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

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

Powell's message was delivered in a concise, direct speech at the Jackson Hole economic symposium on Friday, the year's premier gathering of global central bankers. Stocks tanked in response to Powell's remarks, suggesting investors got the message.

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

Volcker, who died in December 2019, served as Fed chair from 1979 until 1987. His tenure is remembered for one crowning achievement: breaking the back of inflation that plagued the U.S. economy through the 1970s and into the early '80s.

These efforts, however, did not progress in a straight line.

Chairman of the Federal Reserve Board, Paul Volcker, stands with hands on hips and smokes a cigar during a meeting in Washington, 1982.
Chairman of the Federal Reserve Board, Paul Volcker, stands with hands on hips and smokes a cigar during a meeting in Washington, 1982. (Bettmann via Getty Images)

From August '79 through April 1980, Volcker raised interest rates from around 11% to 17.5%. Inflation over this period rose from 11.8% to 14.5%. A pause in inflation pressures in the summer of 1980 prompted Volcker to make an error — the Fed slashed interest rates — that Powell has vowed not to make.

By July 1980, benchmark rates were below at 9%, the lowest in two years. Inflation was trending down but still running north of 12%. Another rate-hiking 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 wouldn't fall back 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 Fed chair. (Source: FRED)
The Fed Funds rate during Paul Volcker's tenure at Fed chair. (Source: FRED)

When Volcker was sworn in as Fed chair, the U.S. economy was in the throes of its second inflationary spike in six years. The "stagflation" fears that have arisen during our current bout with inflation were realized back in the late '70s and early '80s.

Dramatic action was needed from the Fed — but so too were patience and persistence required to finally break inflation.

"History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting," Powell said Friday.

From July of '81 until unemployment's peak in December '82, the unemployment rate in the U.S. rose from 7.2% to 10.8%, a level that would not be seen again until the pandemic-induced downturn, which sent the unemployment rate as high as 14.7% in April 2020.

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

"The successful Volcker disinflation in the early 1980s 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 the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now."

Through much of the summer we saw the stock market rally and bond yields decline as some investors placed bets the Powell Fed would fall short in one key facet of this historical parallel: "lengthy period."

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

And it is this specific doubt Powell seems most eager to push back against.

"In the run-up to Fed Chair Powell’s Jackson Hole Symposium speech, there was a growing sentiment among market participants that the Fed will soon make a dovish pivot as Chair Powell noted at the [July 27] post-FOMC press conference that 'at some point' it would be appropriate to slow the pace of rate tightening," Oxford Economics' Lead U.S. Economist Lydia Boussour wrote in a note on Friday.

John C. Williams, president and chief executive officer of the Federal Reserve Bank of New York, Lael Brainard, vice chair of the Board of Governors of the Federal Reserve, and Jerome Powell, chair of the Federal Reserve, walk in Teton National Park where financial leaders from around the world gathered for the Jackson Hole Economic Symposium outside Jackson, Wyoming, U.S., August 26, 2022. REUTERS/Jim Urquhart

"Given the risk that a premature easing in financial conditions could undermine the Fed's inflation fighting effort and credibility," Boussour added, "Fed Chair Powell leaned against the more dovish narrative and delivered a hawkish message [on Friday] that policymakers 'will keep at it until [they] are confident the job is done.'"

In an interview, Paul Volcker once said: "Inflation is thought of as a cruel, and maybe the cruelest, tax because it hits in a many-sectored way, in an unplanned way, and it hits the people on a fixed income hardest."

Powell's modern echo of this sentiment has been his repeated invocation that the burdens of high inflation fall hardest on those least able to bear them: the poor, the unemployed, the elderly.

"Without price stability, the economy does not work for anyone," Powell said Friday. "Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions."

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

People will lose jobs. Many already have.

Wage gains, so robust in recent years, may slow.

"These are the unfortunate costs of reducing inflation," Powell said. "But a failure to restore price stability would mean far greater pain."

These are the prices the central bank is willing to pay to bring down inflation. A payment the Fed has failed to make in a timely manner before. And one it won't make late again.

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

This article was featured in a Saturday edition of the Morning Brief on August 27, 2022. Get the Morning Brief sent directly to your inbox every Monday to Friday by 6:30 a.m. ET. Subscribe

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