Submitted by Taps Coogan on the 23rd of April 2019 to The Sounding Line.

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In the 1970s, inflation was running rampant in the US and confidence in the Fed’s ability to halt it was faltering. The combination of a series of recessions, the closing of the gold window, oil embargoes, rising national debt interest expenses, and strong political pressures on the Fed to keep interest rates too low sent inflation surging to over 13% by the end of 1979.

The United States seemed to be headed for an inflationary death spiral until incoming Fed Chairman Paul Volcker made it clear that the Fed would do anything, including inducing a recession, in order to halt inflation. Under Volcker, the Fed raised the Fed Funds Rate to an astounding 20%, causing a recession almost immediately. It was the so-called ‘Volcker Moment.’ The Fed was serious about fighting inflation at any cost and they proved it.

Interest rates and inflation have been trending lower ever since. Any time the economy has gotten close to producing significant inflation, the Fed has hiked rates, contributing to many recessions along the way.

Following the 2008 Financial Crisis, inflation and interest rates hit zero. After decades of fighting the spectre of inflation, it was actually lower than central banks desired. It was the logical terminus of the ‘Volcker Moment.’

Deflation, not inflation, is the new economic bogeyman and central banks have unveiled all sorts of radical monetary policies to combat it.

Yet the presumption, however credulous, has been that central banks would try to normalize policy after the Financial Crisis. Extremely accomodative monetary policy and the litany of negative side-effects that come with it, were supposed to be temporary. Yet, a decade into what will soon be the longest economic expansion in US history and interest rates are still half the level they were before the crisis and the Fed’s balance sheet is over four times as large. Many major central banks have not tightened policy at all.

The Powell Pivot

Step back and observe the dramatic reversal in monetary policy since December 2018, and it becomes clear that the Fed completely halted its long belated policy normalization push over a slowdown in growth that is likely to see 2019 GDP growth remain above average levels since 2008. Meanwhile, core inflation remains at average levels and the December market sell-off has been completely erased.

What the ‘Powell Pivot’ signals, consciously or not, is that central banks will do whatever it takes to avoid a deflationary slowdown. It is the opposite of the ‘Volcker Moment’ when the Fed knowingly induced a full-fledged recession in order to fight inflation.

Perhaps the truly lasting significance of this era of monetary policy is not in central banks’ extreme responses to the Financial Crisis, but their subsequent refusal to normalize that policy at any cost, however modest. Just as the Fed’s ‘successful’ fight against inflation since 1980 contributed to the deflationary nature of all recessions since then, their fight against deflation points to recessions of an inflationary nature in the future.

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