Wednesday, Mar 16, 2022 • 29min
Inflation Lessons From the 1970s
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With prices on the rise in the U.S. economy, the Federal Reserve is expected to announce on Wednesday an increase in interest rates, essentially pouring a cold glass of water on the economy.
Why would the central bank do that? The answer lies in the inflation crisis of the 1970s, when a failure to react quickly enough still looms large in the memory.
Guest: Jeanna Smialek, a reporter covering the Federal Reserve and the economy for The New York Times.
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Jeanna Smialek
Michael Barbaro
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Michael Barbaro
00:30
From
The New York Times
. I'm Michael Barbaro
. This is The Daily
.Share
00:42
Later today, the US government is expected to deploy its most powerful tool for fighting inflation, knowing full well that it will weaken the economy. I spoke with my colleague, Jeanna Smialek, about why that is and the painful lesson from a previous era that has convinced American policymakers that this is the right path.
Share
01:10
It's Wednesday, March 16th.
Share
01:36
Jeanna
, the Federal Reserve,
in just a few hours we think, is going to raise interest rates in order to lower inflation in the American economy. Can you just help us understand the mechanics of that? How does that work?Share
Jeanna Smialek
01:49
So, as everyone knows, prices are rising really quickly right now. On cars, on meat, on couches, and there are a few reasons for that. The government spent a lot of money at the start of the pandemic and throughout last year to sort of blunt the impact of the
Coronavirus
and its effect on workers.Share
Michael Barbaro
02:09
Right, there were stimulus checks, for example.
Share
Jeanna Smialek
02:11
Exactly. And that spending fueled really strong demand. Unfortunately, that strong demand collided with supply chains that were all messed up. And so there were too many dollars chasing too few goods and inflation really jumped up. Today, even though the government is spending less, the checks have stopped. The labor market is really strong and that's helping to sustain this pretty robust demand, and it's keeping inflation rising.
Share
02:38
And so we have this real problem where prices have been going up a lot. And now the
Fed
is getting worried that inflation is going to get stuck at this higher rate that they do not want. And so the idea is if you raise interest rates, if you make it more expensive to borrow money to buy a car or to borrow money to buy a house, then fewer people will do those things. There will be less demand and supply will have a chance to catch up, which will allow price increases to slow down a little bit.Share
Michael Barbaro
03:05
Right. When the
Fed
raises the interest rate, it essentially pours a tall glass of cold water on the economy. It deliberately tries to slow down spending.Share
Jeanna Smialek
03:16
Right. You slow things down to bring inflation under control.
Share
Michael Barbaro
03:19
Which has always struck me as kind of strange because what you're describing is a process of our own government hurting the economy in order to eventually help the economy.
Share
Jeanna Smialek
03:31
Right. And so this is the way that central bankers control inflation everywhere. But here in the
United States
, there's a good reason why central bankers tend to be especially attuned to periods where it seems like inflation might hop out of control. And that is because there's a historical example where they did not react quickly enough to inflation, where inflation became really painful. And it's this period that kind of haunts the nightmares of central bankers.Share
Michael Barbaro
03:59
So tell us the story of that time period that haunts economists. When did it start?
Share
Jeanna Smialek
04:05
So the story starts in the mid to late 1960s, really during Lyndon B. Johnson's presidency, when there is just this huge amount of government spending happening
Share
04:14
This administration today here and now declares unconditional war on poverty in America.
Share
Jeanna Smialek
04:24
Johnson
famously tried to tackle poverty in this ambitious program called the Great Society.Share
04:30
Our chief weapons in a more pinpointed attack will be better school and better health and better homes and better training and better job opportunities to help more Americans escape from squalor and misery.
Share
Jeanna Smialek
04:49
And while that's happening, the country still engaged in the war in
Vietnam.
Share
04:53
I have told the American people that we would send to
Vietnam
, those forces that are required to accomplish our mission thereShare
Jeanna Smialek
05:04
And that's also increasing government spending by billions and billions of dollars.
Share
05:08
Two and a half billion dollars in this fiscal year, and 2600 million in the next fiscal year.
