It’s interesting to compare the economic crisis behavior of two Federal Reserve chairmen—Paul Volker and the present holder of that post, Ben Bernanke.
In 1982, while Volker (who is 6’6″ tall by the way) persided over a sluggish economy and raging inflation, running early that year at an 8.9 percent rate, many economists were wary of atacking inflation too strongly. They believed it might plunge the country into a deep recession. Volker knew the risk but acted decisively nonetheless.
He clamped down on the money supply and caused interest rates to shoot up. The perdicted recession came and it was a doozy. But it lasted just a few months and by the time 1982 ended, the inflation rate had fallen to 3.8 percent.
With inflation now way down and with markets assured that the Fed meant business when it came to keeping it down, the economy quickly surged back. The Volker recession made possible the so-called “Reagan economic miracle” that followed, good times really only possible because of Volker’s guts in doing what had to be done in spite of near term howls. Tall Paul.
Which brings us to the present. Late last summer there were great upheavals in financial markets and economists, Wall Streeters and the political classes were afraid a recession might result. They demanded tht the Fed cut interest rates and keep cutting them with no regard for the effect on inflation. Fed Chairman Bernanke accommodated.
Since oil is priced in dollars, its price went up and up as U.S. interest rates came down and down. Bernanke did the popular thing and as the expression goes, “let the inflation genie out of the bottle.” At the just completed Open Market meeting, he still seemed to be trying desperately to balance the risks of economic slowdown versus the risk of inflation, failing to take the only step that could check the latter. A sharp increase in interest rates.
Such an increase would almost certainly produce an even deeper economic downturn. It would also, however, cause the price of oil to plunge, inflation fears to quickly ebb, restore credibility to the Fed, and very likely allow a new upward cycle to begin after the necessary pain.
Chairman Bernanke has given no indication he will take this drastic but necessary step any time soon. Tall Paul. Not so tall Ben.