Please explain to me about inflation.
December 9, 2019 9:58 AM Subscribe
Paul Volcker has died. In much of my reading, he's a kind of villain, willing to solve double-digit inflation with double-digit unemployment. Can you explain to me the ins and outs of Volcker's recessions and why they were deemed necessary?
I have my own vague understandings of monetary policy and so forth, but I'm sure they're riddled with misconception, and so I'll not litter this post with all of that: maybe explain it to me like I'm a five year old.
* Why was the monetary policy of the early 80s, if indeed it helped create two very harmful recessions, deemed an acceptable solution to the inflation?
* Was it possible to find another set of solutions to the inflation situation?
* What's so bad about inflation / how could inflation be made less bad?
* Is the idea that Volcker contributed to or straight-up created a recession actually a controversial one?
* What were the long-term impacts of the recession? (This is perhaps impossible to measure and answer.)
I have my own vague understandings of monetary policy and so forth, but I'm sure they're riddled with misconception, and so I'll not litter this post with all of that: maybe explain it to me like I'm a five year old.
* Why was the monetary policy of the early 80s, if indeed it helped create two very harmful recessions, deemed an acceptable solution to the inflation?
* Was it possible to find another set of solutions to the inflation situation?
* What's so bad about inflation / how could inflation be made less bad?
* Is the idea that Volcker contributed to or straight-up created a recession actually a controversial one?
* What were the long-term impacts of the recession? (This is perhaps impossible to measure and answer.)
The bad type of inflation is called "cost pull inflation" (I think) which Volcker was concerned about from OPEC - meaning that OPEC controlled enough of the world's oil supply where they could dictate price increases that the US had to accept. You want to be the one causing cost-pull inflation, which is basically Trump's goal via added taxes on trade, not the one receiving it.
posted by The_Vegetables at 11:39 AM on December 9, 2019
posted by The_Vegetables at 11:39 AM on December 9, 2019
I'll take a crack at these; understand I'm a complete amateur at economics, but I did live through the Volker years.
* Why was the monetary policy of the early 80s, if indeed it helped create two very harmful recessions, deemed an acceptable solution to the inflation?
* Was it possible to find another set of solutions to the inflation situation?
* What's so bad about inflation / how could inflation be made less bad?
* Is the idea that Volcker contributed to or straight-up created a recession actually a controversial one?
* What were the long-term impacts of the recession? (This is perhaps impossible to measure and answer.)
* Why was the monetary policy of the early 80s, if indeed it helped create two very harmful recessions, deemed an acceptable solution to the inflation?
TPTB were terrified of runaway inflation: inflation that can't be stopped until the currency collapses / becomes drastically devalued. (Read this article about Germany between the wars to get a sense of what that really feels like to live through. Not for the faint of heart; that article was the first time I really understood how economically shell-shocked the German population was, and why/how it lead to... what it lead to.)
In other words, Something Had To Be Done.
* Was it possible to find another set of solutions to the inflation situation?
Don't know; in a kinder, gentler world, maybe everyone agrees to share the pain more equally. This is not that world. The Fed has basically one tool, setting interest rates by controlling the money supply. When all you've got is a hammer...
* What's so bad about inflation / how could inflation be made less bad?
Well...everyone sorta loves some inflation, just not too much. Inflation makes your debts easier to pay off. Assuming your wages and other assets keep up, you're paying off older (less valuable) debt with new (more valuable) money. (Real estate guys like Trump tend to be big fans of inflation.) But too much inflation and the shit hits the fan, see above.
* Is the idea that Volcker contributed to or straight-up created a recession actually a controversial one?
I guess I don't think it's that controversial -- but what is controversial is how one-sided it seemed to be. The Fed is supposed to have two equal mandates: keep inflation in check, and keep unemployment low-ish. If you were laid off, you were pretty screwed. If you had money, you did alright. Per usual.
* What were the long-term impacts of the recession? (This is perhaps impossible to measure and answer.)
To me, it lead directly to the world we live in today (how could it not?)posted by Bron at 3:17 PM on December 9, 2019 [1 favorite]
There were vast numbers of layoffs, for one thing. I don't have the numbers handy, but iirc, the unemployment rate at the time was the highest it had been since the Great Depression. The layoffs also hit hard at white collar/middle management workers, people who had felt pretty immune from prior recessions (not completely, but this was the first time that cohort really got hammered in large numbers, I believe).
These layoffs, in combination with the oncoming technology revolution of cheap computing, gave businesses the upper hand in the wage wars. I'm sure you've seen the famous chart of productivity taking off while earnings remained essentially flat -- this started in the late 70s and really took off in the early 80s, with the twin recessions of the time setting the stage.