Share
Jeanna Smialek
05:17
So there's a lot of government money pouring into the economy and inflation just starts to gradually ratchet up year after year. And many economists think that the government spending from the 1960s helped to kick off that process. But then inflation keeps on rising.
Share
05:34
Spiraling inflation now appears to be a fixture in the American economy, and it's casting a shadow on the American dream of doing better and better every year.
Share
Jeanna Smialek
05:42
By the 1970s, this spiraling inflation had another important effect on Americans.
Share
05:48
The nation was developing a psychology of inflation. The seller asks more than he needs, hoping to cover the cost increase that's sure to come. And the buyer buys now because the price will only get worse later.
Share
Jeanna Smialek
06:01
People began to change the way they thought about their money, the way they thought about inflation.
Share
06:06
Why aren't people saving these days?
Share
06:09
The psychology is, well, tomorrow everything is going to cost me more. It's an inflation cycle, so I better buy now and the heck with saving.
Share
Jeanna Smialek
06:16
So Americans began to feel like their money wasn't going to go as far because prices were so high, and they began to ask for higher wages to cover their rising expenses. And you saw that as companies had to pay more, they started charging more to cover their costs. And we ended up in a situation where prices and wages were in this upward spiral, and they were kind of chasing each other. And so that proceeds through the 1970s. And we're really seeing these very, very rapid price increases on a year-over-year basis.
Share
06:52
And it's worth pausing just a moment to understand what high inflation like that actually feels like. Groceries are a good example because they bounced around a lot, but at times hit double-digit inflation in the 1970s. Given those rates, if you had a $100 grocery order in 1970, it would have cost about $170 in 1978 to buy the same exact things.
Share
Michael Barbaro
07:16
Wow.
Share
07:17
We're in an energy crisis now and will be for some time to come. We have it present an absolute shortage of natural gas.
Share
Jeanna Smialek
07:24
And during the 1970s, both in the early 70s and then in'79, there were oil embargoes.
Share
07:30
Petrol stations can no longer afford to fill up cars whose tanks take 20 gallons. The monsters are dying of thirst. The energy crisis is killing them.
Share
Jeanna Smialek
07:40
And so when those happened, they sort of supercharged this already very high inflation and pushed the cost of gas up quite a lot. And so, you know, between gas and food and all of this sort of day-to-day necessities, you just saw a wide variety of consumer goods starting to become more expensive. You know, it really became sort of this economy-wide problem where prices for everything we're going up, and it wasn't clear how it was going to end.
Share
Michael Barbaro
08:04
And how did Americans feel about all this inflation?
Share
Jeanna Smialek
08:08
Americans did not feel good about all of this inflation, especially in the 1970s when it started really hitting oil prices because they are just so visible. You see them up on price board, and it just was such a big part of people's everyday lives. So people are angry about it. It is just everywhere in the culture. You know, you see it in old magazine articles, you see it in comic strips.
Share
08:29
And now folks, the host of The Price is Wrong, consumer specialist, David Haworth.
Share
Jeanna Smialek
08:36
Comedians are making jokes about it.
Share
08:38
Thank you, thank you. And welcome to The Price is Wrong, the game that deals with your survival and self-respect in these inflationary times.
Share
Jeanna Smialek
08:48
It shows up in
All in the Family
, the sitcom.Share
08:52
It’s the administration. It’s causing all your problems. Where do you think your inflation comes from? I know where my inflation comes from the gas that you give me.
Share
Jeanna Smialek
09:04
And so this just became sort of, you know, everyday kitchen table issue here in
America
.Share
Michael Barbaro
09:18
So what did the
US
government do to address this?Share
Jeanna Smialek
09:22
Not as much as you might think. And the reason for that is elected officials are not especially good at cooling down the economy enough to wrestle inflation under control. Because obviously, if you want to win reelection, you do not want to slow down your economy and possibly to tip it into recession.
Share
09:39
And so politicians talk about it a lot, but they really don't sort of roll-out any super aggressive policies that are enough to constrain prices. And then at the same time you have central bankers who for various reasons over the years really just aren't willing to raise interest rates enough and sort of hurt the economy enough to bring prices under control.
