I knew Paul Volcker. Jay Powell is no Paul Volcker.
I never met Arthur Burns — Volcker’s predecessor, but one, as Federal Reserve chairman — who preferred puffing on a pipe to cigars. But I think I’ve read enough about Burns to suggest plausibly that the current Fed chair, Jay Powell, has more in common with him than with Volcker. This is unfortunate, and potentially disastrous for the US economy.
On Wednesday, Powell sought to re-establish his and the Federal Reserve’s credibility with an increase of 75 basis points in the federal funds rate — the biggest rate hike since 1994. The initial media and market reactions were quite positive. I was, and am not, convinced.
It’s not just that the Powell Fed has a track record for blinking under political pressure — he already had that in common with Burns, long before anyone had heard the word “Covid.” Think back four years, to 2018, the year of Powell’s appointment by President Donald Trump.
The Fed had embarked on a path of monetary-policy normalization after the protracted period of stagnation that followed the global financial crisis of 2008-09. The Fed funds target rate, having been stuck at between 0% and 0.25%, was first raised by a quarter point (25 bps) in December 2015. Beginning a year later, immediately after Trump’s election, then Fed Chair Janet Yellen began climbing a stairway to monetary normality, raising the target rate in 0.25% steps at roughly regular intervals. By the end of 2017, the upper end of the target was 1.5%.
Powell, who became chairman in February 2018, kept on climbing, reaching 2.5% just before Christmas of that year. At the same time, the Fed’s balance sheet began shrinking. In February 2019, it fell below $4 trillion for the first time since December 2013.
Trump repeatedly attacked Powell for this monetary tightening, comparing him to President Xi Jinping of China. “We have a very strong dollar and a very weak Fed,” he tweeted on Aug. 23. “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”
There was more, much more. In the space of less than two years after he appointed Powell, Trump tweeted about the Fed 100 times. The climax came on Dec. 24, 2018, after a three-month stock market selloff: “The only problem our economy has is the Fed,” tweeted Trump. “They don’t have a feel for the Market, they don’t understand necessary Trade Wars or Strong Dollars or even Democrat Shutdowns over Borders. The Fed is like a powerful golfer who can’t score because he has no touch — he can’t putt!”
It worked. The Fed blinked. The rate hikes stopped. On Aug. 1, 2019, the Fed cut by 25 bps, the first of three cuts before the pandemic struck. That fall, the balance-sheet contraction ended, with new Fed purchases of short-term bonds that Powell insisted was “not QE” — for quantitative easing.
Five decades earlier, President Richard Nixon did not have Twitter at his disposal. But his view of Fed independence was not dissimilar to Trump’s, as Burton Abrams has shown. No sooner had Burns’s Fed nomination been announced, in October 1969, than Nixon made clear just what he thought of “the myth of the autonomous Fed.”
On Oct. 10, 1971, Nixon told Burns that any worries about the “liquidity problem” were “just bullshit.” In the president’s words, “I don’t want to go out of town fast,” an allusion to his prospects for re-election in 1972. The last thing he wanted was “a recession next year.”
A month later, the two men spoke on the phone. “Look, I wanted you to know that we are reducing the discount rate today,” Burns told Nixon, relaying the news that the Fed had reduced the discount rate (then the main policy rate) by 25 bps to 4.75%.
A month later, Burns reported another cut, to 4.5%. “Good, good, good,” replied Nixon. “Great. Great. You can lead ‘em,” meaning the Federal Open Markets Committee. “You always have, now. Just kick ’em in the rump a little.”
But Nixon was rarely satisfied for long. On Valentine’s Day, 1972, he complained to George Shultz (who was then director of the Office of Management and Budget) that Burns was seeking justifications for “not raising the money supply.” And he added: “War is going to be declared [on the Fed] if he doesn’t come around some.”
As in 2018, but with much better political timing, leaning on the Fed worked. Nixon swept to re-election on a booming economy. The price Americans paid came later in a surge of inflation, which the 90-day price and wage controls imposed in August 1971 and the subsequent “Price Commission” and price “freeze” of June 1973 could only partly suppress. The money supply (M2) grew at double-digit rates in the election year. Velocity (often overlooked) went up in 1973. Inflation peaked at 12% in the last quarter of 1974 — by which time, of course, Watergate had swept Nixon “out of town.”
Back in early March last year, along with just a handful of economists (notably former Treasury Secretary Larry Summers and former International Monetary Fund chief economist Olivier Blanchard), I warned of the risk that US inflation would overshoot, as a consequence of fiscal overkill (the $1.9 trillion American Rescue Plan of March 2021), ongoing supply disruptions due to the Covid-19 pandemic, and the disastrously slow monetary-policy response by Powell and his colleagues. Their mistake was to think that they could run the US economy hot and explicitly switch to an average inflation target without letting slip the anchor that had held down inflation expectations for two decades.