(This part gets a little ranty, sorry) And speaking of setting the stage, the recessions laid the groundwork for Reagan to come to power...and a certain unreality crept into everyday life, especially financially speaking. Government debt expanded (whatever it takes to outspend the Evil Empire and send them into bankruptcy!) Easy credit replaced wage increases. The FIRE sector (Finance, Insurance, Real Estate) of the economy started to make up more and more of the economic pie as a whole, as good-paying manufacturing jobs were outsourced. And the government started to obfuscate financial data to give people the impression things were better than they really were, a trend continuing to the present (for instance, we're supposed to have low inflation now, unless, of course, you're paying for college, or healthcare, or buying a house, or a car).
It’s worth pointing out that there were various attempts to control inflation throughout the 1970’s: wage and price controls, Gerald Ford’s “Whip Inflation Now” campaign, etc., and nothing really worked. Some of this was OPEC, and some of this was Nixon holding rates artificially low early in the decade.
Most people can handle inflation if it’s true inflation: if both wages and prices are increasing. What gets nasty is if prices keep going up but economic growth slows down, and people can’t afford things anymore. Volcker essentially took this and ramped it up with higher rates, and eventually they got back on top of the prices.
posted by Huffy Puffy at 3:41 PM on December 9, 2019
Most people can handle inflation if it’s true inflation: if both wages and prices are increasing. What gets nasty is if prices keep going up but economic growth slows down, and people can’t afford things anymore. Volcker essentially took this and ramped it up with higher rates, and eventually they got back on top of the prices.
posted by Huffy Puffy at 3:41 PM on December 9, 2019
Best answer: One important point that I don't think anyone's mentioned is that inflation can be a self-fulfilling prophecy. If you're a company and you think that your cash is going to lose 10% of its value over the next year, you'll happily offer your suppliers an 8% premium to deliver your inputs right now. If you're a worker (or a union rep) and you think your salary is going to lose 10% of its value, you're going to fight hard for at least a 10% raise. Once everyone expects high inflation, high inflation can result from those expectations, and it can get out of hand quickly. If you're a central banker who wants to break that spiral, you don't just have to cut the money supply, so that people and companies can't afford to pay those prices or those wages, you have to convince everyone that you're going to keep doing it even if it causes the whole economy to collapse, because if they think you're going to let up any time soon, the people who still have money have every incentive to keep bidding up prices.
I'm far from a Volcker fan, but I think you can say a few things in favor of his handling of inflation, despite the brutal recession that it caused:
1) There's at least a decent argument that rising inflation was a real long-term problem by the late 70's.
2) It sure as hell looks like it worked. In 1973-1981 there was only one year with inflation below 6%, since 1981 there's only been one year above 6%.
3) I don't think the arguments that he was a primary cause of the decoupling of wages and productivity are particularly strong. He probably did accelerate it, but it seems off to me to place the lion's share of the blame at his feet, rather than broader forces like the decline of the American labor movement and the liberalization of trade and investment regulations.
Personally, I think the longest-lasting harm came from the myth of Volcker, the Hard Man Who Made Hard Choices. His story became a central parable in a religion which was carried on both by his direct disciples (e.g. Greenspan, who thought that if keeping inflation below 6% was good, keeping it below 2% must be better) and through the broader community of policymakers in the 80's and 90's who could justify the horrible consequences of the cuts to social programs that they championed by pointing to Saint Volcker who had to throw the whole economy into recession to bring us through trial and tribulation to the promised land of the Reagan 80's.
posted by firechicago at 8:58 PM on December 9, 2019
I'm far from a Volcker fan, but I think you can say a few things in favor of his handling of inflation, despite the brutal recession that it caused:
1) There's at least a decent argument that rising inflation was a real long-term problem by the late 70's.
2) It sure as hell looks like it worked. In 1973-1981 there was only one year with inflation below 6%, since 1981 there's only been one year above 6%.
3) I don't think the arguments that he was a primary cause of the decoupling of wages and productivity are particularly strong. He probably did accelerate it, but it seems off to me to place the lion's share of the blame at his feet, rather than broader forces like the decline of the American labor movement and the liberalization of trade and investment regulations.
