Powell Invokes the Volcker Years to Underscore his Commitment to Crushing Inflation

The head of the US central bank has stepped up his commitment to hawkish monetary policy at the Jackson Hole Symposium over the weekend, by invoking the name of his predecessor Paul Volcker.  

Powell said that the Fed plans to continue with interest rate hikes until breakneck inflation in the US is well and truly quelled.  

In his speech delivered at the Jackson Hole symposium, Powell warned that the US economy would experience “pain” amidst efforts by the US Federal Reserve to crush inflation.  

“While higher interest rates, slower growth, and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses,” Powell said on Friday.  

Powell also gave ambivalent praise to the actions of one of his illustrious predecessors as Fed Reserve chair, Paul Volcker, in order to underscore his commitment to crushing breakneck inflation. 

Volcker held the position of Federal Reserve chair from 1979 and 1987, and he is now best remembered for bringing an end to the crippling stagflation that plagued the 1970’s by means of hawkish monetary policy.  

The stagflation of the 1970’s saw the US economy battle both inflation and high levels of unemployment simultaneously – an unprecedented phenomenon that ran contrary to prevailing economic theory.  

In order to bring an end to stagflation, Volcker set about ratcheting interest rates to unprecedented heights almost as soon as he assumed office in August 1979.  

In October of the same year Volcker set the target interest rate at 13.7%, and by April of the following year it had risen to 17.6%. Volcker would eventually lift the Fed’s target rate to a peak of around 20% in 1981.  

This severe tightening of monetary policy had the effect of throttling economic activity and triggering a spate of recessions. The Fed’s decisions caused real pain for Americans, with the US jobless rate peaking at 10.8% in December 1982.  

The rate hikes also succeeded, however, in putting the malignant genie of excess inflation back into the bottle. US inflation fell to 3.4% by the time Volcker left office, as compared to a peak of 9.8% in 1981.  

While causing considerable short-term pain, Volcker’s actions set the US economy on course for persistent low interest rates over the following decades, making the prosperity of the Reagan and Clinton eras a possibility.  

While Volcker’s policies are generally praised in retrospect, during his speech on Friday Powell pointed out that his predecessor’s success arrived after the misstep of letting his foot off the brakes too early.  

After an initial phase of tightening, Volcker opted to loosen interest rates in April 1980. This reversed some of the gains made beforehand, forcing the Fed to reimpose monetary tightening and trigger an even more severe recession in July 1981.  

“The successful Volcker disinflation in the early 1980’s followed multiple failed attempts to lower inflation over the previous 15 years,” Powell said.  

“A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start of the process of getting inflation down to the low and stable levels that were the norm until the spring of last year.” 

By criticising Volcker for failing to tightening monetary policy sufficiently, Powell is sending an unmistakably signal to markets that he plans to keep interest rates high until inflation is well and truly contained.  

This will have the effecting of stymieing economic activity and undermining risk assets, while also boosting the value of the greenback by maintaining high yields on dollar-denominated assets.