Even now, with inflation above 8% and the Fed scrambling to catch up with expectations, I still hear complacent arguments about the transitory nature of the problem, despite the evidence that the monetary-policy mistake of early 2021 was even bigger than those of the 1960s and 1970s. The argument is that pretty much every component of inflation except energy is now heading downward, while warehouses are overflowing with inventories.
Sure, we can reasonably expect inflation to reach a peak at some point this year. But the lesson of history is that it’s unlikely to come all the way back down to below 3% next year, below 2.5% in 2024, and then 2% thereafter. Yet that’s exactly what the Fed’s projections anticipate — as do those of the Congressional Budget Office and the International Monetary Fund.
The thing the economists’ models omit are the unforeseeable events that have a way of occurring in this thing we call “history.” Despite the fulfillment of my prediction last year that the Fed would have a real problem with inflation expectations if there was a war, people still seem to be assuming that global economic life will return to “normal” (meaning 2019) starting very soon.
Team Transitory thinks that not only inflation is transitory. They think the pandemic and the war in Ukraine are transitory, too. But the striking thing about all three is precisely that they just keep going, in defiance of Americans’ attention-deficit disorder.
Has China’s “Zero Covid” policy miraculously prevailed over the omicron variants of the virus? Only in Beijing’s propaganda. In both the capital and Shanghai, they are back to mass testing and restrictions.
Is an end to the war in Ukraine imminent? Only in the imaginings of those who have insisted all along that Ukraine would win it. On the bloody battlefields of the Donbas, Russia is gaining ground in a brutal war of attrition.
The 1970s are here to remind us that one damned disaster leads to another — and sometimes more than one — and that’s what makes it much harder than it looks in an economics textbook for a central bank to recover from a big monetary-policy mistake.
The late 1960s was the last time US inflation expectations became unanchored. Despite staying relatively contained in the first half of that decade, both headline and core CPI had climbed to 6% by the decade’s end. In addition to Fed errors, the costs of the Vietnam War and President Lyndon Johnson’s Great Society welfare programs were to blame. True, inflation peaked in early 1970 and then came back down to below 3% in August 1972. But that did not mean it was transitory.
Now long forgotten, a sustained rise in food prices was soon driving inflation back up, even before the oil-price shock that followed the Arab-Israeli War of October 1973. That year, 57% of the increase in headline consumer price inflation could be attributed to food; only about 8.2% was attributable to energy.
A combination of factors led to strong food-price inflation — notably failed harvests in the Soviet Union in 1971 and 1972, as well as US government controls on how much land American farmers could use to grow crops. The oil embargo imposed by the Organization of Arab Petroleum Exporting Countries in October 1973 was the coup de grace, greatly amplifying the inflationary problem created by the laxity of the Burns Fed.
Today, in a similar way, the war in Ukraine is battering the world economy with a food- and energy-price shock. Smart guys and central bankers who say we should ignore the prices of those things — to focus on “core” inflation — overlook that consumers do just the opposite: They ignore core and focus on groceries and gas. And doing so right now is precisely what causes people to expect higher inflation in the future.
The result will be stagflationary, as it was in 1974. Higher prices for inelastic goods will force consumers to cut back on other purchases, hampering real demand growth. That’s why there was a recession in 1974-75, which in turn brought down inflation to 5% by the end of 1976. But that didn’t mean inflation was transitory, much less mean-reverting. Another spate of geopolitical instability — culminating in 1979 with the Iranian Revolution and the Soviet invasion of Afghanistan — drove inflation up yet again. It peaked at just below 15% in April 1980.
Judging by the absolute numbers, the Fed’s current tightening path looks closer to the failed tightening of the mid-1970s than to what had to be done later to achieve a “regime change” to disinflation. The Fed hiked by 350 bps in 1973-74, more than seems currently to be envisaged (150 bps since March, with another 175 bps promised in the Fed’s revised Summary of Economic Projections). The 1977-80 tightening, by contrast, amounted to 775 bps. Moreover, in real terms, the Fed was never this far behind the curve in the 70s.
As the late, great historian of the Fed Allan Meltzer showed, the Fed raised rates plenty of times during the Great Inflation. Between the “big error” he identified (the rate cuts of August 1968) and the big solution (the appointment of Volcker 11 years later), the Fed hiked rates at 21 of its 36 meetings. In four cases, however, the Fed paused or even lowered rates well before inflation was defeated.