Share
10:00
And so basically, there's just no sort of concerted government response that is effective at bringing down inflation in these years. The can keeps getting kicked down the road, and we end up with very high inflation that is sort of embedded in the fabric of society and feeding on itself.
Share
Michael Barbaro
10:16
Right. And no one is willing to do anything about it.
Share
Jeanna Smialek
10:20
Or at least not enough. And that was basically the case for a decade until 1979. President
Jimmy Carter
is at the helm. He's struggling to salvage public confidence in his administration, and the economy is just a disaster. So he starts to shuffle cabinet members around, which opens up the top position at the Federal Reserve.
And he calls up this candidate named Paul Volcker
.Share
10:41
Volcker's
already a senior official within the Federal Reserve System,
and there's a few things he's known for. First, he's very tall, six foot seven. He's also frugal. He likes drugstore cigars. He wears badly fitted suits, and he continued driving a car with a broken seat around after he broke it. And he kind of applies all of that frugality to his economic policy. Up until this point, he's been pretty frustrated with the Fed's half-hearted attempts to curb inflation, and he wants the Fed
to take a harder line approach.Share
11:14
So
Volcker
gets to his Oval Office interview and basically tells Jimmy Carter
that if he gets the job, he's going to push interest rates higher. And the clear implication there is that he's going to support a policy that hurts the economy while Carter
is still in office. And that he's not going to continue to allow inflation to just run out of control the way it's been doing.Share
11:36
And so he goes home from this interview absolutely positive that he's not going to get the job given what he's just told the president.
Share
Michael Barbaro
11:42
Right, because he just told the president, "I'm going to make you unpopular".
Share
Jeanna Smialek
11:45
Exactly, exactly. And so he's flabbergasted when, the next morning, his phone rings very early in the morning. He's still in bed, and it's
Jimmy Carter.
And Carter
tells him, "hey, you got the job".Share
12:01
And suddenly
Paul Volcker
finds himself chairman of the Federal Reserve
.Share
12:07
Now, my thesis can be summed up in just a few sentences. First, we need to bring inflation down and restore price stability. We need to do it not just for its own sake, but because lack of confidence in our currency is incompatible with a productive, growing economy. We need to build on the consensus that inflation is at the core of our economic problems. That is its public enemy number one. We need to resist temptation to stimulate the economy through -
Share
Michael Barbaro
12:55
We'll be right back.
Share
Break
Michael Barbaro
14:33
So, Jeanna, once
Paul Volcker
is the head of the Federal Reserve
, what does he do?Share
Jeanna Smialek
14:38
So
Paul Volcker
basically makes good on what he has promised President Jimmy Carter
, which is he wages war on inflation. And we really see that start in earnest in October 1979.Share
14:54
There's the super dramatic scene. On a Saturday night,
Paul Volcker
decides to hold a press conference, which at the time is very rare. The Fed
doesn't do a lot of these.Share
Michael Barbaro
15:05
And on a Saturday night.
Share
Jeanna Smialek
15:06
And on a Saturday night, right? And not just any Saturday night, on a Saturday night when the pope is in town.
Share
Michael Barbaro
15:12
Wow.
Share
Jeanna Smialek
15:12
And so the
Washington
press corps is very, you know, devoted to following the pope around. And Paul Volcker
and his communications staff call up the press and say, "no, come on down to the Eccles building".Share
15:24
And
Volcker's
spokesperson actually has to convince some of the press to show up to this, including the CBS cameraman who basically says, you know, "I have limited resources, and I'm going to the pope". And the press person says, you know, "long after the pope is gone, you're going to remember what happens tonight".Share
15:43
So a lot of drama, a lot of pomp and circumstance. The press comes down and
Volcker
basically tells the press that the Fed
is going to change how it's setting monetary policy that they are going to shake up their whole approach and the whole goal here is really just to vanquish inflation, to bring it down once and for all, to really get a handle on this. This is basically a declaration that things are going to change.Share
Michael Barbaro
16:10
Right. And how does he do it?
Share
Jeanna Smialek
16:15
Volcker
was really committed to the idea that you had to crush inflation completely to get America out of this self-perpetuating cycle. And so he gets aggressive, he took an interest rate that was already at 10% in 1979 and basically pushed it up to 17.6% within like a year. By early 1981, his policies push rates up to about 19%.Share
Michael Barbaro
16:38
Wow.