Personally, I think the longest-lasting harm came from the myth of Volcker, the Hard Man Who Made Hard Choices. His story became a central parable in a religion which was carried on both by his direct disciples (e.g. Greenspan, who thought that if keeping inflation below 6% was good, keeping it below 2% must be better) and through the broader community of policymakers in the 80's and 90's who could justify the horrible consequences of the cuts to social programs that they championed by pointing to Saint Volcker who had to throw the whole economy into recession to bring us through trial and tribulation to the promised land of the Reagan 80's.
posted by firechicago at 8:58 PM on December 9, 2019
The inflation that Volcker tried to address was unknown or at least undefined at the time, sometimes now called "supply-side inflation." The price of oil via OPEC increased drastically and oil is part of all the economy: not just products but transportation, heat, etc. This suddenly raised the price of everything.
Prior to OPEC, the accepted reason for inflation above a nominal rate was an inflated economy: too much money pursuing too few goods. At part, this is an emotional "froth," at the extreme a bubble. Often this related to interest rates and emotionally inflated return rates on investments. For example, the "roaring" twenties, not just in the US but throughout the western world. Or the low-value home loans of the most recent recession.
As others have said, the history to that time (the 70s) of unaddressed inflation was dire. The example people site is Germany between the wars. This is not the only example but it may be the most graphic. Money meant nothing; no one would loan money. This undermined all authority. Many people believe this set the stage for fascism in Germany. (This inflation was, in part, due to the big restitutions required of Germany from WWI. A variation on supply-side inflation.)
Economics is GREAT at predicting the last recession/depression. (That is to write, eventually explaining it.) Not so good in predicting the future and making it possible for governments to address it.
Volcker is a hero and villain, who was presented with a great and important task, with little help from history or economic theory to that time.
posted by tmdonahue at 3:41 PM on December 11, 2019
Prior to OPEC, the accepted reason for inflation above a nominal rate was an inflated economy: too much money pursuing too few goods. At part, this is an emotional "froth," at the extreme a bubble. Often this related to interest rates and emotionally inflated return rates on investments. For example, the "roaring" twenties, not just in the US but throughout the western world. Or the low-value home loans of the most recent recession.
As others have said, the history to that time (the 70s) of unaddressed inflation was dire. The example people site is Germany between the wars. This is not the only example but it may be the most graphic. Money meant nothing; no one would loan money. This undermined all authority. Many people believe this set the stage for fascism in Germany. (This inflation was, in part, due to the big restitutions required of Germany from WWI. A variation on supply-side inflation.)
Economics is GREAT at predicting the last recession/depression. (That is to write, eventually explaining it.) Not so good in predicting the future and making it possible for governments to address it.
Volcker is a hero and villain, who was presented with a great and important task, with little help from history or economic theory to that time.
posted by tmdonahue at 3:41 PM on December 11, 2019
The simplest definition of inflation is a rise in the "general" level of prices of goods and commodities. This is because the increase in the price of just one good or commodity will not affect the general price level in the economy.
While if the prices of most of the goods and commodities increase, it will lead to overall price rise in the economy which is termed as inflation. Of course, there are different types of inflation based on their impact and intensity.
posted by Lazylord at 2:11 AM on January 3, 2020
While if the prices of most of the goods and commodities increase, it will lead to overall price rise in the economy which is termed as inflation. Of course, there are different types of inflation based on their impact and intensity.
posted by Lazylord at 2:11 AM on January 3, 2020
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My opinion: There are many different types of inflation some good and some bad, and prior to Volcker the government used fewer tools to keep it under control, so here's what he is (in)famous for:
The kind of inflation that the Volcker Fed wanted to control was employee wage inflation, with the thought being that if employees make too much money, it'll slow demand for US products overseas among other things. So he jacked up inflation to slow purchases, which slows growth, which means that companies produce less, which means that people get laid off, and the unemployed are not in a position to demand higher salaries.
You might think that this would hurt companies just as much, but not really because they can manage cash, they can layoff, they can structure business differently. Also the government can reduced taxes/add subsidy to make industry whole. In short they have more tools to manage high interest rates than your average consumer.
Someone else can outline the long terms impacts of a recession, but the outcome was the govt and business people were pretty happy (overall) with Volcker (why not subsidy and less hiring and less wages = happy companies) and therefore the Fed basically followed his model (did the same thing in 2005-2006 to start that recession) until Bernake and then really Yellen changed the model to focus on low inflation and focus on consumables, which is a different model. We are just now starting to see minor general wage growth after nearly a decade.
We currently have that alternate model: low inflation = low interest rates = grow your way out of a financial difficulties. Model works great, and is much more 'natural' and companies have found that wage growth can be held back by other policies rather than via the Fed (which is more blunt and does have bad effects on small or poorly capitalized companies).
posted by The_Vegetables at 11:31 AM on December 9, 2019