The hiking cycle that began on Dec. 18, 1968, concluded four months later with a 50-bps hike, for a total of 75 basis points. The Fed then paused for nearly 20 months, before easing in November 1970, with inflation at 5.6%. Similarly, the 25-bps hike of July 1971 lasted a mere four months and was reversed in November of that year, thanks in part to Nixon’s browbeating of Burns.
A more committed effort began in January 1973, when the Fed hiked by 50 bps in the face of mounting inflation. It continued hiking for the next 15 months, with a final 50-bps hike in April 1974, bringing the discount rate to 8%. However, a series of cuts began in December 1974, when inflation was running at 12.1%. Within two years, the Fed rate was back to 5.25% — only 75 bps above the start of the previous hiking cycle.
Following these three abortive attempts, the Fed embarked on its most sustained hiking cycle in August 1977, two years before Volcker was appointed. Over the next 30 months, the Fed raised 14 times, bringing the discount rate to a postwar high of 13% in February 1980. In Meltzer’s words, “the simple explanation” for why inflation persisted during the 1970s is that the Fed failed to sustain efforts to end it.
The Jimmy Carter administration appointed G. William Miller to replace Burns after his term was up in March 1978. Under Miller, according to Meltzer, the FOMC understood inflation as a monetary problem “much more than in the past.” Yet the problem only worsened. Miller’s tenure was brief. After 17 months he was appointed Treasury secretary.
With Volcker at the helm, the Fed raised the discount rate three times in just over two months. In an unusual Saturday night news conference on Oct. 6, 1979, he announced his intention to slay the inflationary dragon with a 1% hike and a package of monetary measures. In February 1980 the Fed hiked by a further 100 bps, the final move in a 775-bps hiking cycle.
Yet even Big Paul was capable of blinking. By the April 22 meeting, the Fed faced not only high inflation but also rising unemployment and rapidly declining output — in short, a recession.
The Fed’s subsequent rate cuts appeared to confirm the suspicions of skeptics that it had once again abandoned its anti-inflationary policy. In total, the Fed cut the discount rate three times for a total of 300 bps over two months, beginning at the end of May 1980. By August, contrary to the Fed staff’s projections, the recession was over. That allowed Volcker to return to the inflation-fighting fray by raising rates by 100 bps in September 1980.
True, the September and October decisions of the board were carried by 8-4 votes, but the dissenters at both meetings were arguing for even tighter policy. The board executed three 100-bps hikes for a total of 300 bps over three months, lifting the discount rate back to 13% before the year’s end. The Fed hiked once more in May 1981 by 100 bps.
Monetary policy during the great inflation was not inert; it was just ineffectual — not so much a stairway as a game of snakes and ladders. At first in the 1960s, in Meltzer’s words, Fed staff and some board members “denied for several years that inflation had either begun or increased. They did not deny the numbers they saw … [but] gave special explanations … in effect claiming that the rise in the price level resulted from one-time, transitory changes that they did not expect to repeat.” (My emphasis on “transitory.”)
Then, when the Fed did act, it failed to follow through. In April 1969, November 1971, April 1974 and February 1980, the rate hikes stopped not because the Fed had won its fight against inflation, but because GDP and employment were going down. In each case (apart from in 1971), hiking ceased during or shortly before a recession, even when inflation was clearly not under control. To quote Meltzer again, bringing down inflation expectations ultimately necessitated “more restriction than anyone on the FOMC had anticipated.”
Will the Powell Fed be more like the Burns Fed or the Volcker Fed? We won’t know for sure until it confronts something much uglier than the current equity bear market. All we do know is that Powell has blinked before now — and in response to a 19% stock market correction in late 2018 and a president with a Twitter habit. Trump’s successor is not much of tweeter. But the market is already down further.
I knew Paul Volcker. I also remember the 1970s. For younger viewers, it’s going to come as a shock to see That ‘70s Show for the first time. Spoiler alert: Not much about that decade was transitory. Try listening to the interminable guitar solos on “Stairway to Heaven” or “Free Bird” to get in the mood.
More From Bloomberg Opinion:
The Fed Has a Narrow Path Between Inflation and Recession: The Editors
The Fed Needs to Get Real About Interest Rates: Bill Dudley
• Have a Little Sympathy for the Federal Reserve: Clive Crook
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Niall Ferguson is a Bloomberg Opinion columnist. The Milbank Family Senior Fellow at the Hoover Institution at Stanford University and the founder of Greenmantle, an advisory firm, he is author, most recently, of “Doom: The Politics of Catastrophe.”
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