Jerome Powell was a Paul Volcker enthusiast and considered him a friend up to his death in 2019.  It appears he may be channeling his inner-Volcker as the economy slides deeper into a recession and financial markets collapse. Volcker was famous for leading the US into the crushing recession of 1981–1983. It was a recession felt across the globe as the Fed raised its lending rate to 20%. Soon after the hike, the economy collapsed, unemployment soared, and hardships, from boardrooms to farms to the industrial Midwest, soared. Volcker‘s action led to 22 straight months of negative growth, 11+% unemployment, and the largest cumulative business cycle decline of employment and output in the post-World War II era. From a long-term perspective, most economist would argue these drastic steps were necessary. The question remains, though, with Powell’s deep appreciation and admiration for Volcker, is this what we should expect in the coming months and years?  

Powell has frequently mentioned the psychology of the American consumer, and argued that Americans cannot come to accept entrenched inflation. Yet, this is a condition the Fed and the federal government helped create. His beliefs are grounded in the following: once consumers accept entrenched inflation, they begin to expect it. Businesses would then continue to raise prices, workers would counter with demands for higher wages (to ensure purchasing power remains constant), and this would lead to an endless cycle of escalating inflation of goods, service, and wages. In turn, this would devalue the dollar and lead to a collapse of the system. Numerous examples abound of this hyperinflation phenomenon (Germany, Hungary, etc). Volcker nearly doubled the Fed rate in a year, and this accounted for much of the destruction. During the next 2 years, inflation fell from a high of 14% to 3%. For Volcker it was mission accomplished, but at what cost?  Powell appears to be closely following Volcker’s path; more than quadrupling the Fed rate since March (.25% to 3.25%). The Fed dot plan points to an end-of-year rate of ~4.4% with a 2023 terminal rate of ~4.6% and ~3.9% in 2024. 

Volcker is linked with Powell for several reasons. One resonates from Volcker’s memoir, “Keeping at It: The Quest for Sound Money and Good Government,” Volcker wrote, “The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets.” This is a powerful statement and lends credence to online discussion that Powell wants to ‘sink the markets.’ Well, maybe not the market but certainly the rampant speculation and excess these markets have spawned. What’s confusing about the Powell-Volcker connection is, if Powell was a true Volcker enthusiast, why would he stand idly-by, refer to inflation as transitory, and allow the rampant speculation that gave way to the Meme craze, Robinhood.com, Nikola Corporation, etc? 

The process of removing money supply and increasing key borrowing rates is classic Keynesian Economics. Keynesians contend that “economic imbalances can be alleviated through a coordinated response between public (government) and private (Banks)”. That is, policy decisions by the government and monetary decisions by central banks can direct and regulate the economy to balance supply and demand in pursuit of full employment and price stability. If you’ve watched  Powell’s conferences he has referred to this Fed push-pull repeatedly. The strategy when dissected is not complicated: less money to borrow and higher rates to borrow it at leads to decreased purchasing power. Inevitably, as rates rise it becomes too expensive to borrow to fund purchases, both large and small. The current inflationary environment, however, is a result of numerous variables that appear outside of the control of economic theory. These include a worldwide pandemic, the largest European conflict since WWII, a complex global economy, the great resignation (And retirement) and geopolitical challenges beyond the scope of the political economy. 

In “Other People’s Blood,” Tim Barker makes a case that there might just be an alternative. As opposed to limiting economic controls to fiscal and monetary policy ,the US could try a more targeted approach known as “incomes policy.” A better term might be, ‘Targeted microeconomic intervention.’ As Barker writes,  “Sometimes governments have gone beyond managing aggregates to target something more specific, namely wage and price decisions in particular industries. Enacted successfully, this would allow the government to fight inflation without forcing recession and unemployment — everyone would keep working at lower or at least frozen wages, rather than some people working in fear of unemployment while the laid-off sat idle and got nothing.” Freezing wages is a non-starter, but targeted intervention in industries that currently have the greatest impact on inflation could be utilized similar to the government’s Empowerment Zone Policy on “highly distressed urban and rural communities.” Currently these might include oil and gas (XLE), food/farming (Wheat, Corn, Water, XLP), and materials (XLB). If successfully mitigated, this targeted microeconomic intervention could move to other sectors experiencing pervasive inflation. 

Barker concludes with some sound reasoning, “There’s theoretical and in some cases empirical justification for concern with regard to these policies. Tradeoffs are inevitable, but if we are to resurrect the “political” in “political economy” we need to have a more honest discussion of both what causes inflation and where it lies on our list of priorities.” Indeed, we do.

Does Powell lead us down the Volcker path? One that will inevitably lead to a major recession, high unemployment, and ruined lives? Or are there alternatives and what would it look like? Only time will tell, but a recently cited quote in BearBullTraders.com warns of what further government intervention may yield,  “President Ronald Reagan once said that the "nine most terrifying words in the English language are: I’m from the Government, and I’m here to help.” 

References

https://www.bu.edu/econ/files/2011/01/GKcr2005.pdf

https://www.nplusonemag.com/issue-34/reviews/other-peoples-blood-2/

https://fred.stlouisfed.org/series/FEDTARMD

https://econsystemsthinking.medium.com/systems-thinking-through-the-volcker-shock-828a68ead1b

https://www.imf.org/external/pubs/ft/fandd/2014/09/basics.htm#:~:text=Keynesians%20believe%20that%2C%20because%20prices,constant%2C%20then%20output%20will%20increase.

https://www.investopedia.com/ask/answers/061515/what-are-some-historic-examples-hyperinflation.asp

https://www.investopedia.com/terms/k/keynesianeconomics.asp

https://en.wikipedia.org/wiki/Empowerment_zone

https://en.wikipedia.org/wiki/Paul_Volcker

https://en.wikipedia.org/wiki/Keynesian_economics