Share
Jeanna Smialek
16:38
And soon it's close to 20%. And that's just this incredibly high interest rate and has ratcheted up there in an incredibly short amount of time.
Share
Michael Barbaro
16:46
And just for a moment, explain what it means for the interest rate to be almost 20% in the
United States
because it's kind of hard to fathom.Share
Jeanna Smialek
16:57
So remember, interest rates very directly translate into how much it costs to buy a house, to borrow to buy a car, or to borrow with a credit card.
Share
17:04
So let's just take a house, for example, If you buy $100,000 house, and you're going to pay it off in 30 years without any interest on that loan. Which isn't realistic, but just for the example. Your payment is going to be about $300 a month. Of course, if you're paying a mortgage rate and the interest rate on your loan is 20%. So around that 1981 level, your payments would be closer to $1,700 a month. So that could obviously be prohibitively expensive, especially if you're dragging it out over time.
Share
17:39
It costs so much to borrow at this stage that you're paying thousands, maybe tens of thousands more than you previously would have just to buy a car, a house, a boat, whatever it is that you want to borrow money to buy. And so people just stop doing it, they just stop spending money on those things. And as that happens,
America
sinks into recession, and that recession is really painful.Share
Michael Barbaro
18:04
How bad? Describe it.
Share
Jeanna Smialek
18:06
Terrible.
Share
18:09
They came in all shapes and sizes, all ages and all backgrounds. Almost 1000 of them showed up at
City Hall
in Soddy-Daisy
today. Lined up from one end of the hall to the other. They were all there in response to a help wanted ad.Share
Jeanna Smialek
18:24
Unemployment rose above 10%.
Share
18:27
All these people stood in line today and filled out applications at Chattanooga's employment security office.
Share
18:32
Just no jobs not here in
Chattanooga
, I guess no jobs here.Share
Jeanna Smialek
18:36
The human impact of what
Paul Volcker
is doing with policy is just palpable at this point. People are out of work, people are seeing their wages growth absolutely crushed. You've got car lots full of cars that just can't sell. You've got home builders who just can't sell houses.Share
18:54
So what you see happening is just this outpouring of anger because people know that interest rates are the thing inflicting so much damage and so much pain throughout the economy. They know that this is
Fed
policy driving this terrible recession. And so people mail two-by-fours. Home builders mail two-by-fours to the Federal Reserve
in protest of the houses they can't sell. The car dealers mail car keys in protest of the cars they can't sell.Share
19:21
And you see, at one point, farmers actually bring tractors and circle the
Fed
in Washington
out of protest. You know, of these very high interest rates and the intense pain that is being felt just throughout the entire economy at this stage.Share
Michael Barbaro
19:42
But, Jeanna, it almost sounds like the cure was worse than the disease. While inflation was bad, people were not losing their jobs or getting priced out of loans for homes and cars the way they were once interest rates soared, right?
Share
Jeanna Smialek
20:00
Right. So that is actually a school of thought that it was worse to raise interest rates than it would have been to let the inflation go. But most economists will tell you that if inflation would have gone unchecked, it might have gotten worse. And the uncertainty around how much money was going to be worth in the future could have been really harmful for the economy, and just for Americans as a whole.
Share
20:20
So how do you plan or save if you don't know what $1 dollar is going to buy in a year? And so it just wouldn't have been a solid foundation to use to build up the rest of the economy. And
Volcker
was very, very aware of how painful this all was.Share
20:35
And we know now that he really agonized over what he was doing to the economy during this period. In his memoir, he describes this patch of carpet in his office that he literally wore out from pacing it so much. And he heard a lot of feedback, you know, people publicly blamed him for just about everything.
Share
20:51
There are those who claim
Paul Volcker
is the real father of this recession. Mr. Volcker
, welcome. First, are you willing to accept parenthood for this recession?Share
20:60
I'll claim no paternity. I don't even like the question being asked that way.
Share
Jeanna Smialek
21:04
But he didn't stand down. There's this moment that's pretty well known in the nerdy circles that I run in, when he was prodded on a show called the MacNeil/Lehrer Report.
