Stephen S. Roach: Poor Jerome Powell

With US inflation close to a 40-year high, the Federal Reserve chair knows what he needs to do. 

Volcker raised US interest rates to unheard-of levels in 1980-81

Using the political cover provided by the 1978 Humphrey-Hawkins Act, which formalized the Fed’s price-stability mandate, and drawing operational support from a shift to targeting the money supply, Volcker increased its benchmark federal funds rate from 10.5% in July 1979 to 17.6% in April 1980.

Volcker then reversed course during an ill-advised but short-lived experiment with credit controls in the spring of 1980, before resuming a monetary-policy tightening that eventually pushed the funds rate to a monthly peak of 19.1% in June 1981. 

Only then did the fever of double-digit inflation break.  

By late 1982, with the US in deep recession, annual headline CPI inflation had slipped below 4%, and the Fed started to reduce the benchmark policy rate. 

Powell’s problem is all the more evident when viewed through the inflation-adjusted lens of real interest rates.

The real federal funds rate has averaged -1.95% (with a stress on the minus sign). This extraordinary monetary accommodation is unmatched in modern times.

I suspect that the federal funds rate will remain below the US inflation rate well into 2023. That would push the Powell average down to -2.25% over the 59 months ending in December 2022.

If the Fed wishes to avoid a replay of the stagflation of the late 1970s and early 1980s, it needs to recognize the extraordinary gulf between Volcker’s 4.4% real interest rate and Powell’s -2.25%

Stephen S. Roach Project Syndicate 25 May 2022

https://www.project-syndicate.org/commentary/jerome-powell-paul-volcker-inflation-interest-rate-contrast-by-stephen-s-roach-2022-05

Volcker: “If I had known what was going to happen, I never would have done it.” 

https://englundmacro.blogspot.com/2022/05/volcker-if-i-had-known-what-was-going.html