1. After I earned my Ph.D, my first job was as an economist at the Fed. Volcker was chairman. The staff was happy that he greatly increased the prestige of the Fed. But he had no use for anyone on the staff, other than Stephen Axilrod. In contrast, Alan Greenspan made extensive use of the staff, mostly looking into minute details. For many, but not all staff economists, being used this way was preferable to being ignored.
2. Volcker wanted to raise interest rates but to deflect some of the responsibility for doing so. Axilrod devised a monetary control technique called “non-borrowed reserves targeting.” I think that the staff paper that explained this was something like 50 pages long. The more obscure, the better, for Volcker’s purposes. I don’t think that non-borrowed reserves targeting was ever used before or since the period in which Volcker was trying to raise interest rates to bring down inflation.
3. My view, which makes me a real outlier, is that the Fed does not control inflation. The disinflation that took place during the Volcker years is the most outstanding apparent counter-example to my view. My view is that inflation is influenced by habitual expectations. Inflation and expectations thereof took off in the late 1960s with the breakdown of fiscal discipline and especially after the end of Bretton Woods made the value of the dollar subject to floating. I would choose to interpret the “Volcker disinflation” as a return to normal expectations, aided by a sharp decline in oil prices.
3. I do think Volcker had some influence on Inflation although it is greatly exaggerated. (Like a lot of historical events!)
a. The big driver of disflation was Oil Prices which decreased due to increased US production and cracking up of OPEC.
b. I do think the big driver of disflation was the impact of labor supply slowing down. The 1970s had the largest number of jobs created than any other Post WW2 decade and was only second to 1960s in percentage terms. The impact of women joining workforce and Baby Boomers reaching adulthood was a key driver of Inflation as they did not want to take lower wages.
c. I still think there was the impact of Volcker and high interest rates that worked as a Black Swan event in 1982. Expectation and COLA union wage increases were a big driver and we needed to hit hard for a couple years to stop this.
I tend to think the 1974 – 1982 was just one long recessionary period in which the US economy had to deal with the decline of middle class manufacturing jobs and the large increase of labor supply.
The Fed did exit the gold market and leave many precious metal dealers with stranded dollars, that is inflation.
Everything else was pricing chaos, nothing worked from 1972 to 1981. The GDP factory model broke down, it takes about five years to re-assemble it.
the Fed does not control inflation.
What??? The Fed has more influence over inflation than IQ has in life’s success.
Yes, it’s not ‘total control’, but there is no other institution or gov’t policy which has more influence.
Instead, you
interpret the “Volcker disinflation” as a return to normal expectations, aided by a sharp decline in oil prices
For this particular episode of rising inflation, then Volker’s falling inflation, oil prices were very important, both the huge first ’74 shock, and the later post-Iran revolution ’79 shock, followed by more supply and slowly declining price. With oil priced, and traded, in USD — so the US get’s a special first purchase benefit whenever it prints money and buys stuff.
A big part of the Fed’s influence is based on their control of the interest rate, which is combined with their statements of expectation. When Volker started raising interest rates, he was resetting inflation expectations. Here’s a good history up until Yellen.
https://www.nytimes.com/interactive/2015/12/11/business/economy/fed-interest-rates-history.html
October 1979: Mr. Volcker raises the Fed’s benchmark rate by 4 percentage points in a single month, to 15.5 percent.
The NYT says this is was new regime, and being willing to raise interest rates meant the Fed was really serious about stopping inflation, and expected it to stop. The rest of the economy has other, mixed expectations, including complex ideas of other responses — but most money making folk accepted that the Fed meant business and that inflation would be going down. With Volker raising some more to 20%, then down (15%) then Back Up to 20%.
Whatever real econ effects the interest rate raises have, they clearly have a large setting expectations effect.
Arnold explains:
My view is that inflation is influenced by habitual expectations.
This is mostly true most of the time (no quantification: inflation is 90%, 50%, 30% expectations?). But the oil shocks were outside of the bounds of habit, up until then.
In the complex vs complicated paradigm, it seems that most of the time the economy is mostly complicated, and small Fed tuning is enough to make small changes, as desired, with minimal unintended changes. When there is a shock, the economy goes into a more complex mode, so that tuning changes have more significant unintended results which often increase bad feedback loops.
Like the complicated 777 having something break and then start performing in a more complex, uncontrollable fashion.
Another big influence on inflation is the gov’t budget deficit. Another is the general economy, another is the big sector special economy. We’ve seen oil shocks. We haven’t yet seen massive global flooding or droughts that cause too little global food, but that’s an unlikely but possible shock. We haven’t yet seen an EMP or other huge storm or attack on the electric power grid, but blackouts in CA indicate that such problems seem to more likely to occur in the future, than less likely; and a big, long term blackout would be a massive shock.
Without the shocks, the inflation rate remains more normal; and the new normal is less than 2% (excluding homes &). At a <2% rate, it should be good for business planners, and they can ignore inflation in their decision making at low cost, with the ability to focus more on the other uncertainties of their What If modelling to compare alternative business strategies for the next year, next 5 years; maybe next 50 years (does Sony really look out that far?).