Summary: This Isn’t Our First Fight Against Inflation
Paul Volcker has experienced a resurgence in popularity over the past couple of years as inflation became a problem in Canada and the United States for the first time in generations. The playbook for dealing with high inflation was developed by Volcker, the man credited with fixing the problem once and for all after more than a decade and a half of aggressively rising prices. Volcker took the one option available to him to solve the problem: he hiked interest rates (to 20%!), put the brakes on the US economy, and triggered a recession which would finally ease the upward pressure on prices. While this caused a lot of economic pain among Americans, Volcker is looked upon fondly for doing what needed to be done to solve an untenable problem.
Arthur Burns, a predecessor of Volcker, does not elicit these same positive feelings when he’s brought up. Most people these days don’t even know who he is. That’s likely a mercy, because his legacy-defining career move was blinking too fast when it came to inflation.
There’s a good reason why central banks are designed to operate independently of the elected government: they occasionally must make difficult decisions and they can’t risk being swayed by elected officials. Burns, for his part, was good friends with Richard Nixon. Perhaps that had some influence on his interest rate decisions. He acquiesced to Nixon’s demands to follow an expansionary, low-rate monetary policy in the run-up to the 1972 election to increase Nixon’s likelihood of winning1. Inflation spiked shortly thereafter, topping out above 12% by the end of 1974. While the Fed aggressively raised rates to 13% that year, they started down the path of aggressive cuts (with occasional increases) in response to headline inflation readings. By the middle of 1976, they thought the inflation problem was licked, as the November reading came in at 4.86%, and Burns had lowered the Fed Funds rate all the way to 4.75%.
By May of 1980, two years after Burns left office, inflation almost hit 15%.
While Fed Reserve chairmen have reached the zenith of their professional field, they’re still people. People who are used to succeeding at all levels. Arthur Burns earned a scholarship to study at Columbia at age 17 and had a Master’s degree by the time he was 21. He went on to teach economics at Columbia, serve as President of the National Bureau of Economic Research, and as Chair of the Council of Economic Advisors2. For all his academic and professional accomplishments he is primarily remembered, rightly or wrongly, as the worst Chairman in Federal Reserve history. More than half a century of unequivocal success was whitewashed by mismanagement of the inflation problem that plagued his tenure as Fed Chairman.
I can’t look inside Jerome Powell’s head but I’m pretty sure that he wants to be another Paul Volcker, not another Arthur Burns. Powell wants his legacy to be bolstered by doing the hard things when he needed to, not tarnished by taking the easy way out and causing a bigger long-run problem. Expectations have already shifted toward recession, with level of severity being the primary debate. The associated economic contraction will bring about job losses. The Federal Reserve has a dual mandate of keeping prices stable and the economy as close to full employment as possible, but at a time like this it’s highly unlikely that they can solve one problem (rampant inflation) without causing another (job losses). Powell has acknowledged this and insists that higher-for-longer inflation poses a much greater threat to the economy over the long-run than triggering a recession does.
Some of the stock market’s strength so far in 2023 is tied to the idea of a “Fed pivot”, the notion that the Fed will stop increasing interest rates and may in fact start cutting them sooner than expected. After all, inflation readings have been coming down sequentially. But this is the Arthur Burns playbook, and the subsequent snapback in inflation stained his reputation. With that level of career and reputation risk looming, I don’t anticipate that Powell will be cutting rates any time soon.
For more articles similar to this one (Arthur Burns & the Danger of Stopping Too Soon When It Comes to Inflation) by Max Kirouac, click here.
1Journal of Economic Perspectives
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