Share
21:12
Let's not forget that while people are concerned about a recession right now, and that's understandable, we have had and still do have a problem of inflation. And as I suggested earlier, if we fail to deal with that inflation in a constructive way, I think we can look forward to a lot more economic instability. The better job we do on inflation, the better this economy will behave over a period of time. I don't think there's any doubt about that.
Share
Jeanna Smialek
21:40
And
Volcker
was encouraging the country to basically keep this bigger picture in mind.Share
21:45
Do you feel that the strategy that you laid out in October to control the money supply is in fact working?
Share
21:51
It's -
Share
21:52
Where you wanted it to.
Share
21:54
Yeah, well, it's working in the immediate sense. We're more perfectly on track, maybe partly by luck, than one could have imagined. Now, if you look at the economy, and you say things going in a beautiful way. Obviously, they're not going in such a beautiful way. We've had more -
Share
Jeanna Smialek
22:10
I think overall, he is definitely grappling with the pain he's causing the economy. But he is sort of remaining dedicated to this broader goal in this broader plan which is to bring inflation down even if it costs a lot to do that.
Share
Michael Barbaro
22:29
Right. And of course, the biggest question of all is, does this work?
Share
Jeanna Smialek
22:35
It is very painful, but it does work.
Share
22:38
We eventually go from 14.6% inflation in March 1980 to closer to 1% inflation by 1986. And so you just see this really rapid, really extreme deceleration in price increases. And inflation is under control in a way that it hasn't been in decades.
Share
22:56
As that happens, you get a lot of really positive knock on effects throughout the rest of the economy. And so consumers start to have much more stable outlooks. Businesses also start to feel like they can plan ahead and that they don't have to worry about prices, just going crazy. And as those two things happen, we see it really affecting behavior
Share
23:16
Lately, American consumers have been shopping with even more vigor than usual.
Share
23:21
I think everybody in a good mood. By the looks of them all, it looks like it's full of people.
Share
Jeanna Smialek
23:25
Businesses start to sort of invest again.
Share
23:29
The US economy continues its seemingly inexorable expansion.
Share
Jeanna Smialek
23:32
Consumers, as interest rates come down alongside inflation, are able to buy houses again. Cars are selling again.
Share
23:39
On today's announcement, the personal income shot up at the highest rate in five and a half years, comes as the nation's unemployment rate remained near a 30-year low.
Share
Jeanna Smialek
23:48
Really by the late 1980s and early 1990s, we're having a really strong, solid, steady growth economy.
Share
23:58
A friend of mine told me try America Online. I said, why? I've got a computer.
Share
Jeanna Smialek
24:02
Then in the 1990s -
Share
24:03
Welcome. I don't mind saving for retirement anymore. I can research mutual funds, chart all my stocks and do my banking all from home anytime I want.
Share
Jeanna Smialek
24:13
You get a productivity boom as personal computers come online. And really just, we've set the stage for these several decades of very strong, very stable growth. And that is sort of the legacy of this
Volcker
era.Share
Michael Barbaro
24:27
So it's not a stretch to say that
Volcker
did as he promised, slay the dragon of inflation with this strategy of higher interest rates and showed that hurting the economy in the short-term, really does improve the economy in the long-term?Share
Jeanna Smialek
24:50
I think that that has become sort of the economic consensus in the time since. Yes, I think people very much attribute the good outcome to
Paul Volcker
. So this does great things for Paul Volcker's reputation in the intervening years. And one person who grew up in the inflationary era and who is a real big admirer of Paul Volcker
is Jay Powell
, the current Fed
chair. And Jay Powell
has talked publicly about his deep admiration for Paul Volcker
.Share
25:19
So when you first became chair, you were seen, you were spotted numerous times carrying Paul Volcker's book under your arm.
Share
Jeanna Smialek
25:28
When Volcker's autobiography came out a couple of years ago -
Share
25:31
So I actually thought I should buy, you know, 500 copies of this book and just hand them out at the
Fed.
