The Federal Reserve will release its second quarter report today and the market is reacting to the expected rise in inflation. There won’t be a significant impact on borrowing costs or interest rates, but there’s still some sentiment that it could move up as much as 20 basis points.
The “the great inflation” is a term that is often used when discussing the effects of hyperinflation. In this article, it discusses how the market has been too serene about inflation.
Sargent, Thomas J., and Silber, William L.
6:25 p.m., January 11, 2022 ET
On July 30, 1979, Paul A. Volcker testifies before the Senate Banking, Housing, and Urban Affairs Committee in Washington, D.C.
Associated Press photo by Charles Harrity
While the yearly rate of inflation approaches 7%, the interest rate on the 10-year US Treasury note stays around 1.75 percent, indicating that investors think high inflation is just transitory. Despite the spike in government deficits and the central bank’s monetization of a substantial portion of those deficits, the market seems to believe the Federal Reserve will soon bring inflation back to within a tight range focused around 2% per year. Little interest rates now “predict” low inflation, according to the Fed’s “rational expectations” theory. However, the central bank should not be overconfident.
In the early 1980s, the Fed faced a similar scenario, but this time in reverse. Chairman Paul Volcker persuaded his Federal Open Market Committee colleagues to boost short-term interest rates in order to combat double-digit inflation in the United States and the corresponding double-digit long-term interest rates. Volcker and the FOMC had vowed in public that the tightening of money and credit would be part of a long-term plan to combat inflation. They reasoned that once the market realized the FOMC was serious about business, long-term interest rates would soon decrease to reflect the FOMC’s strategy’s potential for lower inflation. They were in for a rude awakening.
Long-term interest rates took a long time to fall. Despite a drop in inflation from more than 12 percent in 1980 to less than 4 percent in 1984, the 10-year Treasury note averaged 11.5 percent in 1980 and surged over that level in 1984. Volcker and the FOMC were worried by the inadequacy of interest rates to reflect the new monetary realities. During early internal conversations, one member expressed concern about long-term interest rates moving “up instead than down.” The market did not seem to think that the Fed would stay to its guns, instead betting that the same dynamics that drove the Fed to fuel high inflation in the 1970s would drive the Volcker-led FOMC to do the same. Investors refused to trust that Volcker had brought forth a new monetary system, believing instead that policy would return to previous levels.
Volcker’s lack of credibility likely increased the cost of eradicating inflation in the 1970s. The early 1980s recessions might not have been as severe if the market had recognized Volcker’s tenacity as an inflation fighter sooner. Furthermore, the “rational expectations” hypothesis, which states that long-term interest rates produce excellent average inflation projections, would have worked better. Instead, interest rates have been excessively high as inflation forecasters for far too long. It wasn’t until 1986 that the 10-year note rate dropped into the single digits.
We are concerned that the current scenario represents a reversal of the Volcker experience. The Federal Reserve has had forty years of price stability, yet interest rates in the United States may once again generate erroneous inflation projections. Most market participants appear to have discounted the possibility that we are in a new monetary and fiscal regime, one in which policymakers are less concerned about large deficits and excessive money creation, and new goals such as combating climate change divert the Fed’s attention away from inflation. We hope our concerns are unfounded, but if they are, the new reality of greater inflation will ultimately take root, and the 10-year rate will rise to reflect it. Central bank credibility tends to move slowly in both directions, according to history.
Mr. Sargent is a senior fellow at the Hoover Institution, a professor at New York University, and the 2011 Nobel Laureate in Economics. Mr. Silber is a senior adviser at Cornerstone Research and the author of “The Power of Nothing to Lose,” his most recent book.
It isn’t temporary, according to the journal’s editorial board. It’s a disaster for the majority of Americans. Images courtesy of Getty Images Mark Kelly’s composite
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The print issue of the 12th of January, 2022, was published.
The “Paul Volcker net worth” is a figure that has been in the news recently. Paul Volcker, former chairman of the United States Federal Reserve, has had his net worth rise to $50 million since he left the Fed. Reference: paul volcker net worth.
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