Could Inflation Prompt Powell to Act Like Volcker?

To Jerome H. Powell, the chair of the Federal Reserve, Paul Volcker is more than a predecessor. He is one of his professional heroes.

“I knew Paul Volcker,” Mr. Powell said during congressional testimony this month. “I think he was one of the great public servants of the era — the greatest economic public servant of the era.”

Now, if rapid inflation proves more stubborn than policymakers expect, Mr. Powell could find himself in a situation in which he must follow Mr. Volcker’s lead. The towering former Fed chair is best remembered for waging an aggressive — and painful — assault on the swift price increases that plagued America in the early 1980s.

Mr. Volcker’s Fed rolled out policies that pushed a key short-term interest rate to nearly 20 percent and sent unemployment soaring to nearly 11 percent in 1981. Car dealers mailed the Fed keys from unsold vehicles, builders sent two-by-fours from unbuilt houses and farmers drove tractors around the Fed building in Washington in protest. But the approach worked, killing off the rapid price inflation that had festered throughout the 1970s.

Mr. Powell was asked this month if the Fed was prepared to do whatever it took to control inflation — even if it meant harming growth, as Mr. Volcker did.

“I hope that history will record that the answer to your question is yes,” the Fed chair replied.

Few, if any, economists think that the 2022 Fed will need to repeat Mr. Volcker’s policies to the same degree, in part because the central bank is taking action much more quickly. The Fed is expected to begin raising interest rates from near zero at its meeting this week, and is likely to signal that it expects to make a series of moves this year as it tries to cool down the economy and control inflation.

Price increases had run high for more than a decade by the time Mr. Volcker became chair in 1979, making them a part of everyday lives. Shoppers expected prices to go up, businesses knew that, and both acted accordingly.

This time, inflation has been anemic for years (until recently), and most consumers and investors still expect costs to return to lower levels before long, survey and market data show. While inflation has been rapid for the past year, that is a comparatively short period and one that may not fuel the same kind of expectations for higher prices that bedeviled Mr. Volcker’s era.

And while today’s inflation is taking a bite out of household budgets, it is slower than in previous periods: While it rose to 7.9 percent in February, the fastest pace since 1982, it is still well below a peak of 14.6 percent in 1980. Economists expect price gains to begin moderating this year, rather than climbing to such high levels.

But in other ways, the backdrop Mr. Powell faces is beginning to look eerily similar to the one Mr. Volcker confronted.

Wages are increasing rapidly, and employers report raising prices to cover their bigger labor bills, posing the possibility of a more muted version of the wage-price spiral that helped keep inflation high during Mr. Volcker’s years.

Oil prices are climbing as Russia wages war on Ukraine, mirroring oil price shocks that rocked the economy in the years before Mr. Volcker’s ascent to the chair. The Arab oil embargo of 1973-74 and the Iranian revolution of 1979 both curtailed supply and sharply pushed up pump prices.

And geopolitical instability is fueling uncertainty about what will happen next, much as it did in the 1970s, when war raged in Vietnam.

“That’s the proper historical reference for what we’re trying not to replicate,” Mr. Powell said of the 1970s during separate remarks to Congress this month. “One of the things that is different now is that central banks — including the Fed — very squarely take responsibility for inflation.”

When inflation was taking off in the 1960s and 1970s, Fed officials bickered about how high to raise rates as they worried about hurting the labor market too much. Many economic historians now think that their reluctance to act more quickly allowed those price gains to become locked in until they required a more draconian response.

“The one really big difference — huge difference, consequential difference — is that the Fed, and the country, lived through the 1970s,” Donald Kohn, a former Fed vice chair, said in an interview. “I think the Fed is determined not to let us get there.”

The inflation challenge facing Mr. Powell, who was renominated by President Biden for a second term as chair and is awaiting Senate confirmation, is the latest economic test that he has had to contend with during his tenure.

Mr. Powell, 69, began his first four years as Fed chair in early 2018. By that Christmas, the central bank’s campaign of steady rate increases intended to fend off inflation had collided with President Donald J. Trump’s trade war to send markets plummeting.

