The spirit of Paul Volcker lives on at 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 subsides and remains low.

Powell’s message was delivered in a short, direct speech On Friday at the Jackson Hole Economic Symposium, the major gathering of global central bankers of the year. Stocks fell in response to Powell’s remarks, sending a message to investors.

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

Volker, who died in December 2019, served as Fed chairman from 1979 to 1987. His tenure is remembered for an important achievement: breaking the back of inflation that plagued the American economy in the 1970s and early ’80s.

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

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

From August ’79 to April 1980, Volcker raised interest rates from about 11% to 17.5%. Inflation rose from 11.8% to 14.5% during this period. A pause in inflationary pressures in the summer of 1980 prompted Volker to commit an error—the Fed slashed interest rates—which Powell has vowed not to make.

By July 1980, benchmark rates were below 9%, the lowest in two years. Inflation was trending down but still north of 12%. Another rate-increase cycle began.

By 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 will not fall below 9% until December of that year. It was not until 1985 that the fed funds rate fell below 8%.

Fed funds rate during Paul Volcker's tenure as Fed Chair.  (source: FRED)

Fed funds rate during Paul Volcker’s tenure as Fed Chair. (source: FRED)

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

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

“History shows that the employment cost of moderating inflation is likely to increase with delay, as higher inflation becomes more trapped in wages and pricing,” Powell said Friday.

From July ’81 to the unemployment peak in December ’82, the unemployment rate in the US rose from 7.2% to 10.8%, a level that would not be seen again until the pandemic-induced recession, which sent the unemployment rate higher . 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)

“Volker’s successful dissolution in the early 1980s followed several unsuccessful attempts to reduce inflation over the past 15 years,” Powell said. “A prolonged period of extremely restrictive monetary policy was required to begin the process of preventing high inflation and bringing inflation down to the low and stable levels that were the norm by the spring of last year. Our aim is to avoid that outcome. Resolution now.” working with.”

During most of the summer we saw the stock market rally and bond yields plummeting as some investors bet that the Powell Fed would be short on a key aspect of this historical parallel: “the long term.”

by the end of July, were pricing in the market The Fed will cut interest rates early next year. as it fades Own forecast tips in June The rates will increase by another 100 basis points before the end of this year.

And it’s the specific skeptics to which Powell looks most keen. push back against,

“For Fed Chair Powell’s Jackson Hole symposium speech, there was a growing sentiment among market participants that the Fed would soon make a dovish pivot as noted by Chair Powell. [July 27] Post-FOMC Press Conference Lead US economist Lydia Bussour, Oxford Economics, wrote in a note on Friday that “at some point” it would be appropriate to slow down the pace of rate tightening.

John C. Williams, President and Chief Executive Officer of the Federal Reserve Bank of New York, Lyle Brainard, Deputy Chairman of the Federal Reserve's Board of Governors, and Federal Reserve Chairman Jerome Powell walk in Teton National Park, where financial leaders from around the world Jackson , gathered for the Jackson Hole Economic Symposium outside Wyoming, US, August 26, 2022.  Reuters/Jim Urquhart

John C. Williams, President and Chief Executive Officer of the Federal Reserve Bank of New York, Lyle Brainard, Deputy Chairman of the Federal Reserve’s Board of Governors, and Federal Reserve Chairman Jerome Powell walk in Teton National Park, where financial leaders from around the world Jackson , gathered for the Jackson Hole Economic Symposium outside Wyoming, US, August 26, 2022. Reuters/Jim Urquhart

“Given the risk that a premature easing of financial conditions could undermine the Fed’s inflation-fighting effort and credibility,” Boussour said, “Fed Chair Powell leaned against the more bland narrative and delivered a sharp message. Gave [on Friday] that policy makers will keep it until [they] I am sure the work is done.

In an interview, Paul Volcker once said: “Inflation is regarded as a brutal, and perhaps most brutal, tax because it hits many sectors, in an unplanned way, and it hits people hardest on a fixed income.”

The modern echo of Powell’s sentiment is his repeated call that the burden of high inflation falls least on those who are able to bear them: the poor, the unemployed, the elderly.

“Without price stability, the economy works for no one,” Powell said on Friday. “It will take some time to restore price stability and our tools need to be used to better balance demand and supply. Continuing periods of downward trend development may be required to moderate inflation. In addition, there is a possibility of some moderation in labor market conditions.”

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

People will lose their jobs. several is already,

Salary gains so strong in recent years may be slowing.

“These are the unfortunate costs of reducing inflation,” Powell said. “But a failure to restore price stability will mean far more pain.”

These are the prices the central bank is willing to pay to reduce inflation. A payment the Fed has previously failed to make in a timely manner. And one it won’t be late again.

A lesson learned by a former Fed chairman whose attendance was large in Wyoming this week.

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This article was featured in the Saturday edition of Morning Brief on August 27, 2022. Get the Morning Brief delivered straight to your inbox every Monday through Friday at 6:30 a.m. ET. to subscribe

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