I didn't do that. But it's a book I strongly recommend.Share
Jeanna Smialek
25:41
Powell
talked about how he thinks that, you know, he and his colleagues should be thinking about this example as something that they want to emulate.Share
25:48
I don't think there has been a greater public servant in our broad area in our lifetimes. I mean, he really just did exactly what he thought was the right thing all the time, and he let the chips fall where they may, you know, we can all hope to live up to some part of who he is.
Share
Jeanna Smialek
26:06
And so really a long track record of just really looking up to this, this former
Fed
chair, and you know, his long ago predecessor.Share
Michael Barbaro
26:14
And if you are somebody like
Jay Powell
and you study this era closely, as it sounds like Powell
did, what is the big lesson of the 1970s and Paul Volcker
that Powell
would carry into a moment like this?Share
Jeanna Smialek
26:32
I think that the big overarching lesson is that you don't want to let inflation carry on for so long that it becomes sort of a major part of how people think about the world because once that happens, it is so painful to cure.
Powell
, like many economists in this era, has really studied sort of the pain that Volcker
had to put the economy through. And nobody wants to see a repeat of that. It was a really miserable era.Share
27:02
And so I think the lesson is you get out ahead of this early. You take care of it as soon as it starts to become a problem. Basically, you don't be the
Fed
in the 1960s and 1970s and just let this drag on year after year and kick the can down the road. You try and take care of it right away.Share
Michael Barbaro
27:19
Right. Which is why later today
Powell is
going to raise the interest rate just a little, which will inflict a little bit of pain, you're saying, so that he never has to do what Volcker
did, which is raised it again and again and again, and inflict a tremendous amount of pain on the American worker and the American economy.Share
Jeanna Smialek
27:38
Exactly.
Powell
is going to nudge the rate up a little bit at this meeting. And he's probably going to sort of send a signal that the Fed
is going to continue raising interest rates steadily throughout the year.Share
27:50
But the goal here is to maybe eventually raise interest rates up to perhaps 3%. So nothing like the 20% that
Volcker
was touching by the early 1980s.Share
Michael Barbaro
28:02
So instead of a tall glass of cold water being poured on the economy, it's kind of like a spritz.
Share
Jeanna Smialek
28:07
Right, and the sort of hope and dream here is to sort of cool off the economy, to pull down inflation, to get things under control. But to do that quickly and to do that in a gentle way so that you don't have to inflict the tremendous amount of pain that
Paul Volcker
did in the 1970s and 1980s.Share
Michael Barbaro
28:32
Well, Jeanna, thank you very much. This has been very enlightening.
Share
Jeanna Smialek
28:36
Thanks for having me.
Share
Michael Barbaro
28:48
We'll be right back.
Share
Break
Michael Barbaro
29:26
Here's what else you need to know today.
Share
29:30
In a dramatic show of solidarity with
Ukraine
, three European heads of State
, the prime ministers of the Czech Republic, Poland
and Slovenia,
traveled to Kyiv
on Tuesday despite heavy Russian shelling across the city.Share
29:46
Hi, nice to meet you. You all are welcome.
Share
Michael Barbaro
29:49
During a briefing, Ukrainian President,
Volodymyr Zelenskyy,
thanked the prime ministers for taking the risk of visiting him in a war zone.Share
30:04
In
Washington
, the White House
said that President Biden
himself would travel to Europe
next week to show his support for both Ukraine
and NATO. Meanwhile, Russian forces said they had taken control of the entire region of Kherson
in Ukraine's South, where local officials said that Russian troops have been rounding up activists who opposed Russia's presence. Finally, Russia
imposed sanctions against 13 American officials, including President Biden
, Secretary of State Antony Blinken
and Defense Secretary Lloyd Austin,
in retaliation for US sanctions against Russian officials.Share
Speaker 5
30:51
Today’s episode was produced by Rikki Novetsky, Diana Nguyen and Mooj Zadie. It was edited by Liz O. Baylen. Contains original music by Marion Lozano, Elisheba Ittoop, and Dan Powell, and was engineered by Chris Wood. Our theme music is by Jim Brunberg and Ben Landsverk of Wonderly.
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31:20
That's it for
The Daily
. I'm Michael Barbaro
, see you tomorrow.Share
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