a level that would not be seen again until the pandemic-induced recession, the which drove the unemployment rate as high as 14.7% in April 2020.

The unemployment rate peaked in 1982 during Paul Volcker's tenure as Fed chairman.  (Source: FRED)

The unemployment rate peaked in 1982 during Paul Volcker’s tenure as Fed chairman. (Source: FRED)

“Volcker’s successful deflation in the early 1980s followed multiple failed deflation attempts over the previous 15 years,” Powell said. “It eventually took a long period of very tight monetary policy to arrest high inflation and begin the process of reducing inflation to the low and stable levels that had been the norm until the spring of last year. Our aim is to avoid this outcome by acting decisively now.”

For most of the summer we saw the stock market rally and bond yields decline as some investors placed bets that the Powell Fed would fall short on a key aspect of this historical parallel: the “long run.”

By late July, markets were pricing in a Fed rate cut as early as next year. This as the Fed’s own forecasts in June suggested interest rates would rise by another 100 basis points before the end of this year.

And it is this particular doubt that Powell seems most willing to make push back against.

“During Fed Chairman Powell’s speech at the Jackson Hole Symposium, there was a growing sentiment among market participants that the Fed will soon be on an adventure, as Chairman Powell noted in the [July 27] After the FOMC press conference that “at some point” it would be appropriate to slow the pace of rate tightening,” Oxford Economics chief economist Lydia Boussour wrote in a note on Friday.

John C. Williams, president and CEO of the Federal Reserve Bank of New York, Lael Brainard, vice chairman of the Federal Reserve Board, and Jerome Powell, chairman of the Federal Reserve, walk in Teton National Park where economic leaders from around the people gather for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart

John C. Williams, president and CEO of the Federal Reserve Bank of New York, Lael Brainard, vice chairman of the Federal Reserve Board, and Jerome Powell, chairman of the Federal Reserve, walk in Teton National Park where economic leaders from around the people gather for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart

“Given the risk that a premature easing of financial conditions could undermine the Fed’s effort and credibility to fight inflation,” Boussour added, “Fed Chairman Powell relied on the most apt narrative and delivered an aggressive message. [on Friday] that policymakers “will keep it up [they] they are confident that the job is done.”

In an interview, Paul Volcker once said: “Inflation is seen as a harsh, and perhaps the harshest, tax because it hits many sectors, in an unplanned way, and it hits people on fixed incomes the hardest. “

Powell’s contemporary echo of this sentiment was his repeated plea that the burdens of high inflation fall hardest on those least able to bear it: the poor, the unemployed, the elderly.

“Without price stability, the economy doesn’t work for anybody,” Powell said Friday. “Restoring price stability will take some time and requires aggressive use of our tools to bring demand and supply into better balance. Declining inflation is likely to require a sustained period of below-trend growth. Furthermore, very likely there will be some softening of labor market conditions.”

To reduce inflation, in other words, the Fed expects the economy to slow down.

People will lose jobs. Many already have.

Wage gains, so strong in recent years, may be slowing.

“That’s the unfortunate cost of deflation,” Powell said. “But a failure to restore price stability would mean much more pain.”

These are the prices the central bank is willing to pay to reduce inflation. A payment the Fed had not made on time in the past. And one that won’t be late again.

A lesson learned by a former Fed chair whose presence was large this week in Wyoming.

This article appeared in a Saturday edition of the Morning Brief on 27 August 2022. Get the Morning Brief direct to your inbox every Monday to Friday by 6:30am. ET. Sign up

Click here for the latest financial news and financial indicators to help you with your investment decisions

Read the latest financial and business news from Yahoo Finance

Download the Yahoo Finance app for apple the Android

Follow Yahoo Finance at Twitter, Facebook, Instagram, Flipboard, LinkedInand YouTube

Leave a Reply

Your email address will not be published. Required fields are marked *