When Did We Get “Tough Love” From the Federal Reserve?
Demonstrating Russia’s current plight, this graph so perfectly illustrates stagflation:
When GDP sinks and inflation increases, the stagflation that results is tough to cure. If monetary authorities target inflation with tight monetary policy, then interest rates go up and further harm the GDP. On the other hand, by trying to boost the GDP with lower interest rates, inflation usually gets worse.
When the US had the same dilemma in 1979, the newly appointed Fed Chair, Paul Volcker, decided tight money was the answer. Selected by Jimmy Carter, Volcker wanted to send the message that inflation would be licked. Only then could he reverse an inflationary spiral in which labor wants increasingly higher wages and businesses keep raising their prices.
Doesn’t the shape of the US stagflation graph, below, look remarkably similar to the Russian one, above?
Showing admirable fortitude, even during the double dip recessions of 1980 and 1982, Volcker held steady. Sort of like a parent displaying “tough love,” he created lots of pain when he slowed the growth of the money supply and diminished economic activity. But it worked. Between 1982 and 1984, growth soared and inflation remained low.
You can see Volcker’s impact on interest rates (below). The discount rate touched 14% in 1981 and the prime hit historical highs at 21.5%.
Today the discount rate is .75% and the prime rate is 3.25%.
Sources and Resources: The Quartz overview of Russian stagflation took me back to my description the late 1970s in the US and in Econ 101 1/2. Correspondingly, my stats for the second graph came from the 2014 Economic Report of the President and my FRED graphs from the St. Louis Fed.