In 2019, Mr. Trump publicly pushed for lower rates and accosted Mr. Powell — whom the president had chosen to lead the central bank — in interviews and on Twitter, calling him a “bonehead,” an “enemy” and a golfer who could not putt.

Then came the onset of the pandemic in 2020, and Mr. Powell and his colleagues crossed red lines and upended norms to rescue markets and the economy. They averted a financial crisis, but 2021 brought with it a new challenge: rapid inflation.

Now, critics are questioning whether the monetary help that Mr. Powell’s Fed unleashed to protect the pandemic-stricken economy — lowering rates to near zero and buying trillions of dollars in government bonds — combined with huge fiscal stimulus to supercharge demand and release an inflationary genie that could prove hard to trap.

The Fed has already begun removing some of that support, stopping bond purchases and communicating plans to raise interest rates by a quarter-point this month and steadily throughout the rest of the year. Mortgage rates have already begun climbing in anticipation of those actions.

But some are asking whether the Fed, which wanted to see full employment return before paring back its support, has been too slow to react to changing conditions.

This moment “represents a decade of economic experience in the late 1960s and 1970s, compressed into a year,” said Lawrence H. Summers, a former Treasury secretary who spent last year warning that inflation was going to take off as the government overstimulated the economy.

“The question is: Is this the Fed’s Paul Volcker moment, or is this the Fed’s Arthur Burns moment?” he said.

Mr. Burns preceded Mr. Volcker as Fed chair and was late to react to fast inflation, afraid of slowing the job market and hurting Republicans politically. Mr. Summers warned that so far, today’s situation looked more Burns than Volcker, because the Fed spent 2021 only slowly adjusting to the reality of inflation and is now planning to only steadily adjust policy.

While White House and Fed officials had expected inflation to fade last year, optimistically labeling it “transitory,” their hopes were foiled as rapid consumer demand for couches, cars and other goods collided with pandemic-constrained supply chains. Price gains accelerated rather than slowing down.

“Transitory” has now become a dirty word in policymaking circles. Though officials continue to predict that inflation will moderate, they acknowledge more clearly how uncertain that is.

“We have never put our economy into a deep freeze and then defrosted it before,” said Megan Greene, a senior fellow at a Harvard Kennedy School center and chief global economist for the Kroll Institute. “And we haven’t had a war in continental Europe for a while.”

The war in Ukraine threatens to keep costs elevated for longer. Gas prices have already surged, lifting headline inflation as consumers pay more at the pump. Disruptions to supply chains — and shortages in Russian and Ukrainian exports like neon, palladium and wheat — could curtail car and food production and the transport of goods, exacerbating global shortages.

Now, fresh coronavirus restrictions in Shanghai and Shenzhen, China, a major technology manufacturing hub and port city, are boosting the risk that supply chains remain roiled in the coming months. Those shocks from outside come when price pressures have already begun broadening to categories like rent, another development that could make inflation last.

It is not clear whether those factors will keep inflation drastically higher, but Fed officials will be watching warily.

If the Fed has to raise interest rates to painful levels to cool off the economy and put a lid on prices, it could send financial markets tumbling, erasing stock and housing wealth. It could also slow wage increases and throw people out of jobs as companies retrench, curtailing investment and hiring.

But Fed inaction — or under-action — would also carry risks. High prices that chip away at consumer buying power year after year would make it hard for families and businesses to plan for the future. They could especially hurt people who are out of work and living on savings, or the poor, who devote a big chunk of their budgets to necessities and have less room to cut back if costs get out of control.

Mr. Volcker, Mr. Powell’s long-ago predecessor, one of his professional idols and — potentially, if things go wrong — his muse, died in 2019. But he had thoughts on the trade-off.

Maintaining confidence that a dollar will be able to buy tomorrow what it can today “is a fundamental responsibility of monetary policy,” Mr. Volcker wrote in his 2018 memoir. “Once lost, the consequences can be severe and stability hard to restore.”